• 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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Geopolitical uncertainty and economic growth: the indirect impact of the Ukraine conflict in Spain

When there is an increase in uncertainty, households and businesses tend to postpone consumption and investment decisions, which ends up affecting the pace of economic activity. In this article, we attempt to estimate the impact of uncertainty on Spain’s economic growth.

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The conflict between Russia and Ukraine is affecting our economy in many ways. One of them, which we already addressed in another article, is the impact of rising energy prices.1 Another channel also worth examining is the increase in uncertainty, because in such a situation, households and businesses tend to postpone consumption and investment decisions, which ends up affecting the pace of economic activity. In this article, we attempt to shed some light on this issue.

Uncertainty is a concept that is very difficult to measure. That said, in recent years a number of indices have been developed which give us an idea of how it is evolving practically in real time. For instance, according to the geopolitical risk index developed by Iacovello and Caldara, since the outbreak of the conflict uncertainty has increased substantially, as shown in the first chart.2 Indeed, this daily index reveals that since the start of the Russian invasion geopolitical risk has risen to levels not seen since the outbreak of the Iraq War in March 2003, although it still lies 30% below the level of that time.

  • 1. See the Focus «The impact of a rise in the price of oil and gas in Spain: possible scenarios» in the MR03/2022.
  • 2. See https://www.policyuncertainty.com/gpr.html.
Global: geopolitical risk

Another index that also faithfully captures the evolution of the degree of uncertainty is the European Political Uncertainty (EPU) index produced by Baker, Bloom and Davis.3 As can be seen in the second chart, the EPU index has a close relationship with Spain’s economic activity data: the higher the uncertainty index, the lower GDP growth tends to be. As an example, a rise in the uncertainty index like that which occurred following the failure of Lehman Brothers in 2008 was accompanied by a 1.6-point reduction in year-on-year growth in the quarter in question.

  • 3. This index reflects uncertainty in Europe as measured by the relative frequency of news and newspaper articles containing terms related to the economy, uncertainty, politics and public policy. We plotted the rise in the EPU index against the rise in geopolitical risk in order to see to what extent it has a knock-on effect on uncertainty in Europe. Historically, a 100-point increase in the geopolitical risk index translates into a 25-point increase in the EPU index. Using this relationship, we calculate how the EPU index would be affected by the upturn in the geopolitical risk index following the outbreak of the war in Ukraine.
Spain: economic activity and political uncertainty in Europe

The indices mentioned help us to gauge the current level of uncertainty, as well as its relationship with economic activity. However, increases in uncertainty tend to be accompanied by other phenomena which also affect economic activity. To what extent can a rise in uncertainty reduce economic activity growth? In order to better identify the direct impact of uncertainty, we use a statistical technique4 which allows us to quantify the impact on the Spanish economy over time of an uncertainty shock with external origins. In this case, the estimates suggest that an uncertainty shock such as the one observed to date due to the war in Ukraine could result in a 0.6-pp slowdown in year-on-year GDP growth in Q2 2022.

Thus, the rise in uncertainty that is currently occurring could have a significant impact on economic activity. Whether or not this ends up happening will depend, above all, on how the conflict develops, and this is very difficult to foresee. However, it will also depend on the speed and effectiveness of the economic policy measures that are put in place.

On the one hand, the ECB has already made it clear that it will adapt its course of action according to the circumstances and, therefore, that it is ready to adjust the various tools which it has at its disposal if necessary. From the point of view of fiscal policy, it is important that any action taken is swift and effective, helping the groups and sectors that are hardest hit by the crisis and creating a framework of confidence for the economy as a whole.

  • 4. The technique in question is a vector autoregressive (VAR) model. See details in the notes of the third chart.
Spain: response of year-on-year GDP growth to a Europe-wide uncertainty shock
What channels have we considered in estimating the impact of this uncertainty?

Our model captures an erosion of economic growth due to the impact of the uncertainty shock on consumers, businesses and the financial markets. In this exercise, we assume that the financial variables are first affected by the shock, and that this shock is then also transmitted to the macroeconomic variables of the real economy. On the one hand, when analysing the impact of an uncertainty shock consistent with the rise in the geopolitical risk index that was observed following the start of the Russian offensive, the risk premium shows an increase in the short term, while consumer confidence is eroded. In this context, investment growth contracts (by approximately 1.2 pps in year-on-year terms), as some companies postpone their investment plans until they have greater visibility.

The impact of this uncertainty shock on the average growth of 2022 in Spain could lead to a reduction of 0.2 pps.5 That said, this is assuming that the conflict will be de-escalated in the coming months and that we will not experience the same degree of uncertainty in the second half of the year. If the conflict were to draw out for longer, the toll on growth would be greater.

  • 5. This impact is similar to that which we obtain using the CaixaBank Research semi-structural model for the Spanish economy (see «Modelo semiestructural de CaixaBank Research para España», Working Paper 01/21, content available in Spanish). According to this model, the reduction in GDP growth resulting from the uncertainty effect would amount to 0.3 pps when we consider a scenario in which the conflict is de-escalated within a few months.