• 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 geopolitics of energy

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What do you think would happen if, all of a sudden, the country where you live no longer had access to foreign sources of energy and the emergency systems could not supply the entire system for, say, a week? Such a situation (although it is an extreme case!) would evidently have significant adverse consequences for the daily lives of all citizens and highly negative macroeconomic implications. This serves to demonstrate the importance of having access to energy sources, continuously and at an affordable price. Thus, countries that have control over their energy sources can better protect their national interests and, in parallel, exert economic and political influence at the international level. In contrast, economies that are dependent on imports of fossil fuels may suffer energy security problems. In this regard, the current energy mix has led to the development of certain geopolitical relations in which net oil exporters play a significant role (OPEC members and Russia, mainly). Faced with the changes that lie ahead and which will shape the energy mix of the future, we must ask ourselves which states might gain geopolitical influence, which might lose it and whether today’s current partnerships will continue for a long time to come.

As we have seen in the article «The energy mix of the future» of this same Dossier, global energy consumption will continue to rise until at least 2030, mainly as a result of the momentum of the emerging Asian economies, albeit at a much slower rate than economic growth. In addition, the change in the composition of energy sources that is expected to take place over the coming years will lead to greater demand for natural gas and renewable energy, to the detriment of oil and coal. These dynamics will have two main implications at the geopolitical level. On the one hand, greater use of renewable energy sources will allow economies that foster them to become more energy independent, since they will be able to consume energy that is generated within their own territory. One of the best examples of a country that is almost energy independent is Iceland, where more than 80% of the energy it consumes comes from renewable energy sources generated within its territory (mainly geothermal and hydro).1 Renewable energies, therefore, will make it possible to reduce energy dependency. Currently, however, electricity that is generated using renewable sources, or indeed any other energy source, cannot travel long distances, making it hard to export and, consequently, to gain geopolitical influence.

On the other hand, increased consumption of natural gas to the detriment of coal will allow gas exporting countries to gain prominence in international relations, while the main exporters of coal and oil will lose influence.2 An example of this new trend that can already by seen is Qatars departure as a member of OPEC announced at the end of 2018, after which the country’s Minister for Energy argued that it was a strategic decision in order for the country to focus on the extraction and distribution of natural gas.3

As such, the main beneficiaries of this greater use of natural gas will be the biggest current net exporters (Russia and Qatar), as well as those expected to increase their net exports over the coming years (mainly Iran and the US, according to estimates by the US Energy Information Administration, or EIA). On the other hand, those adversely affected by the new energy mix will be Saudi Arabia, given that oil will make up a relatively smaller portion of the new energy mix, and the main exporters of coal, namely Australia and Indonesia, whose exports go to India and, above all, to China.4 Nevertheless, thanks to its abundant reserves of natural gas, Australia will be able to mitigate the negative impact of the decarbonisation process expected to take place in China by increasing its gas exports.

The increase in the consumption of natural gas will not only benefit the countries that export this fuel, however. Since it is primarily transported by pipelines, countries located at strategic points will also be able to benefit politically and economically. A clear example is Turkey, through which a gas pipeline passes that distributes gas from the Caspian Sea to Southern Europe. However, the expected increased use of liquefied natural gas (LNG) will moderate the influence of these transit countries. This form of processed gas can be transported long distances by merchant ships, provided that the receiving ports are equipped to handle it.5 This facilitates a greater homogenisation of the gas price internationally and provides importing countries greater bargaining power by increasing the range of potential vendors.

In this changing environment, focusing on the situation of Europe, a cornerstone of the EU’s strategy is to strengthen the region’s energy security, which means reducing its high degree of dependency on energy from abroad.6 Currently, more than half of the energy consumed in the region is imported, a phenomenon which can be seen above all in fossil fuels, where the main trade partners are Russia and Norway (currently, 90% and 69% of all the oil and natural gas consumed, respectively, is imported, and the dependency on imports of these fuels is expected to increase slightly according to European Commission estimates). The EU has expressed some concern in this regard due to the possibility that disruptions in the supply of these products, whether due to infrastructure failures or political or trade disputes, could make the member states that are most dependent on Russian oil and gas more vulnerable. Indeed, this occurred in 2009, when Russia stopped supplying natural gas to Eastern Europe due to its conflict with Ukraine, which until then was the main route through which Russian gas entered the rest of Europe. The work to be done in this regard should include increasing energy production within the EU (mainly through an increase of renewable energy), strengthening the internal energy market and diversifying the routes of entry and the supply of exporting countries. On this note of diversification, the European Commission has pointed out that, in addition to strengthening ties with current partners (mainly Norway, Russia and Saudi Arabia), it is necessary to improve alliances with new partners in the Caspian Sea (most notably Azerbaijan and Turkmenistan). By doing so, it is expected that the EU will be able to become a more energy independent region and, above all, have a greater diversity of suppliers.

If we look at the Iberian Peninsula in greater detail, the situation is a little more adverse than it is in the EU as a whole, since neither Spain nor Portugal have reserves of oil or natural gas and their geographical position makes gaining full access to the internal European market more difficult. This leaves these countries with among the highest energy dependency rates in the EU (see second chart). For this reason, the Integrated National Energy and Climate Plan proposed by the Spanish Government aims to reduce this rate by 15 pps by 2030, mainly through a reduction in energy intensity and greater use of renewable energies.7 In addition to the increase in the generation of energy through renewable sources, in the Iberian energy mix there will be an increase in the weight of natural gas. The largest exporter of this fuel is Algeria, which accounted for 45% and 35% of imports in Spain and Portugal in 2017, respectively.8 The alternatives to rely less on Algerian gas involve increasing imports of LNG (especially from the US) and strengthening ties with the European energy market. In fact, if these alternatives were properly developed, the Iberian Peninsula could contribute to reducing Europe’s overall energy dependency on Russia by becoming a thriving point of entry for gas coming from the other side of the Atlantic and Algeria.

In short, international relations forged through energy sources will continue to change, this time probably to the benefit of states that export gas. However, more efficient use of energy, together with the commitment to renewable sources, will allow countries that develop them to become more energy independent. As in the 1979 former US president Jimmy Carter words, «No one can ever embargo the sun».

Ricard Murillo Gili

1. The remaining 19% corresponds almost entirely to oil consumed by vehicles in land and sea transport. Data published by the National Energy Authority of Iceland.

2. Even if net oil exporters see an increase in their sales of crude oil, they will lose influence relative to exporters of natural gas.

3. Its departure from OPEC was also driven by the diplomatic blockade imposed on it by Saudi Arabia (the most influential state of the cartel) and six other countries starting in 2017.

4. Although China is the largest coal producer in the world, it is a net importer of this fuel.

5. In the Iberian Peninsula there are currently ports equipped for LNG in Barcelona, Bilbao, Huelva, Sagunto, Cartagena, Ferrol, Gijón and Sines (Portugal).

6. See European Commission (2014). «European Energy Security Strategy». Communication from the Commission to the European Parliament and to the Council.

7. For further details, see the article «The new energy mix in the Iberian Peninsula: the fight against global warming», in this same Dossier.

8. In fact, the largest exporter of natural gas to Portugal is Spain, representing 45% of the total, most of which likely comes from Algeria. For this reason, Portugal’s energy dependency on Algeria is greater than the figure of 35% would suggest.

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