• 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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The promises of the varieties of capitalism, or on the impossibility of having it all

The American political philosopher John Rawls coined the concept of the «veil of ignorance». Under this somewhat cryptic expression lies a suggestive notion: in order to determine which society is the best one to live in, we must ask ourselves: «if I did not know what position I would have in this society, in what kind of society would I choose to live in at birth?»

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Rawls raised this concept in terms of a fairer society, but we are going to propose the following reflection: in view of the available evidence and your preferences, in which variety of capitalism would you, dear reader, prefer to «live»? Let us review the list of the main options available.

One way to draw up this list is to compare different socio-economic characteristics in the different varieties of capitalism (see table below). As mentioned in the previous article, a first major distinction can be made between those economies that have greater coordination through the market, a high degree of labour flexibility or a less prominent role of regulation and public intervention (liberal economies) and those that are characterised by less market-mediated coordination, a more regulated labour market and a more prominent role of public intervention (coordinated economies, also known as social market economies). In addition, we can identify two variants that share some, but not all, characteristics (quasi-liberal and quasi-coordinated) and a fifth variety whose most relevant feature is the predominance of public activity. This exercise allows us to draw our first major conclusion: in many areas, hybrid varieties – i.e. quasi-coordinated and quasi-liberal market economies – currently seem to offer good possibilities in terms of growth, innovation and inclusiveness.

However, in order to refine our analysis, we must go beyond the current cross section and, by means of an econometric exercise (see the methodological details in the chart), connect the main socioeconomic variables with the various forms of capitalism and their evolution over time since 1990. Let us take a look at the result of this analysis.

Key characteristics of the varieties of capitalism
The impact of the differents varieties of capitalism on the main socio-economic variables
Growth as an indispensable requirement

Throughout this Dossier we have reiterated that any economic system that is unable to create prosperity at a minimally acceptable level is condemned. On this note, if growth is the goal then our econometric exercise, which is summarised in the charts below, is quite conclusive: quasi-coordinated and liberal market economies are the two forms of capitalism that offer the most growth in the long term. On the other hand, the coordinated variety offers worse results in terms of growth.

What is the basis for this outcome? Firstly, quasi-coordinated economies stand out for their higher productivity growth, whether measured in terms of apparent labour productivity or in terms of total factor productivity (TFP). Another area that can be linked to long-term prosperity is the ability to take advantage of globalisation, as there is a clear link between an economy’s openness to international trade and growth.

The great dilemma: efficiency in exchange for equity?

So far, the list of options can be summarised as follows: if creating prosperity is the goal, regardless of the extent to which it is done in accordance with innovation or globalisation, then the best option is to play it safe and choose liberal, quasi-liberal, or quasi-coordinated economies. State-dominated economies (when they existed) lag further behind. Coordinated economies are best avoided. But what if the price that must be paid for this growth is an unacceptably low level of equity? Judging what is considered unacceptable is beyond our reach and will depend on everyone’s individual preferences. What we can assess, however, is to what extent the different varieties of capitalism are equitable. The results offer some surprises.

Whereas liberal economies display the least equity (as expected), it is somewhat surprising that the «hybrid» forms, namely quasi-liberal and quasi-coordinated economies, are more equitable than coordinated ones. It is indeed a paradox that despite coordinated economies having higher public spending than the rest – suggesting a greater predominance of public intervention in the economy – this does not translate into higher levels of equity. Part of the problem might be that the efficiency indicators for the public sector of coordinated economies are not all that good, although the state-dominated and quasi-coordinated economies are not exactly exemplary in this area either.

On the ability to choose

In any case, on the basis of our analysis we come to the interesting conclusion that at least two of the varieties of capitalism, namely quasi-coordinated and quasi-liberal, have managed to offer satisfactory results in terms of growth while simultaneously achieving a good level of equity (at least comparatively speaking). This offers us a glimmer of hope to counter the apocalyptic views that deny capitalism the chance to reach a certain virtuous equilibrium related to human welfare.

The question, however, is whether this preference for one variety of capitalism or another is solely based on economic considerations. While an in-depth exploration of this issue is beyond the scope of this article, one thing we can do is propose an underlying thesis: cultural elements, defined in a broad sense, undoubtedly also play an important role. In a previous Dossier1 we found that what we referred to as the illiberal shift in economic policy could be linked, to a not so negligible degree, to cultural factors such as the values of each society. As explained in the article «Capitalism, variety is the spice of life» of this same Dossier, the fact that the number of countries within the liberal category has fallen by half in the last two decades can be linked, to some extent, to this illiberal shift. Therefore, while there is no denying the importance of economic factors, the fact that cultural elements also appear to be behind this option should not be overlooked. This is a lesson we must remember, because, as we will explore in the next article of the Dossier, tough times lie ahead for the varieties of capitalism that are less well equipped for the world we are entering into.

  • 1. See the Dossier «The threat of the illiberal shift» in the MR01/2020.
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