• 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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Risks in 2018: (geo)politics and international trade

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An analysis of political and geopolitical risks is becoming essential to reliably forecast the economic outlook. Tensions in these areas tend to have a significant impact on global macroeconomic performance, as well as on the ever-nervous financial markets.

According to the geopolitical risk (GPR) index developed by Caldara and Iacoviello, geopolitical tensions have increased in recent months (see the chart).1 This kind of indicator is very useful for assessing (and quantifying) the impact of geopolitical uncertainty on global economic performance. In fact, Caldara and Iacoviello estimate that a spike in tensions such as the one observed in recent months tends to lead to a decline in economic activity and lower asset prices, both real and financial, as well as increased financial volatility, largely due to greater uncertainty.

The escalation in protectionist political forces often lies behind this increased tension between countries, especially in the developed bloc. The so-called rise of populism. Macron’s victory in France and the unexpectedly poor results achieved by the far right in the Netherlands in the first half of 2017 may have eased Europe’s greatest fears. But in September the far right entered the German parliament for the first time since 1945. The far right also performed very well in Austria’s elections in October, while the populist and Eurosceptic billionaire, Andrej Babis, is the Czech Republic’s new Prime Minister.

Generally speaking, these parties may not have enough support to govern but they are already influencing the political agenda and this is very likely to continue over the next few years. This influence is most noticeable in the area of trade. There are two perfect examples of such influence: Brexit, and the protectionist policy President Trump is trying to implement in the US.

The United Kingdom’s withdrawal from one of the most prosperous free trade areas on the planet can be seen as a protectionist shift by the country. However, in recent months the UK’s bargaining position has appeared relatively weak and the country has little support for a hard Brexit. In fact, a reasonably far-reaching agreement in terms of free trade in goods and services and a transition period seem increasingly likely, what is known as a soft Brexit.2 Uncertainty, however, remains very high.

On the other side of the Atlantic, Trump’s «America First» brand of populism has already claimed a few victims. These are climate change, with the US abandoning the Paris Agreement; Iran, with potentially new demands regarding nuclear security; and also international trade, with the US abandoning the Trans-Pacific Partnership deal (TPP). There are also concerns regarding the outcome of negotiations to redesign the North American Free Trade Agreement (NAFTA), which began in summer 2017 and are expected to end at the beginning of 2018.

This agreement between Canada, Mexico and the United States, established in 1994, boosted North American economic relations. Trade flows between the three countries increased substantially, tripling in just a few years, a much higher increase than growth in trade with the rest of the world. And although it is very difficult to separate the ultimate impact of the treaty from the many different events of the time, such as the huge technological changes of the 1990s and 2000s and China’s entry into the international arena, estimates generally point to a distinctly positive effect.

In an economic bloc as strong as North America (which accounts for about 30% of world GDP and 12% of global exports), any final redesign of the Treaty that entails some reversal in trade would weaken global demand and could jeopardise the strength of the current expansion. In the long term, moreover, such a move would compromise the productivity gains achieved through these countries becoming more open to trade, something that the region and, in particular, the US cannot afford.

We believe the NAFTA renegotiations will ultimately be constructive, helping to modernise the agreement. But we cannot be sure. In particular, because the US has made it clear it wants significant changes in the Treaty’s conditions. Changes that allow it, among other things, to reduce the considerable trade deficit it has with Mexico. Changes to cope with increasing Asian competition by altering the «rules of origin». These determine which goods are entitled to preferential tariff treatment under the NAFTA, based on the percentage of intermediate inputs from the US, Mexico or Canada. At present the US believes they allow too many non-US inputs to enjoy the advantages of the free trade region. And the US also wants to lower existing barriers to trade in digital services. Demonstrating its willingness to push for far-reaching change, it has also proposed a sunset clause every five years if all three countries fail to ratify the agreement. As this would increase uncertainty and depress investment flows, we do not believe such an extreme proposal will succeed. However, there could be a compromise, such as the one proposed by Mexico a few weeks ago, in which the status of the agreement would be reviewed every five years.

Brexit, the NAFTA renegotiation and the US withdrawal from the TPP and TTIP (the agreement it was negotiating with the EU) may give the impression that the world is embarking on a new protectionist phase. But the truth is that, outside the borders of the US and UK, globalisation continues to expand steadily, with several significant multilateral trade agreements under negotiation or virtually signed.3 In November, for example, Japan, Canada and Mexico, along with the other countries in the original TPP, agreed to continue negotiations without the US economy. The US had been a key member for two reasons. First, because of its size. With the US, the countries under the umbrella of the TPP accounted for 40% of world GDP and around a quarter of trade flows. These figures fall sharply without the US but they are still relevant. For example, the remaining countries still account for an impressive 15% of world exports. Secondly, because the US was demanding high standards related to intellectual copyright and also in areas such as labour where, for example, it was demanding compliance with International Labour Organisation standards. However, the determination of the other countries to carry on is highly significant politically, sending a clear message in favour of continuing to work towards greater trade integration at a global level. They have also announced their intention to maintain high standards in the final agreement, which will probably be reached early in 2018.

A new trade agreement (the RCEP) is also being forged in Asia that will encompass 16 countries, including especially China, Japan and India, the region’s three largest economies. Although the RCEP cannot be considered a substitute for the original TPP, since it focuses only on reducing tariff barriers in a region where tariffs are already relatively low, the inclusion of India, a large economy whose tariffs are still high, has huge potential. We should remember that, 25 years ago, China hardly traded with its neighbours (and even less with the rest of the world) but is now the leading exporting power.

Finally, the group of countries that make up the EU is not missing out either. This year agreements have already been signed with Japan and Canada and negotiations are currently underway with the four founding countries of the Mercosur bloc (Argentina, Brazil, Paraguay and Uruguay), among others (see the diagram). The agreement with Japan not only sets up a free trade area that rivals NAFTA in size and scope but also sets very comprehensive standards and provisions regarding the environment, labour market and intellectual copyright, in line with the high degree of development of both countries. The agreement with Mercosur countries, however, does not aspire to be as broad in non-tariff and regulatory issues as the agreement with Japan or Canada, although it is relevant for many economic sectors (such as agriculture).

Trade’s centre of gravity is fast shifting from the Atlantic to the Pacific. The US tried to establish its industry regulations as international standards through the important economic treaties it was negotiating but now it seems to have renounced this aim, at least for the moment. This new situation must be seen as an opportunity for the EU which, providing it acts quickly and effectively, now has more leeway to influence the rules of global trade. China will not make this easy and another very likely obstacle is the potentially new US president in three years’ time.

Clàudia Canals

Macroeconomics Unit, Strategic Planning and Research Department, CaixaBank

1. The Geopolitical Risk Index counts the number of words related to tensions and geopolitical acts in the main newspapers. See https://www2.bc.edu/matteo-iacoviello/gpr.htm for more details.

2. For more information, see the Focus «Brexit, the road ahead» in MR10/2017.

3. In recent years, major multilateral agreements such as those that would result from the completion of the Doha Round, have given way to smaller multilateral agreements.

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