• 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 challenge of America First for globalisation: threat or opportunity?

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Àlex Ruiz
September 12th, 2018

It is highly unlikely that the names Reed Smoot and Willis C. Hawley will be familiar to the contemporary reader, and yet the 1929 law that bears their name brought about the mass introduction of tariffs on some 20,000 products imported into the US. While the world was left astounded at how a stock market crash gave way to an unexpected fall in economic activity, the reaction of most countries to the Smoot-Hawley tariff was to respond with their own tariff measures. All this contributed to turning a recession that could have been «normal» into one which became extremely harmful. A few years later, the Second World War gave the final blow to the international system.

Out of its ashes, and under the undisputed leadership of the US, the current architecture of global governance was erected, known as the liberal international order: a set of rules and values embodied in a series of institutions whose ultimate goal was to ensure macroeconomic stability at a global level. Thus, after the Second World War, a set of economic and financial institutions were created (the IMF; the World Bank; the GATT, which was the predecessor of the current World Trade Organization; and the first incarnation of the future OECD). At the same time, other institutions were converted (the Bank for International Settlements) and new projects were sponsored (such as the EEC, which would lead to the current EU). These institutions and projects gave form to a common framework of shared values. This framework included a number of beliefs, such as that exporting, importing and investing should not be driven by countries’ political power, that the growth of different countries was not a zero-sum game, and that property rights should be protected (including intellectual property rights, a requirement for the international dissemination of knowledge). Incorporating these values into good practices required many elements. These included ensuring that the system provided common mechanisms for conducting international trade and financial transactions, ensuring that there was a virtually universal currency conversion system, and defining mechanisms to establish, calculate and control tariffs and customs rules, to name just the most essential aspects. In addition, the system defined institutions and methods for resolving differences between the partners (commercial differences in particular), it established technical harmonisation mechanisms and it offered protection schemes against certain risks (of a natural, macroeconomic and financial nature), ranging from emergency humanitarian aid to the exceptional provision of liquidity among central banks.

Well, all this institutional architecture is now being challenged. By whom? Paradoxically, by the founding partner, the US. Under the slogan America first, the current US Administration has embarked on what appears to be a profound rethinking of the world liberal order. Whereas the US’ international strategic approach to date has been multilateral and based on compliance with rules, it now appears to want to establish a bilateral philosophy, analysing each case from a cost-benefit perspective (in economic terms, but also political).

Let us go over what has been proposed to date, although this is an area which is constantly evolving and perhaps, when the reader reads this article, new measures may have been announced. From the very beginning of the new Administration, the US has abandoned the Trans-Pacific Partnership (TPP), it has withdrawn from the Paris Agreement on climate change, it has chosen not to renew its participation in the Nuclear Non-Proliferation Treaty with Iran (reimposing sanctions instead), it has begun an ambitious (albeit somewhat unrealistic) review of NAFTA and it has cast doubt, if not over NATO itself, over its military and financial commitment with the alliance. Furthermore, it has questioned the World Trade Organization and has left the United Nations Human Rights Council.

This litany of decisions has been accompanied by a progressive threat (and, in some cases, the actual implementation) of imposing tariffs on imported goods. In January 2018, the US applied tariffs to imported washing machines and solar panels. Shortly afterwards, in March, it announced its intention to apply tariffs on purchases of steel and aluminium, as well as on a wide variety of Chinese products. In addition, on various occasions it has threatened to impose tariffs on cars, and even on all Chinese imports. If these two measures were to be implemented (tariffs on cars and on all Chinese imports), a situation which seems unlikely (although nothing can be ruled out entirely), the average tariff of the US would go from 1.7% to 6.5%, a level not seen since the early 1970s. At present, and in response to the tariffs applied, the US’ trading partners have begun to respond by establishing similar measures: since the beginning of July, Canada, Mexico, the EU and China have already applied tariffs on some of their US imports to compensate – partially for the time being – the new tariffs imposed by the US.

Could these skirmishes (calling them a trade war is still debatable) mutate into something more serious and end up damaging global growth? A shock of this kind would affect growth in two ways, one direct and the other indirect. The direct impact would come in the form of a reduction in trade flows, disruption to global supply chains and higher prices of imported goods. The indirect impact would materialise in the deterioration of business and consumer confidence and in the tightening of financial conditions.

The quantitative exercises that have been undertaken tend to confirm that, if protectionism remains at current levels, or even slightly higher, its impact on global growth should be contained. But the situation would change if the level of tariff protection were to increase significantly (at the high end of the tariffs threatened by the US Administration). According to calculations by CaixaBank Research, using estimates provided by the Bank of England as a starting point, a 10-pp increase in tariffs between the US and its trading partners lasting for three years (2018-2020) would reduce global growth, over the same period, from the expected annual average of 3.9% down to 3.2%. This decline, which is rather significant, would be mostly driven by the direct impact, which would affect growth approximately twice as much as the indirect impact. However, we must not lose sight of the fact that the indirect impact can take various forms, some of which are potentially very harmful to growth. This being the global impact, the US would be particularly affected, since its average annual growth currently expected for the period 2018-2020, of 2.5%, would be reduced to a meagre 1.1%. The euro area, meanwhile, would suffer slightly less, growing by 1.4% in the event of a trade shock compared to the 2.0% expected today.

To reiterate the point, this represents an adverse scenario for the global economy. The levels of tariffs resulting from the aforementioned 10-pp increase would result in a situation similar to that last seen in the early 1950s, when the GATT had just started to remove tariffs. But even if the situation does not reach this level of severity and the short-term impact ends up being relatively limited, this does not mean that the consequences for the global institutional architecture in the medium and long-term will not be significant. One way to explore this terra incognita is to develop scenarios that integrate some of the essential features of the international system, as well as its players, which are currently in flux. Let us delve into the future by taking ownership of the US Administration’s slogan, as if under a small license, to offer three different visions of what might lay ahead.

Globalisation first. Let us imagine that the risks associated with the current situation are read properly and governments react accordingly. Now let us jump ahead a decade; what would we see? One possibility is that we would be decisively entering into what historians of the future would call the third wave of globalisation (after the first, which succumbed in the 1930s, and the second, which hypothetically ended with America First). The renewal of globalisation would have come at the hand of profound changes in the way in which institutions operate, giving a bigger voice to the new global powers (China, as well as other medium-sized powers such as Russia, India and Brazil) and opening up the agenda to new areas of globalisation. These would include the development of the agricultural sector (long-neglected demand from Africa and other exporting regions), alterations to financial globalisation (which enhances international coordination) and an intensification of trade in services (demanded by the advanced countries). The institutional reform should also allow them to resume their role as a forum for resolving competition issues and to effectively defend intellectual property. This renewed globalisation would also be more sustainable, incorporating solutions to the main sources of instability of previous years by finding creative ways to compensate those perceived as the «losers» of globalisation, whether citizens or countries. All this should allow the populist agenda to lose its grip. In this scenario, the world order would continue under the political and economic leadership of the US, but it would be a far cry from the unipolarity that followed the fall of the Berlin Wall.

America first, America out. Here we are moving away from win-win scenarios in which everyone benefits. One possible story would be as follows. As a result of the America First strategy and what earlier we have referred to as cost-benefit bilateralism, the US will have intensified its isolationist shift, an ever-present temptation in American foreign policy since the 19th century. The rest of the world, however, would not go down the same path: when dealing with the US, other countries would have little choice but to conform to the bilateral logic, but in all other cases globalisation would continue and its economic roots would remain deep. In its final stage, this scenario implies that a modified version of today’s globalisation would continue to operate, albeit on a smaller scale. In order for this to be a success, the problems mentioned above (essentially institutional and redistributive problems) would need to be solved, probably with solutions set out in the first scenario mentioned above. Given that the isolationism of the US would imply a more-than-likely decrease in prosperity and, by extension, in the US’ economic weight, under this scenario the system would swing towards a more pronounced multipolarity. This would involve a larger number of key players, possibly with China at the helm and probably followed by the EU as defenders of the new globalisation, as well as a myriad of medium-sized powers. The main complexity with this scenario is the transition from the current situation towards the new balance. At the end of the day, when it comes to international relations, history reminds us that wanting something is not the same thing as being able to implement it. In the 1930s, the only country with the capacity to exercise stabilising leadership was precisely the one that did not wish to do so, while the country which tried did not have the capacity to do it (the reader might have guessed that we are talking about the US and the United Kingdom, respectively). The complexity of the transition would be intensified by the need to implement a profound change in how the current form of globalisation operates. This would range from the reconfiguration of global production chains on a different scale, to the capacity to substitute the fundamental role of the US in the field of financial globalisation.

America first, Europe First, China first. In this scenario, the central element is the fragmentation of the global economic and political systems. To capture the essence of the scenario, we can think of a mercantilist form of globalisation in which each centre (the US, Europe and China) would integrate with its natural hinterland, accompanied by certain regional champions such as Brazil or India. Although this option might seem suboptimal but not disastrous, the truth is that it would lead to a clearly less efficient economy, on a smaller scale and with an even more complex transition process than the previous scenario. In addition, as happened with the historic phases of mercantilism of the 17th and 18th centuries, it would be a somewhat unstable system with a tendency for confrontations to arise between the different blocs.

Do these distant scenarios sound implausible, or perhaps overly dramatic? Of course, they have to be. All of us are children of a long period of prosperity and peace, and to think of sacrificing one of the key instruments of this result, the liberal institutional order, seems incomprehensible. For the common good, we must trust that the threats that are currently looming over globalisation result in a constructive process, leading to an enhanced and more sustainable version of the phenomenon. Not in vain, and on this point the consensus of economists is virtually unanimous, free trade is the most powerful tool for creating global prosperity that exists. Defending it, which does not mean sanctifying it but rather ensuring that it reaches its full potential, requires reform of the institutional system that protects it and improving the balance between the winners and losers of globalisation, even if this means giving minimum satisfaction to demands that are not always well founded. But renovating the building is very different to demolishing it, as the fateful history of the Great Depression reminds us. In 1930, they were well-aware that the Smoot-Hawley tariff was going to be a death sentence for future prosperity: in May of that year, 1,028 American economists signed a declaration calling for the policy to be vetoed. It was to no avail. Repeating the past is sad, but repeating errors of the enormity of those mentioned here is unforgivable. It should not happen.

Àlex Ruiz

CaixaBank Research

 

Àlex Ruiz
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