• 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 effects of the illiberal shift: little evidence, much concern

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In 1972, at the historical dinner at which Richard Nixon and Zhou Enlai endorsed the restoration of diplomatic relations between the US and China, someone asked the Chinese premier about his opinion regarding the French Revolution of 1789. After a long pause, he replied, «it is too early to say». While it is likely that the reliability of this anecdote is dubious, like many that surround famous quotes, we do believe that it is applicable to another quieter and less media-covered revolution that does not involve barricades or shots fired from the Bastille, which we have called here the illiberal shift. As we shall set out below, it is perhaps still too early to assess its effects, but unlike Zhou Enlai, we do believe that there are sufficient elements to warn of the risks it entails. Without further ado, let us address these issues one by one.

Effects of the illiberal shift: limited evidence for the time being

When we analyse whether the change in the extent of aggregate illiberalism, as set out in the article «The illiberal shift in economic policy: let the data speak!» of this Dossier, has an impact on key macroeconomic variables, the results are inconclusive. If the increase in the illiberal shift corresponded with a deterioration in potential growth, we would be in a position to state that the shift affects economies’ baseline. However, there is no statistically significant relationship between the two variables. A second hypothesis could be that illiberalism eroded inflation expectations. Here, once again, the data do not support this premise. Finally, could it be that, despite not hindering growth or price stability, it could have an impact on the perception of country risk? Again, the change in the level of country risk in the countries studied does not appear to be caused by the shift towards illiberalism. In other words, investors are not clearly inclined to consider countries that have embraced the illiberal agenda as being inherently riskier.

If we abandon our measure of aggregate illiberalism as an explanatory variable and we use the various measures
that approximate the illiberal shift in the seven spheres mentioned above (as a reminder: illiberal competition policy, macroeconomic illiberalism, restrictions to international trade, restrictions to foreign direct investment [FDI], restrictions to immigration, anti-multilateralism and illiberal industrial policy), the results barely improve. Thus, neither the expectations of long-term growth nor inflation seem to have changed due to variations in the level of illiberalism in any of these spheres, and only the increase in the level of country risk seems to be related to variations in some of these spheres. Specifically, in countries where parties have proposed introducing measures that restrict FDI in one way or another, there has been a movement in the country risk indicators that seems to point towards a more negative assessment among investors. However, given that the causality in this field is complex, and the number of observations low (it is an aspect on which many parties and countries do not express an opinion in their political programmes), this result should be taken with a pinch of salt.

In short, the empirical evidence is inconclusive as to the effects of the illiberal shift. However, a dismissive attitude towards the possible negative effects of this shift could be misguided. To make further progress in this regard, it is important to understand why the data may be hiding risks for future prosperity.

Why do the data not show any significant effects of the illiberal shift?

First of all, our inability to identify an economic effect may be due to there being two types of discontinuities operating between cause (illiberal shift) and effect (impact on the economy). The first would be due to the fact that the process of policy implementation is complex. A change in preferences (which is what we are able to measure with our methodology, which, remember, is based on the reading of electoral programmes) may not lead directly to a shift in economic policy in the same direction and with the same intensity. It could be, for instance, that parties propose an illiberal agenda in order to win elections but then, once in government, they end up carrying out a more orthodox economic policy (for example, due to pressures from international investors or the existence of an institutional system that acts as a counterweight to illiberal tendencies).

All in all, it is true that, generally speaking, changes in preferences tend to be reflected in new economic policies or variations of existing ones. Even if this is the case, a second discontinuity between cause and effect might be at play: given that many of the measures in which this departure from the liberal consensus materialises are of a structural nature, in many cases it is likely, quite simply, that insufficient time has passed for the new policies to have a significant effect.

Little room for complacency in the face of the illiberal shift: a coded reading of risks

How should we interpret the above results (or, strictly speaking, the lack thereof)? Any hint of complacency must be immediately discarded. Although the empirical evidence has not found clearly negative macroeconomic effects, as stated previously, it may be only a matter of time before they begin to emerge. Furthermore, we do not know the counterfactual situation: the fact that a country implements a clearly illiberal agenda with no noticeable change in its potential growth tells us nothing about what might have happened if its economic policy had remained liberal (it could, for instance, have grown more).

However, we must place another possibility on the table, and this is a conclusion that as economists we may find unsettling: it may be that the effects of an illiberal agenda might not be as negative as one might expect. Here we enter into intellectual quicksand and we must proceed with caution. For starters, we must remember that there is some consensus on the fact that the first-order economic principles, which we set out in the article «Illiberal forms of economic policy: evolution or radical change from the existing consensus?» of this Dossier, can be tailored to different circumstances. As such, they could take different forms for countries at different stages of development.

The most representative case in this field is the study of emerging countries. Many countries, particularly those in Asia, have opted to keep certain strategic sectors protected until they have been deemed ready to withstand international competition.

However, tailoring the principles is very different to revoking them altogether. This is illustrated by the case of the heterodox economic policies that were followed in different Latin American countries in the 1970s and 1980s, or in Venezuela in this century. These policies led to major macroeconomic imbalances that ended up destabilising these economies and generating a significant deterioration in economic well-being.

All in all, besides startling errors like those set out above, and assuming that we are talking about countries with a comparable level of development, could it be that illiberalism sometimes works, from an economic perspective? The literature on the economic effects of populism, which has parallels with the kind of intellectual reflection we propose to the reader here and which is still at an early stage of academic development, suggests that a key element is determining what type of restrictions are removed by unorthodox policies.1 A part of the liberal economic policy agenda focuses on restrictions, whether technocratic (an independent central bank, fiscal rules, etc.), or external (for instance, opening up to international capital involves fiscal discipline). If the restrictions removed are ones that certain power groups had previously established for their benefit (for instance, not all forms of integration into globalisation are neutral, as there is evidence that they sometimes reflect the preferences of certain economic sectors rather than those of the population as a whole), then there could be an efficiency gain. Therefore, the paradox is that an illiberal measure could enable the recovery of a situation that the liberal consensus was originally seeking to achieve and which, to some extent, had been perverted.

However, even if this is the case, the bottom line is that this temptation to break free of restrictions is often fraught with danger. It could end up wearing away at the limits on which reaching consensus has taken so much effort and of which the benefits are backed by ample evidence. As a very clear example: it took nearly two decades for the majority of emerging countries to have independent central banks, yet this independence is being sacrificed at an alarming rate in countries that, until recently, were considered exemplary. Are we playing with fire?

Moreover, and what follows suggests an even more serious risk, it should be borne in mind that the rupture of the liberal consensus has implications that go beyond the strictly economic sphere. In a society in which the seed of illiberalism germinates, it is difficult to imagine that the illiberal temptation will be constrained to the sphere of economic policy, and this poses the risk of an anti-democratic trend. History reminds us that whenever there has been a shift that has significantly eroded pluralist, democratic and liberal norms, the path followed has ended badly. Let us hope that this Dossier, with its attempt at characterising and measuring the phenomenon, provides a small contribution to a fundamental debate which we cannot afford to get wrong.

Álvaro Leandro and Àlex Ruiz

 

1. See R. Dornbusch and S. Edwards (1991). «The Macroeconomics of Populism in Latin American». Chicago: University of Chicago. And D. Rodrik (2018). «Is Populism Necessarily Bad Economics?» AEA Papers and Proceedings, vol. 108, p. 196-99, for instance.

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