• 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 threat of protectionism in the global economy

Since the beginning of 2018, the Trump Administration has adopted a more belligerent tone in trade policy: for example, it has increased tariffs on Chinese imports worth 250 billion dollars, it has added Huawei to the list of companies that require government approval to purchase US technology, and it is studying tariffs on auto imports. This can be seen in the following chart.

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  • Trade tensions between the US and China pose a risk to growth, both for the US and China themselves and for the rest of the world.
  • Under a moderate tariff stress scenario, we estimate that average annual global growth over the next three years could be 3 decimal points lower than anticipated (3.1% versus 3.4%), largely due to greater uncertainty.
  • Under a high tariff stress scenario, growth could be 8 decimal points lower than forecast (2.6%), due to trade and uncertainty in equal measure.

Since the beginning of 2018, the Trump Administration has adopted a more belligerent tone in trade policy: for example, it has increased tariffs on Chinese imports worth 250 billion dollars, it has added Huawei to the list of companies that require government approval to purchase US technology, and it is studying tariffs on auto imports (see following chart).This can be seen in the following chart:

US company stock prices

So far, the tariffs adopted represent a small percentage of global trade (less than 3%).1 However, their economic consequences go much further than what it might seem, since effects are transmitted through uncertainty and disruption to global supply chains. Below, we analyse and quantify the economic impact of the trade tensions between the US and China.

  • 1. This refers to the total exports of goods affected by the tariffs since 2018, relative to the overall total exports of goods at the global level. Based on IMF and US Foreign Trade data.
The effects of protectionism on economic activity

The rise of protectionism in the US is affecting the economic activity of the country itself and that of the world through different channels:

1.Trade channel (or direct). A tariff hike raises the price of imports (from China in the case of the current escalation of protectionism) and leads to an increase in the prices paid by consumers and companies. These higher prices have a detrimental impact on consumption and investment and, therefore, on the economic activity of the «protectionist» country.

Certain factors, however, can either exacerbate or alleviate this direct impact on the US, as well as producing a knock-on effect on other economies:

  • The boost to tax revenues generated by the new tariffs can partially offset the detrimental economic impact, although the increase is usually limited.
  • Chinese exporters could cut their prices (squeezing their profit margin), which would reduce the detrimental impact on consumers and businesses. However, this has not occurred in the current tariff escalation, in which most of the detrimental impact has been borne by US consumers. According to a recent study, the current measures will cost US households an average of 620 dollars a year.2
  • If the consumption of imported goods is replaced by goods produced domestically, there is a boost to the country’s economic activity (to the detriment of the original exporting country, in this case China).3 However, this comes with a cost at the global level, since the original exporters are being replaced by less efficient producers.
  • In net terms, estimates suggest that the positive effect on US economic activity is less than the direct negative impact. One of the reasons for this is that, as has occurred in the current situation, the foreign countries that have been the subject of the tariff rise tend to respond by imposing similar measures on the US.
  • Some countries may temporarily benefit since, faced with rising prices of some Chinese imports, US consumers and businesses can replace a portion of these purchases with imports from other countries (which are cheaper, after factoring in the tariffs). This is known as a «trade diversion» effect, although it is becoming less and less important in a world dominated by global supply chains.

2. Uncertainty channel (or indirect). Faced with a more uncertain outlook, households tend to postpone their spending decisions, and companies, their investment decisions: a «wait and see» approach that depresses economic activity at the global level. Furthermore, a climate of heightened uncertainty tends to drive up the costs of financing for both households and companies. This, again, affects spending and investment decisions and, ultimately, has a detrimental impact on economic activity.

  • 2. See M. Amiti, S.J. Redding and D. Weinstein (2019). «The Impact of the 2018 Trade War on US Prices and Welfare» National Bureau of Economic Research n° w25672; and the most recent numerical update in the Blog of the Federal Reserve Bank of New York («New China Tariffs Increase Costs to U. S. Households», Liberty Street Economics, 23 May 2019).
  • 3. The exchange rate is another factor to consider. If the yuan depreciates (as has happened, by 9.5% against the dollar since April 2018), the effect of the tariffs on US consumers is lower. On the contrary, an appreciation of the dollar (like the one that has occurred, amounting to 7.4% against a whole series of currencies) depresses foreign demand for US exports.
Impact of protectionism on economic activity
Estimates of the impact of the trade tensions

Given the multiplicity of mechanisms discussed, in order to estimate the economic impact of an escalation of protectionism like the one that might occur between the US and China, we need to use general equilibrium models, i.e. models that seek to capture all the relationships of supply and demand that occur in the different markets at both the country level and between different countries. In the summary table, we present the results reached by the IMF, the Bank of England (BoE) and the European Central Bank (ECB) with this type of exercise.4 In all three cases, the results take into account both the direct impact through trade and the indirect impact of a climate of greater uncertainty.

This latter channel, uncertainty, is no doubt the most relevant in a situation like the current one (with protectionist measures that are still relatively moderate in global terms, but with many threats). That said, it is also the most difficult one to determine. For this reason, we use the simulations performed by the above institutions, together with an analysis of our own. In particular, our estimates suggest that a spike in uncertainty similar to that seen in 2018 would cause global GDP growth rates to fall by 2 decimal points compared to those forecast under a scenario in which the two powers reach an agreement in the coming months.5 In the event of shocks considerably greater than those that occurred in 2018, annual growth rates would be some 4 decimal points lower than forecast (as a result of the indirect channel).6

Following this analysis of uncertainty and of the results of the aforementioned simulations by the IMF, the BoE and the ECB, we built two adverse scenarios relating to how the trade conflict between the US and its various trading partners could develop over the period 2019-2021, i.e. three years (see the last chart):

  • Scenario of moderate tariffs. This scenario assumes a slightly higher level of protectionism than we have seen to date. In this context, the average annual growth of global GDP in the period 2019-2021 would be 3.1%, compared to the 3.4% forecast by CaixaBank Research. This would be mainly as a result of the uncertainty channel (accounting for 2 decimal points of the reduction). By country, the impact in the US and China would be substantially greater than the impact in the euro area. In Europe, on the other hand, while the uncertainty channel would clearly have a detrimental impact, the trade channel could be favoured by what we referred to as «trade diversion». However, as the trade tensions grew in 2018, Europe suffered a major slowdown in growth (from 0.7% quarter-on-quarter in Q4 2017 to 0.2% in Q4 2018). As such, this «trade diversion» effect does not appear to have made an impact so far.
  • Scenario of high tariffs. This scenario assumes a much greater escalation of protectionism than that witnessed at present, with measures imposed on all US imports and a response of the same calibre imposed against the US by the countries affected. In this case, the average annual growth of global GDP in the period 2019-2021 could fall to 2.6% (8 decimal points below the expected scenario). In this case, trade and uncertainty would contribute equally to lower growth. Again, the US and China would be the most adversely affected economies, although the US economy more so, since it would suffer all the replicas of the tariffs imposed by its various trade partners.
  • 4. See the IMF (WEO, October 2018), the ECB - Economic Bulletin Issue 3/2019, «The economic implications of raising protectionism: a euro area and global perspective» and the Bank of England (speech given by Mark Carney on 5 July 2018).
  • 5. In our scenario, we are assuming that the two powers reach an agreement during the second half of 2019 or in early 2020. The agreement would possibly contain very specific measures on products, making it possible to ensure that it is complied with (it will be a highly technical document). In addition, we envision certain elements in the field of technology transfer and intellectual property. However, the agreement will not entail an immediate withdrawal of the tariffs imposed to date, but rather a gradual removal.
  • 6. We take the global economic policy uncertainty index developed by Steven J. Davis («An Index of Global Economic Policy Uncertainty», Macroeconomic Review, 2016) based on the analysis performed by Baker, Bloom and Davis. A vector autoregression (VAR) of order three is estimated using quarterly data on global GDP growth, global CPI, the short-term (3-month) global interest rate and the global economic policy uncertainty (GEPU) index. The GEPU index reflects global uncertainty, as measured by the relative frequency of news and newspaper articles containing terms related to the economy, uncertainty, politics and public policy in a set of countries that represent two-thirds of the world’s GDP.
GDP growth scenario

However, the risk posed by this potential escalation of tariffs goes beyond the negative short and medium-term effects. The major fear is that this escalation could lead to non-tariff protectionist measures that affect international trade and investment more directly, such as restrictions on foreign technology companies, with potentially far greater impacts both at the economic and the institutional level. Furthermore, in the long term, all these economic obstacles represent a toll on productivity, since they impose barriers for the spread of knowledge and the establishment of network economies, trends that are key in an increasingly digital world.

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