• 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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Democracy and the pandemic: more light than darkness

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Álvaro Leandro
Àlex Ruiz
February 16th, 2021
Detalle de grabado de Pericles en el ágora de Atenas

At this point in the Dossier, two major conclusions can be considered reasonably well-founded. The first is that democracy is undoubtedly in bad shape and it is accused of being incapable of solving the problems of the present and the future. The second is that, although the COVID-19 crisis has caught democracies off guard, the evidence from our empirical analysis suggests that its response to the pandemic has not, generally speaking, been worse than that of autocracies. In fact, it is quite the opposite. The most notable exception is probably China, but saying that the Asian giant has responded with a good anti-COVID strategy does not mean that democracies have got it all wrong.

Now let us take another more normative and prospective step. The time has come to take the bull by the horns and try to answer the question of whether the pandemic could mark a turning point for the trend of popular disaffection with democracies or whether, on the contrary and most unfortunately, it will be another missed opportunity to regain harmony with democracy. Anybody expecting definitive answers in black or white, we are sorry to say, will be disappointed. What they will find, however, are some reflections which we hope will shed some light on this crucial topic and suggest which shade of grey we read from it.

Changes of preferences and pandemics

A first obligatory reflection concerns the key question of the possible change of preferences which a shock like the current pandemic can induce and the ability of the political system to respond to these hypothetical new preferences. History provides us with some important lessons. First of all, the great pandemics of the past have tended to generate political responses which suggest that such a change of preferences does indeed tend to occur in the wake of such health crises.1

A second reflection is that this political response has not always been successful. Since analogies connecting the fateful 1930s with our present situation abound, it is worth mentioning a recent study by Kristian Blickle, a Federal Reserve economist. In it, he notes that there is a correspondence between the German electoral constituencies that were hardest hit by the 1918-1920 flu pandemic and those where the Nazi Party obtained better results in the various electoral contests of the time.2 The author argues, rather convincingly, that the combination of prior preferences (in this case, anti-semitism) and the shock of the 1918 flu pandemic made radical alternative political stances more appealing.

In our view, and in general terms, the democracies of today are much more functional than those that existed in the 1930s, and the response this time around is bound to be better than it was in the past. We therefore believe that, while preferences will change, public decision-makers will be capable of producing policies that are adapted to them and, generally speaking, better. This will depend, to no small extent, on the next element to be taken into consideration, which we call the «shielding» of the regulator.

  • 1. See the Dossier on the world after COVID-19 in the MR05/2020, in particular the article «COVID-19 and black swans: lessons from the past for a better future».
  • 2. See K.S. Blickle (2020). «Pandemics Change Cities: Municipal Spending and Voter Extremism in Germany, 1918-1933». Federal Reserve Bank of New York.
The critical role of technocracy

We are now delving into an issue that is extremely controversial, but inevitable, in the debate before us: that of how to protect the regulator from the excessive influence of interest groups. The answer is a greater role of technical groups in the decision-making process (technocracy), whereby these groups have a sufficient degree of independence so as to limit pressure from lobbies. If anyone thinks this is impossible, we must remember that there is a very powerful precedent of unquestionable success: that of modern central banks. Indeed, the central banks’ «shielding» (independence) responds fundamentally to the need to isolate monetary policy from political decision-making (given that, in their legitimate effort to win elections, politicians pursue objectives other than price stability). This shielding is effective too: independent central banks consistently generate more stable and lower inflation expectations than non-independent ones.

In this regard, technical bodies with the same degree of independence would provide better protection for public policies that are likely to be «captured» by sectoral interests or excessive electoralism. It would thus be possible to reach a reasonable degree of consensus on technical matters, which could be integrated into those great agreements which we tend to define as state policies and whose effects tend to materialise over a period far exceeding the electoral cycle.

In this area, again, we are more hopeful than fearful. The ability we credit democracies with to emulate best practices in other countries or spheres ultimately justifies our view that here, once again, the future is more white than it is black. Many democracies have tended to establish independent technical groups that have been able to manage areas of public policy which required it. And if there are concerns that the technical experts might have their own agenda, let us recall that strong political control exists in these independent bodies too. After all, it is precisely the mechanism through which their objectives are set (whether relating to price stability, competition or public health) and which controls their effectiveness. But the mechanisms remain separate from the day-to-day politics.

Scientific knowledge and policy

The independence of technocracy is intrinsically associated with what are referred to as «evidence-based public policies» – in other words, the ability to use the best scientific and social knowledge available in order to develop public policies. We believe this to be quite a solid legacy of the current crisis: science, which in this case has led to the development of the vaccines, has been revalidated as a fundamental element of society. But we have to go further. Adhering to technical criteria must become a core attribute of public decision-making. There is still a long way to go, as the pandemic itself has shown (see the attached chart for a sample of countries), but democracies ought to be better placed to address this shortcoming.

Use of scientific advice on COVID-19 by politicians
Efficient policy will either be global or it will not exist at all

Another key element for the implementation of efficient public policies, and which adds weight to democracy’s claim to legitimacy, is that they must be designed within the appropriate geographical framework. In other words, if many of the public goods (and evils) which democracy pursues are of a global nature, then the optimal scale on which to tackle them will necessarily be supranational. Key policies for addressing structural change in relation to climate change or digitisation, for instance, must be designed with a global approach and global coordination. Typically, this requires an international framework for cooperation, and for us here in Spain the strongest of these is the EU. If guidelines are established within this framework which contradict local preferences, then political disaffection will grow. The complex solution involves finding common ground in the preferences of the different states and finding approaches to local implementation that allow room to adapt to national idiosyncratic factors. Are our democracies capable of achieving this complex balance? We cannot be too particular, nor do we want to be negative, but the challenge ahead is substantial and success may not be guaranteed. In our chromatic analogy, the outlook is a darker shade of grey than we would like.

Political fragmentation

Finally, it is time to delve into another controversial and complex issue, that of political polarisation and fragmentation. This has been one of the underlying factors in the tendency for blockages to arise that have a detrimental impact on decision-making processes. Of course, this is a fundamental issue to which a great deal of space and effort has been devoted in the pages of this Monthly Report in recent years. Our synthesis could be as follows: i) history concludes that political polarisation is present in many secular systemic political changes, and ii) the underlying factors which have fuelled an increase in polarisation in the past (in particular, technological change, globalisation, and demographics; perhaps also cultural factors) are active in our contemporary societies.

This does not mean that we are doomed to repeat the crises of the past. Structural factors restrict us, but they do not determine our fate, especially in societies that are fortunate enough to have a voice and a vote in the process. Churchill was probably right when he said that democracy is the worst form of government, except for all the others. In the same spirit, today’s liberal democracies are far from perfect, there is no doubt about it, but their quality and, above all, their potential for improvement should allow ways to be found to recover the indispensable common story that every society needs in order to build its future.

Álvaro Leandro
Àlex Ruiz
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