• Global value chains: yesterday, today and tomorrow

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    Made in Spain, Made in the USA and even Made in China labels make less and less sense in today’s world. Since firms decided to fragment their production processes and move them to other countries, the label Made in the World probably better represents the nature of most of the manufactured goods we consume. In this article we review the past, present and future of global value chains at a time when pandemic-induced restrictions on travel and supply disruptions have brought them back into the spotlight.

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    The creation of global value chains

    he 1990s saw the beginning of a far-reaching optimisation of production processes beyond the borders of a single country. Companies decided to fragment these processes and carry them out in as many countries (in order to make the most of each country’s advantages of specialisation), giving rise to what are known as global value chains (GVCs). Several factors helped to encourage the creation of GVCs but first and foremost were the advances made in information and communication technologies (ICTs), which enabled the different production stages to be coordinated perfectly. A second factor was the reduction in trade costs, helped by the important free trade agreements reached during that decade,11 as well as by improvements in transportation, especially by air.

    In fact, GVCs have boosted international trade flows to values that were unthinkable a few decades ago: exports of goods and services as a percentage of GDP rose from around 18% in the early 1990s to levels close to 30% just before the pandemic, while the relative weight of GVCs in total trade flows went from around 40% to just over 50% in the same period (see the chart below).12 

    • 11. 1994 saw the conclusion of the largest round of multilateral trade negotiations (the Uruguay Round), in which 123 countries took part. Also in 1994, the North American Free Trade Agreement (NAFTA) was concluded. Both agreements led to a substantial reduction in tariffs worldwide: from levels of around 16% in the early 1990s to 5% today (according to World Bank data, simple averages).
    • 12. The development of GVCs was particularly dynamic between 1990 and the early 2000s, just before the outbreak of the global financial crisis. Since then, the relative importance of these chains in trade seems to have stagnated.

    The importance of global value chains in trade flows

    Last actualization: 04 May 2022 - 09:16
    The pandemic: present impact and future approaches to GVCs

    The COVID crisis has raised many doubts regarding the high degree of globalisation achieved, as well as the adequacy of GVCs. At first, in countries such as Spain, we became aware of the high external dependence (beyond the EU’s borders) of goods which, at that time, were essential.

    In a second phase, with the strong recovery in demand focusing particularly on durable goods and the disruptions in some factories due to the effects of COVID,13 we have been faced with a global supply shortage problem we had not experienced since GVCs were created. And, in this world of global manufacturing, disruption in one stage of the production chain leads to major disruptions throughout the entire process. The longer the GVC, the greater the impact (the bullwhip effect).

    Such disruptions will undoubtedly change people’s minds about GVCs. Although it is still too early to know what changes the future holds, we can suggest some strategic rethinks company directors are likely to pursue in order to increase the robustness of the production chain.

    First, the chains will probably be shorter to avoid the amplifying effect of disruptions. Secondly, they will be more redundant in key components. In other words, there will be alternatives to the production of these components. Thirdly, they will be equipped with new digital technologies that will enable them to detect chain failures early on. And, in terms of logistics, investment in inventories is likely to increase: from just in time to just in case, as stated in a recent article by the Financial Times14 (see the chart below).

    • 13. See the article «Bottlenecks: from the causes to how long they will last» in the Monthly Report of December 2021.
    • 14. See the Financial Times (December 2021). «Supply chains: companies shift from ’just in time’ to ’just in case’».

    Global value chains are likely to be shorter in order to avoid the amplifying effect of disruptions.

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    However, it should be noted that these possible strategic changes, if they occur at all, may be more gradual and less far-reaching than we might have assumed after the shock of the pandemic. One of the reasons is that such changes would entail an increase in costs, with the evident impact on prices consumers would have to pay. In a globalised world, this could mean a significant loss of competitiveness compared with other countries and/or companies. Furthermore, as Harvard professor Pol Antràs has noted, the configuration of GVCs forces companies to incur large sunk costs, which leads to them being extremely rigid regarding strategic production changes.15 

    In other words, the COVID shock will indeed bring about a change in our approach to the configuration of new GVCs and may certainly lead to some rethinking of the existing chains. But, in the latter case, this rethinking might be less radical and rapid than some are predicting.

    • 15. See Antràs, P. (2020). «De-Globalisation? Global Value Chains in the Post-COVID-19 Age». National Bureau of Economic Research, no. w28115.
    The future of GVCs: plus and minus factors

    In addition to the impact of the pandemic, other factors (mostly new technologies) have the capacity to reshape GVCs and we present a brief review (see the diagram below).16

     

    Automation and 3D printing

    Although automation is a process that has been going on for centuries, today’s robots, equipped with artificial intelligence and at a cost that has decreased substantially over the past few decades, represent a full-fledged revolution. The improved productivity of these new robots may result in some of the manufacturing processes which had been moved to emerging countries in order to take advantage of low labour costs now returning to advanced countries. In other words, we would be shifting from an offshoring to a reshoring trend, which would entail a certain reversal in the globalisation of supply chains.

    On the other hand, 3D printing is a technology that could result in GVCs becoming shorter and, along with this, to the reshoring of part of the manufacturing activity. In fact, with this technology, it is not necessary to send physical products; all that’s required are the computer files to manufacture them! However, there is still no clear evidence in this respect. In fact, a paper published by the World Bank shows a strong increase in trade flows following the adoption of 3D technology in hearing aid production, something we would not expect with a shortening of GVCs.17 Although this is a very specific case, it does reveal some interesting effects that need to be considered. In particular, the hearing aid sector adopted 3D printing for almost all its parts when this became technologically feasible (about 10 years ago) and, since then, trade flows linked to the sector have increased by 60%. The main reason for this growth is that 3D printing has led to a huge reduction in the production cost of hearing aids and an improvement in terms of quality, resulting in a sharp increase in demand for the product. And with greater demand, international trade in hearing aids has intensified.

    • 16. Based partly on Canals, C. (2020). «Revolución tecnológica y comercio internacional 4.0». Geopolítica y Comercio en tiempos de cambio. Published by CIDOB.
    • 17. See Freund, C. L, Mulabdic, A. and Ruta, M. (2020). «Is 3D Printing a Threat to Global Trade? The Trade Effects You Didn’t Hear About». World Development Report.
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    The electric car

    Another case that also warrants particular attention is that of electric cars, which have the potential to alter some of the most relevant GVCs (those of the automotive sector), as well as to considerably reduce international trade. The reason is that classic combustion-engine cars require a large variety of parts and gears that are often manufactured in different countries to maximize the competitive advantages of each location. In fact, the automotive sector is responsible for a substantial part of the world’s trade flows of intermediate goods. However, the electric car, with its much simpler mechanics (far fewer parts that are also less subject to wear and tear) could lead to a reduction in these classic intermediate flows and, consequently, to a radical change in the structure of automotive GVCs.

    The production of batteries, a key component for the new electric vehicles, will also determine the future of numerous trade flows, which in this case will focus on raw materials such as lithium, nickel and cobalt.

     

    Digital technologies and the emergence of new services

    The continuous evolution of ICT, hand in hand with 5G and blockchain technology, will continue to push down logistics costs and, with it, boost the trade flows of goods and services and participation in GVCs. For instance, 5G will support the development of the Internet of Things, which will enable faster and more secure tracking of shipments in the case of goods, and better connections in the exchange of services. Likewise, blockchain has the potential to greatly facilitate international payments.

    On the other hand, these digital technologies will also encourage the emergence of new products, especially services, whose organisation could be decentralised and located in different countries, creating new GVCs in the image and likeness of the chains already established for the production of manufactured goods.

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    History reminds us that technological development and international trade are not independent of geopolitical developments.

    Geopolitics

    Finally, it should not be forgotten that geopolitics has always played an essential role in international trade. In this respect, the USA’s intention to «decouple» from China, especially in the field of technology, could bring about a very significant change in world trade and in how GVCs are managed, especially in the technology sector. Even more so because the US is not alone in wanting to put more distance between itself and other economies. For instance, Europe also seems willing to reduce its external dependence in some technology segments, such as semiconductors, with the European Chips Act.

    In summary, although we do not expect any radical or abrupt change in the form taken by GVCs since they tend to be relatively stable over time, we might see a change in trend in the next few years due to the various 4.0 technologies. In addition to these ongoing trends, factors such as the Coronavirus crisis will further exacerbate certain technological dynamics. However, history reminds us that technological development and international trade are not independent of geopolitical developments. And in this respect, trade-technology tensions between the US and China will play a decisive role.

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How COVID-19 will change the way we produce

Today’s economic headlines are focusing on the devastating economic impact that the COVID-19 crisis is having on the labour market, businesses and households, and on the steps being taken by more than half the world’s governments and central banks to mitigate these effects. However, when everything passes, the changes that the current crisis is triggering more quietly and discreetly in many other aspects will become apparent. In this article, we focus on the changes that are likely to occur in the way we produce.

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Chips

More robust global value chains

For years, the hyper-optimisation and hyper-globalisation of supply chains and the just-in-time strategy1 have played a key role in the enormous efficiency gains achieved in the production of goods and services. However, the outbreak of the current pandemic has highlighted their fragility. An interruption in only one link in the chain can cause the entire production process to grind to a halt.

The automotive industry is already aware of this domino effect following the earthquake and tsunami that hit the east coast of Japan in 2011.2 Since then, some of the firms in the sector that were affected by that disaster decided to increase their stocks of key components within their production chain or to diversify some of their production lines. Toyota, for instance, developed the RESCUE system, a complex database with information on all the distribution networks of each component, which shores up the production process in the event of unexpected events. However, these strategic changes are not exempt from risks: this greater robustness comes at the expense of reduced competitiveness.

The shock of the coronavirus could support a strategic shift towards more robust supply chains in many more sectors and companies. It is difficult to generalise about what features these new global supply chains will have, but they will no doubt be shorter and, therefore, less globalised; they will have more redundancy in terms of key components (i.e. with alternatives in the production of these components), and they will perform more checks at all stages of production. Also, in the field of logistics, there is likely to be greater investment in stocks.

As for the dilemma of whether to maintain more processes or links in the chain in the country of origin or abroad, the inability to predict where the next black swan will occur (whether at home, abroad or worldwide) invites diversification within and beyond our borders. In any case, this diversification will offer more alternatives in the face of disruptions to activity.

On the note of this national/international dilemma, the fragility of supply chains was already revealed in February, when the COVID-19 epidemic was concentrated in Wuhan (China) and a global escalation of such intensity was not foreseen. Since then, and after activity ground to a halt in most of the Asian giant’s factories and industries, the appropriateness of the world’s high dependency on China was called into question. Indeed, this dependency is prevalent across most of the world’s economies in a large number of global production and manufacturing chains, such as the electronic goods needed for information and communication technologies (see second chart).

Digitalisation and automation: supporting production and the fight against COVID-19

Another trend that the coronavirus crisis is revealing is the greater resilience of firms that are more digitalised and automated in disruptive contexts like the current one. Digitalisation and automation facilitate remote working and social distancing in factories, warehouses and shops, and there is ample scope for improvement in these areas. For instance, in terms of remote working, various studies estimate that, at present, between 20% and 35% of jobs can be performed remotely in the major advanced economies.3

There is no doubt that post-COVID-19 many companies will increase their investment in digital capital in order to facilitate remote services as well as remote working. This greater flexibility will allow them to shore up their production processes, similar to the redundancy that we highlighted in global supply chains. In addition, the flexibility of being able to work remotely on a regular basis has been associated with improvements in worker productivity, especially in more creative tasks.4

In the same vein, companies can also be expected to increase investment in automated machines in order to ensure greater social distancing both among their employees and their customers. McDonald’s, for example, has accelerated the tests it was conducting to use such machines in its kitchens and in servicing customers. Furthermore, several studies show that automation in companies not only spreads gradually, but there are also surges at certain times, particularly after economic recessions.5 Thus, the need for social distancing combined with the sharp contraction in economic activity throughout the world will provide a double boost to the spread of automation.

Finally, capital in digital and automation technologies represents one of the key tools in the very fight against COVID-19 itself. The current international collaboration6 on the coronavirus in the scientific field has been largely made possible by the digital platforms that instantly share the information obtained by each team.7 In many hospitals, meanwhile, autonomous robots that emit ultraviolet light are helping in the disinfection of surfaces. Also, mobile phone geolocation technology could prove to be a very useful tool in containing the spread of the coronavirus. In Europe, for instance, a project using this technology has already been launched with the backing of the European Commission.8

A shift towards «made at home»?

No doubt companies will also have to deal with regulatory changes in relation to their production models as a result of the health crisis. Governments could legislate that certain goods and services that are considered essential, such as primary healthcare equipment, must be produced locally. Even Adam Smith himself considered the possibility of certain exceptions in his argument in favour of free trade, one of them being precisely when certain industries were necessary for a country’s defence or national security (in this case, defence against an invisible enemy like the virus, but defence nonetheless).9

However, we must be very careful and precise when it comes to defining what constitutes a matter of national security in order to avoid an indiscriminate use that could open the door to protectionist policies on a large scale. This is what we have experienced repeatedly during the past two years in the trade policy of the Trump administration, which has often invoked national security to justify tariff hikes.

In the EU, on the other hand, we may witness a strengthening of coordination among member states. In the end, size could prove to be an advantage when dealing with unexpected shocks. Thus, it would make sense for the legislation on «essential» goods and services to be determined in the framework of the Union.10 If Europe secured its self-reliance in the field of agriculture and food with the common agricultural policy as early as 1962, now it is key to achieve a stable supply of goods and services that are deemed essential.

In short, more robust value chains, a definite boost to digitalisation and automation, and adaptation to a new legislative environment that could become more protectionist are some of the changes that we may observe in the way we produce. Changes in value chains and in the way we work could help to accelerate the economic transition towards a more sustainable and environmentally-friendly system. However, we must also take into account the many other changes that will be driven by the consumption habits that arise and prevail after the health crisis: these could include the growth of e-commerce, a return to local products or greater demand for health services, to name just a few of the most likely candidates.

1. A policy of maintaining stocks at their lowest possible level, whereby suppliers deliver what is needed at just the right time to complete the production process.

2. For more information about the significant impact that the earthquake and tsunami of 2011 had on production as a result of high proliferation of global supply chains, see H. Inoue and Y. Todo (2019). «Firm-level propagation of shocks through supply-chain networks». Nature Sustainability, 2(9), 841-847.

3. See T. Boeri, A. Caiumi and M. Paccagnella (2020). «Mitigating the work-security trade-off while rebooting the economy». Covid Economics 2 VoxEU. And also J.I. Dingel and B. Neiman (2020). «How many jobs can be done at home?». White Paper. Becker Friedman Institute (also NBER WP W26948).

4. See N. Bloom, J. Liang, J. Roberts and Z.J. Ying (2015). «Does working from home work? Evidence from a Chinese experiment». The Quarterly Journal of Economics, 130(1), 165-218. And E.G. Dutcher (2012). «The effects of telecommuting on productivity: An experimental examination. The role of dull and creative tasks». Journal of Economic Behavior & Organization, 84(1), 355-363.

5. See B. Hershbein and L.B. Kahn (2018). «Do recessions accelerate routine-biased technological change? Evidence from vacancy postings». American Economic Review, 108(7), 1737-72. And N. Jaimovich and H.E. Siu (2020). «Job polarization and jobless recoveries». Review of Economics and Statistics, 102(1), 129-147.

6. It is important to mention that this type of collaboration is a form of globalisation. As such, not all forces point towards deglobalisation with the outbreak of the pandemic.

7. See, for example, the article in the New York Times of 14 April «Covid-19 Changes How the World Does Science, Together».

8. Pan-European Privacy-Preserving Proximity Tracing (https://www.pepp-pt.org/).

9. See A. Smith (2010). «The Wealth of Nations: An inquiry into the nature and causes of the Wealth of Nations». Harriman House Limited.

10. The EU’s still inadequate response to the needs of the COVID-19 crisis, however, could lead to a completely opposite scenario to the one we propose here.

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