• 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 challenges of financial globalisation

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September 13th, 2018

Since the 1980s, the world has witnessed a process of unprecedented financial globalisation, as illustrated, for example, by the significant increase of capital flows that has occurred both in the advanced and in the emerging economies. In addition, in recent years, along with the acceleration of financial flows, there have been a series of notable changes that force us to think about the challenges that this new phase of financial globalisation will bring. In order to make sense of a broad and complex matter, this article sets out those changes, and then provides an overview of the economic and financial consequences that they may entail.

A natural starting point is to consider what are the benefits of greater global financial integration. In general, financial globalisation brings important benefits for economic activity.1 Specifically, in addition to supporting international trade, greater financial openness contributes to making the global allocation of capital more efficient, while also providing opportunities to diversify risks and obtain greater returns.2 The increase in international trade that has occurred in recent years, therefore, has continued to favour the expansion of financial globalisation. Nevertheless, this has been accompanied by two very noticeable changes, which have bolstered it even more: the growing interconnection of monetary policy at the global level and the emergence of truly global financial institutions. Both innovations have introduced complexity in the way financial globalisation operates.

Thus, and in relation to the first of these developments, as a result of the changes in monetary policy in the context of advanced countries’ response to the Great Recession (with the extension of monetary expansion to new heights with few historical precedents), spillovers between the main central banks and those in the periphery have increased.3 One of the consequences of this dynamic is that it limits the ability of the monetary authorities of smaller economies to implement a monetary policy consistent with their domestic needs. As such, when global financial conditions become more accommodative, for example following an interest rate cut by the US Fed, there tend to be significant capital inflows in economies with a more restrictive monetary policy. These capital inflows can lead to a loosening of the country’s financial conditions beyond what is desirable and, thus, to an overheating of the economy and macrofinancial imbalances.

The fear, expressed on numerous occasions by the Bank for International Settlements (BIS), is that this transmission mechanism is particularly relevant at the current juncture, given that the non-conventional monetary policy measures implemented by the central banks of the major advanced economies since the financial crisis have generated an important abundance of liquidity at the global level, which has been directed towards other economies in search of higher returns. Now that the monetary policy stance of the major central banks is starting to change, with the process of monetary normalisation underway in the US and Europe, some emerging economies could run into trouble if this process is not carried out very gradually.4

The greater protagonism of the global financial institutions is the second of the key developments of the current phase of financial globalisation. These global financial institutions operate in many countries of the world through branches and subsidiaries. Through this international presence, they are able to obtain resources in the major global financial centres with more favourable credit conditions, since they can obtain financing directly from the central bank and issue financial instruments to private investors at a lower cost, as well as being able to distribute these resources in other economies or provide liquidity to other banks through the interbank market. Thus, the monetary policy implemented by the main central banks affects the supply of credit and, since these institutions sometimes take on global risks, this contributes to the transmission of the financial conditions of the major advanced economies to all other countries.

The consequences of these institutional changes are multiple, but the two main ones refer to the greater degree of synchronisation of capital movements and the expansion of the use of «strong currencies». The first of these concerns is directly derived from the change in monetary policy and the greater importance of its global spillovers. Thus, in recent years, what is referred to in the literature as the global financial cycle has taken on greater importance. Although coming up with an empirical estimate of the extent of the phenomenon is not easy, there is evidence that the common - or global - factor which determines the evolution of the global flows of capital is important and that it also extends to aspects such as the dynamics of the returns of assets exposed to global risks.5

A second consequence is the change in the use of global currencies – particularly the US dollar 6 as a means of payment throughout the world and as a source of financing. This is largely the result of the incentives that access to abundant international financing and attractive financial conditions (in particular, a low interest rate) offers to borrowers. This dynamic contributes to the «strong currencies» playing a central role in the determination of the financial conditions of other countries. Furthermore, since the monetary authorities, including those that issue these currencies, tend to focus on the domestic conditions when implementing their policies, they may end up favouring an increase in macrofinancial imbalances beyond their borders if the economic cycles of these countries do not coincide.

Thus, when there are sharp increases in a country’s debt through financing in strong foreign currencies - with more favourable financial conditions -, this practice leads to the borrower taking on a foreign exchange rate risk from which it can scarcely be protected. In fact, in recent years, in a context of ultra-accommodative monetary policies in the advanced countries, this exposure appears to have increased considerably. In particular, credit denominated in dollars of the non-financial sector in emerging markets has doubled in just eight years.7 Furthermore, according to data from the BIS, credit denominated in euros to non-residents has increased by 34% in the last four years, reaching 3.1 trillion euros. It is therefore not surprising that, now that the major central banks have begun to change the tone of their monetary policy and the emerging currencies have depreciated significantly, the exchange rate risk is one of the major risks faced by many emerging countries.

Given the institutional changes and their potential consequences, it seems clear that in order to take advantage of the benefits of financial globalisation, it is important to have the necessary tools to be able to mitigate the risks we have spelled out. To this end, it is essential for countries to implement domestic policies that improve their ability to absorb shocks, make it less susceptible to global factors and prevent the accumulation of macrofinancial imbalances.

These policies include prudential policies,8 which can help to safeguard financial stability by increasing the robustness of the financial sector and reduce the procyclicality of credit flows.

It is also essential for there to be effective international cooperation that complements the domestic policies and helps to manage the risks associated with greater financial interconnectedness at a global level. To this end, a consolidated, global regulatory and macrofinancial supervisory framework should be established to help prevent future crises. It is also increasingly necessary to improve international coordination on economic policy, and on monetary policy in particular.

Since the 2008 financial crisis, considerable efforts have been made in both directions. For example, regulatory reforms have been introduced that focus on increasing the resilience of banks that operate at the international level, which are a key element of global financial intermediation.9 Attempts have also been made to improve the cooperation of macroeconomic and financial policies at the global level in response to the financial crisis.10

In any case, there is a lot of room for further discussion and evaluation of the effects of the monetary and macrofinancial policies of the major global financial centres in other countries. This could be done through an institution such as the IMF or the BIS, which could facilitate greater coordination between the major central banks.

In short, financial globalisation has become an important pillar in the development of the global economy, but it must be supported by a regulatory framework and by policies that help to contain the risks inherent to this increased interconnection.

Roser Ferrer

CaixaBank Research

1. Bank of International Settlements (2017), «Understanding Globalization», 87th Annual Report.

2. The development of globalisation is also due to other reasons, in particular the political changes that allow it to thrive (through changes to policy and regulation) and the technology that provides the basis for moving capital quickly and cheaply.

3. On this matter, see the Dossier «The globalisation of monetary policy» of the MR09/2016.

4. See the Focus «Growth in the emerging economies and global financial conditions: a close relationship» of the MR05/2018.

5. On this matter, see, for instance, S. Miranda-Agrippino and H. Rey (2015), «US Monetary Policy and the Global Financial Cycle», NBER Working Paper 21722, and E. Cerutti, S. Claessens and A. Rose (2017), «How important is the Global Financial Cycle? Evidence from capital flows», BIS Working Paper 661.

6. In fact, according to data from the Bank for International Settlements, the dollar is used to denominate almost half of all cross-border banking claims and it appears in 90% of all foreign currency transactions.

7. Specifically, the total credit (loans and debt securities) denominated in dollars in the non-financial sector in emerging markets reached 3.68 trillion dollars in Q1 2018, compared to 1.82 trillion at the beginning of 2010. Data from the Bank of International Settlements, global liquidity indicators.

8. Prudential policies consist of measures that promote good practices and encourage economic players to act with caution in the face of potential risks. Examples include imposing additional capital requirements on financial institutions to protect them from shocks, as well as restrictions on their activities.

9. For example, stricter standards of banking capital and liquidity have been introduced, as well as regular stress tests and greater external banking supervision.

10. In particular, the countries of the G-20 coordinated their response to the crisis through the Financial Stability Board, and the IMF bolstered its mechanisms for multilateral surveillance.