• 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 US-China technology conflict: an initial insight

The new technology restrictions that the US has imposed on China represent an escalation of the decoupling policy pursued by the current US Administration. Although the distancing between the two powers has a long history, under Trump’s presidency it has become a fully-fledged conflict.

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While the First Phase trade agreement reached in early 2020 seemed to defuse the trade dispute,1 the battle is now focusing on the technology sphere, and in particular on the information and communication technology (ICT) sector. Moreover, this is a battle with a broad bipartisan consensus in the US. But what has happened so far, and why? What could the consequences be?

  • 1. See the Focus «International trade: first impression of the First Phase» in the MR01/2020 for details about the First Phase agreement.
The what (chronology)...

The trade conflict itself already included technology restrictions in its early days, such as tariff increases and controls being imposed on exports of ICT products. In May 2019, the tone of these restrictions was raised when Huawei and its subsidiaries were added to the US Entity List, which details individuals, institutions and companies that are considered to pose a threat to US national security. In the case of Chinese tech companies, with this measure the US Administration sought to prevent them from using US technology in the production of their goods and services.

Up until August 2020, this ban was circumvented through the multiple extensions granted to Huawei by the US Department of Trade itself, as well as through a legal loophole in the ban. In August, however, the US stopped granting these extensions and significantly stepped up the restrictions imposed on Huawei and other large Chinese tech companies such as ZTE from acquiring US technology. In the highly-integrated global ecosystem of information technologies, this meant practically halting the supply of high-end chips to Huawei. This was a somewhat unexpected move, since the first chapter of the partial trade agreement reached in early 2020 focused on improving the protection of intellectual property, especially on China's part. As we shall see below, this is one of the US’ great concerns regarding China.

... the why (reasons)...

The concerns raised by the US in the technological sphere since the escalation of the economic and political conflict with China have focused on three aspects: the pressures applied on US firms operating on Chinese soil to hand over their technology, the government aid that Chinese tech firms receive in acquiring US firms, and the theft of sensitive business information through computer networks.

However, the true motivations behind the conflict run deeper: China’s technological rise and the threat it poses to US dominance. As was the case with basic manufacturing goods, China is making significant headway in the ICT race, a sector that is seen as key to the new industrial revolution we are entering. For instance, in just over 20 years, Huawei has gone from being a local company to becoming the world leader in ICT equipment sales (see first chart), and in particular in mobile sales (overtaking Apple in 2018 and, most recently, Samsung in 2020) with 55 million devices sold in Q2 2020.

Global sales of ICT equipment

Furthermore, China is a very different hegemon in political, geopolitical and social terms. In this regard, the US is not the only country taking a stand against China’s technological advance. The United Kingdom, Japan and Australia have all banned the use of Huawei equipment in their 5G networks. France and Germany, meanwhile, have not yet declared their stance, although the former seems likely to impose significant restrictions on the Chinese tech giant.

The political scientist Graham Allison describes the US-China rivalry as a case of Thucydides’s trap, alluding to the ancient Peloponnesian War: an established power (the US in this case) sees its dominant position threatened by an emerging power (China). Generally, the trend favours the emerging power, so the dominant power has an interest in stopping it in its tracks. This suggests an element of rationality in the US approach and indicates that the conflict will continue regardless of what may happen in the November presidential election.2

  • 2. See Graham Allison (2017). «Destined for war: Can America and China escape Thucydides's trap?». Houghton Mifflin Harcourt.
... and the potential consequences

The technological struggle between the two countries could have substantial economic consequences. Strong economic ties exist, so the decoupling process will not be easy. For instance, the leading Chinese ICT companies listed on the US stock market at the end of August had annual sales amounting to 463 billion dollars and a market capitalisation of 1.3 trillion dollars (slightly more than double the trade flows between the US and China).3

Moreover, in the middle of this year the US Senate passed a new law that increases control over all Chinese companies (not just technology companies) listed on the country’s stock exchanges, which could lead to the expulsion of some of them. The magnitude of such an expulsion would be vast: the 300 Chinese companies that were listed on US stock exchanges at the end of the summer (including both tech firms and non-technology companies) had total sales amounting to 5.3 trillion dollars and a market capitalisation of 5.7 trillion dollars (10 times the volume of bilateral trade and on a similar scale to the famous American FAANGs).

Another sign of the close ties between the two economies is the high stock of US foreign direct investment (FDI) in China and what this represents in terms of sales. In particular, much of the US’ FDI in the Asian country is focused precisely on selling in the Chinese market itself: sales which in 2018 amounted to 600 billion dollars (slightly more than the trade flows between the two economies and around three times the volume of US exports to China).4

The bilateral FDI flows between the US and China in recent months can also offer us an indication of the direct impact that the dispute is having on the two countries. Just before the start of the technology-focused trade conflict, foreign direct investment flows between the two countries averaged 37 billion dollars a year (2013-2017), with investments from China to the US of around 24 billion and some 13 billion in the opposite direction. This figure fell by half in the average for 2018-2019, mostly due to the stagnation of investment from China (see second chart).5 As expected, this stagnation has been much more pronounced in the ICT sector, in which direct investment from China to the US has been virtually nil since 2018.

  • 3. These are companies whose shares could be purchased either through ADRs (American depositary receipts) or OTC (over-the-counter). The market capitalisation figure is expressed in terms of market value.
  • 4. Data from Gavekal Dragonomics and Macrobond.
  • 5. Figures calculated using data from The US-China Investment Hub.
Direct investment flows between China and the US

It is also essential to point out that the ICT sector has a knock-on effect on other major sectors and countries, so a dispute between the world's two biggest players will have global consequences. For instance, Europe is highly dependent on Chinese equipment to deploy its 5G network (which is key to the new industrial revolution), and this restricts the partnerships it can enter into with the US.

The current tech war also has the potential to weaken or curb progress in the field of international technology governance. The rapid development of new technologies and their capacity for economic and social disruption require international standards in order to minimise such disruptive effects. However, cooperation is difficult in an environment in which the two leading technological exponents are embroiled in a battle.6 In fact, when cooperation fails, progress in global terms suffers. It was Chinese drones that helped to put out the fire at Paris’ Notre Dame in 2019. French legislation was quickly changed to let drones fly over the country's capital. But if Notre Dame were to burn again, Chinese drones may no longer be there to quell the flames.

  • 6. See Haiyong Sun (2019). «US-China Tech War: Impacts and Prospects». China Quarterly of International Strategic Studies 5, nº 02, 197-212.