• 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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Illiberal forms of economic policy: evolution or radical change from the existing consensus?

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In 2018, on the occasion of its 175th anniversary, the weekly publication The Economist stated that: «Liberalism created the modern world, but the modern world is turning against it». This is no light statement, coming from the publication that has embodied a liberal vision of society, politics and the economy come hell or high water. But is this really the case? In this Dossier we will analyse, from different angles, whether economic policies are shifting away from what, broadly speaking, could be considered orthodox practices and what might be the causes and effects of this shift. With this goal in mind, the logical starting point for this first article of the Dossier is to try to precisely define what we mean when we talk about the «emergence of illiberal forms of economic policy».

An attempt at a definition: what are illiberal policies?

In order to understand what we refer to as illiberal (economic) policies, we must first define what we mean by liberal economic policies, since they will serve as our frame of reference. We will then be able to assess the extent to which the economic policies of recent years diverged from this framework.

The essential idea is that there is a reasonably broad and consolidated consensus among economists about what characteristics are shared by economic policies that predominantly improve countries’ economic prospects, both in the short and long term. Far from any simple and universal recipe («do this and the economy is certain to grow more in the long term»), there are a few general principles that are sufficiently common across the board. This is what Rodrik (2005) refers to as first-order economic principles, and they can be defined reasonably accurately by collating a broad series of contributions from across the economic literature of recent decades.1 In particular, these principles emerge from reviewing three major areas of academic work: that which rethinks and modernises the economics of development,2 that which guides the transition towards a market economy in the former planned economies3 and, finally, that which draws conclusions on how economic policy should change as a result of the lessons learned from the Great Recession of 2008-2009.4

So, what are these first-order principles of economic policy on which there is a reasonable consensus? In general terms, we can identify four major areas:

The markets for productive factors and for goods and services have to be competitive, since this is the primary mechanism for generating efficiency in an economy.

The macroeconomic and institutional framework has to generate an environment that facilitates stability, since such stability offers conditions (credibility, the anchoring of expectations, the reduction of uncertainty, etc.) which improve the prospects for growth, both in the short and long term.

Integration into global flows of goods, services and factors is essential in order to improve the prospects for creating prosperity. This integration also has to be as «undirected» as possible.

The critical long-term economic policy is that of supply, and it has to be coherent with the two previous principles. For example, an industrial policy that tries to select specific sectors or firms (picking winners) tends to be less effective than a broader industrial policy that addresses competitiveness factors that are common to most sectors.

These principles generally share a liberal approach to understanding what the best way for an economy to function is, namely the conviction that growth is the best way to increase prosperity for society as a whole.5 Thus, in this article, as in many others, we categorise this set of principles as the liberal consensus on economic policy.

Therefore, if these are the characteristics or, to be more precise, the principles which guide a liberal approach to economic policy, a departure from them will entail an increase in the degree of illiberalism (a new term that first appeared in the 1990s). In other words, in this Dossier an illiberal economic policy will be understood as one which is significantly removed from all or some of the principles set out above.

A moderate or radical shift from the core principles?

At this juncture, an important question is to what extent this illiberal departure merely represents a more or less pronounced evolution in the consensus or, on the other hand, something more disruptive. Answering this question, however, is no easy task. As the economic literature has highlighted, there are multiple variants of economic policy that can all be considered liberal.6 One example, within the principle of macroeconomic stability, would be everything related to central banks. A fundamental truth in this field of macroeconomic stability is that such stability is difficult to achieve without a framework for monetary stability, and in order to attain such monetary stability it is considered essential to have an independent central bank. The specific institutional manner in which this independence is established is not predetermined, with the system of the Fed and that of the ECB offering just two of many different varieties that do not alter the aforementioned principle. Similarly, monetary policy can be implemented in different ways. For instance, the goal of the Fed, as expressed by the mandate assigned to it by Congress, is to support three objectives: to achieve price stability, to achieve the highest possible level of sustainable employment and to have a moderate long-term interest rate. In contrast, in the case of the ECB only the first variable is considered essential. No one disputes that both alternatives allow their respective institutions to contribute to ensuring macroeconomic stability.

Up to this point, there should be little debate: two distinct institutions with two different policy mandates can be equally liberal. In contrast, a more controversial matter could be assessing the unconventional monetary policy followed by many central banks after the financial crisis. In 2016, the Centre For Macroeconomics,7 a British institution, asked a panel of economists about the role and consequences of unconventional monetary policy. The responses confirmed the division that this topic generates. As an example, some interviewees stated that these unconventional policies were quasi-fiscal interventions that could end up damaging the independence of the central banks. These are strong arguments that would place these practices at the limit of the liberal consensus, if this were the opinion held by the majority and there were evidence to support it.

Beyond the personal views of the authors of this article (we cannot resist expressing that, in our view, unconventional monetary policy, as it has been implemented up until now, is a practice that falls within the principle of seeking macroeconomic stability in the liberal manner set out above), what is important is to understand the difficulty in the real world of objectively judging whether a particular economic policy approach is liberal or not, especially if it is not an extreme approach. In order to avoid, insofar as possible, the subjective biases that are inherent to a value judgement, in the next article of the Dossier we will quantify in a reasonably precise manner the extent to which this departure from the liberal consensus is occurring. Only then can we say that we are entering unknown territory, that of illiberalism, and begin to reflect on causes and consequences, two questions that we will explore in articles three and four of this same Dossier. At the risk of revealing too much (spoiler alert), we can say now that the departure from liberalism, which has occurred in a relatively short period of time, is significant and, in our opinion, should not be taken lightly.

Álvaro Leandro and Àlex Ruiz

1. See D. Rodrik (2005). «Growth strategies». Handbook of Economic Growth, 1, 967-1014.

2. In addition to Rodrik, also see J. Williamson (1990). «Latin American Adjustment: How Much Has It Happened?». Washington, D.C.: Institute for International Economics; J. Williamson (2000). «What Should the World Bank Think about the Washington Consensus?» World Bank Research Observer, 15(2): 251–64. And A. Saad-Filho (2010). «Growth, poverty and inequality: From Washington consensus to inclusive growth». New York, NY: UN.

3. See T. Besley, M. Dewatripont and S. Guriev (2010). «Transition and Transition Impact: A Review of the Concept and Implications for the EBRD». Report for the EBRD’s Office of the Chief Economist.

4. See J.B. Taylor (2010). «Getting back on track: macroeconomic policy lessons from the financial crisis». Federal Reserve Bank of St. Louis Review, 92(3), 165-176. O. Blanchard, G. Dell’Ariccia and P. Mauro (2010). «Rethinking macroeconomic policy». Journal of Money, Credit and Banking, 42, 199-215. And W. White (2009). «Modern macroeconomics is on the wrong track». Finance and Development, 46(4), 15-18.

5. This conception of the economy does not fit into the redistributive mechanisms that must be articulated once the objective of increasing the well-being of society as a whole is achieved.

6. In this regard, see Rodrik (2005), who has developed the idea of «one common principle, many feasible institutions».

7. Survey available at https://cfmsurvey.org/surveys/future-role-unconventional-unconventional-monetary-policy. «The future role of (un)conventional unconventional monetary policy», The CFM Surveys, June 2016.

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