Global value chains: More a development strategy than a mere process Global Economic Outlook, Q4 2015

“Made in the world” perhaps describes the origin of most goods and services today, as they go through global value chains (GVCs) that cut across geographies. GVCs are set to benefit both developed and emerging economies as they enable firms and economies to participate more in global trade.

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Gone are the days when you could pick up a product and immediately relate it to the country of its origin. “Made in the world” is perhaps a better way of describing the origins of most goods and services we consume today. Indeed, production processes nowadays involve bits of manufacturing, services, capital, and labor-intensive inputs that are funneled and get traded several times in well-defined yet complex stages spread across geographies. Welcome to the world of global value chains (GVCs), a key component in today’s international trade ecosystem (figure 1).

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An interesting and unique aspect of GVCs is that they are relevant for both high-end products and services as well as relatively low-value-added ones. Ever thought about the origins of the cup of coffee that helped keep you awake for a meeting? Wondered where the beans came from, the logistics involved, the processing, the patent for the particular brand you sipped, and the accounting software that took care of the transaction? A GVC does not end when a product or service is created. Instead, the chain spreads across activities, starting right from conception to its end use and beyond.1

The rising prominence of GVCs is due in large part to the rapid advances in information and communication technology (ICT).2 ICT has also facilitated a sharp rise in services trade, a key component of all GVCs (see the sidebar “Increasing prominence of services in GVCs”). In fact, competitive services provide the ideal field in which the full potential of GVCs can be unlocked. The rapid spread of GVCs and services within them are having a profound impact on how trade is measured and analyzed in contributing to economies’ growth and development strategies. They are also influencing policy implications vis-à-vis trade in how best to set new rules of the road for the global—and now GVC-intensive—marketplace.

A country’s participation index is also another helpful indicator of GVC participation. It measures an economy’s role in a vertically fragmented production process.

GVCs have played a key role in global trade and growth

The spread of GVCs has aided the sharp growth in global trade and investments. Of course, trade agreements, including ones through the World Trade Organization (WTO) and its predecessor, General Agreement on Tariffs and Trade, have also helped. Nevertheless, greater exchange of goods and services would not have been possible without breaking down value chains across geographies. GVCs have enabled firms and economies to participate more in global trade and, hence, in greater value creation.

To support that point with solid data, however, is not easy given the difficulty in calculating value addition by firms and economies within GVCs. An economy’s contribution to a GVC, for example, is not reflected in total exports. Still, a few indicators come in handy. These include an economy’s participation index and the content of domestic value added in exports (see the sidebar “Measuring the value added by GVCs is an ongoing exercise”). For example, over 1995–2011, China’s domestic value added in exports recorded a compound annual growth rate (CAGR) of about 18 percent. As a result, China’s exports and GDP growth shot up during this period. A similar comparison across key economies highlights the contribution of GVCs to global trade, growth, and investments (figure 2).

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Increasing prominence of services in GVCs

Services are the “sleeping giant” of the global economy; their full potential is yet to be tapped. According to the World Bank, the share of value-added services in global GDP in 2013 was 70 percent, up from 61 percent in 1995.3 So it is not surprising that the role of services has also increased within GVCs, helping to expand existing GVCs and create new ones. In manufacturing GVCs, for example, there is a wide use of services such as:

  • Transport and warehousing, used to complement production
  • Insurance and banking at multiple stages
  • R&D, maintenance, and advertising at the beginning and end of GVCs

Thanks to ICT, services can be increasingly unbundled, digitally transported, and traded across the world. An example of this is the outsourcing of back-end transaction processing. However, services are often overlooked in the wider context of GVCs. Ignorance about activities such as logistics, accounting, and after-sales services as components of GVCs is one reason. Also, the role of services in GVCs has been underreported owing to the lack of comprehensive statistical techniques. In an attempt to solve this problem, the Organization for Economic Cooperation and Development (OECD) and the WTO have been trying to measure the value added at different stages of a GVC (see the next sidebar “Measuring the value added by GVCs is an ongoing exercise”).

 

Measuring the value added by GVCs is an ongoing exercise

To understand better the contributions of different players in a GVC, it is important to measure the value added at each stage. For example, China may export a smartphone valued at $194.04, although it may have contributed only $6.54 in value addition (figure 3). The rest are imports: design from a studio in the United States, software from India, a silicon chip from Singapore, and metals mined in Bolivia. Thus many countries benefit from the production of the smartphone, although traditional trade data often does not reveal this.

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Thankfully, the OECD-WTO Trade in Value Added (TiVA) initiative allows better measurement of a country’s value addition in exports.4 Work on this is still ongoing; data are currently updated until 2009–11. Measuring value addition also helps break a few myths. Traditional data show that China has high surpluses with the United States and the European Union, and a large deficit with Japan. When calculated in value-added terms, however, the surpluses and the deficit decrease due to high foreign content in China’s exports.5

A country’s participation index is also another helpful indicator of GVC participation. It measures an economy’s role in a vertically fragmented production process. The index is expressed as a percentage of gross exports and indicates the share of foreign inputs (backward participation) in exports and domestically produced inputs (forward participation) used in third countries’ exports.

Contrary to the infant industry argument, GVCs enable a grand alliance of businesses—large and small—in the global marketplace.

GVCs as a development tool

Back in the early 1980s, when China slowly opened its economy, it was an unknown frontier. As it started using the GVC network, the country transformed fast. Today, China is the world’s manufacturing hub and a key center of global growth. In this context, it is worth looking at a few numbers. In 1995, China’s participation index was 25.7; by 2009, it had increased sharply to 46.1. And during that period, China emerged as one of the world’s largest economies with a leading share in global trade (figure 4). China is not the only country worth quoting. Neighboring India has also fared well over the last two decades due to its participation in services GVCs. Policy liberalization in the early ’90s and a well-qualified English-speaking workforce also helped. But even with this progression for both China and India, there remain opportunities for further pro-growth policy liberalization enhancements.

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The emergence of GVCs as a route to economic progress ensures that countries need not wait for domestic champions to emerge to take on giant multinational companies. By linking to a GVC, businesses in a developing economy can tap opportunities, technology, and credit across the world. Contrary to the infant industry argument, GVCs enable a grand alliance of businesses—large and small—in the global marketplace. Moreover, in a world where technology and demand patterns change fast, GVCs help businesses to be nimble, thereby ensuring dynamism and sustainability. For example, as costs rise in India’s information technology (IT) sector, the Philippines can attract more call centers, even as Indian firms try to move up the value chain.6

The four-step GVC participation roadmap

The participation of economies in a GVC is based on numerous factors, including competitive advantage, trade policy, and growth objectives. As an economy undertakes measures to open itself up to international markets, it can use the GVC route to promote trade and attract foreign investments. The following steps, not always chronological, illustrate a few ways to tap into GVCs (figure 5).

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Step 1: Just tap it!

One step is to merely tap into relevant GVCs. Examples abound in Eastern Europe, Asia, and Latin America, where the first move of integrating with external markets has been to tap one small part of a GVC. For example, given its proximity to the United States and its membership in the North American Free Trade Agreement, Mexico first tapped into the auto supply chain. Today, Mexico exports more cars than any country except Germany, Japan, and South Korea.7

Instead of competing in all activities along a GVC, it may be prudent for economies to focus on one task (or a few). For example, certain service activities require less capital and infrastructure, thereby providing opportunities for developing economies. If these countries have a good low-cost knowledge base, they may turn out to be more competitive than developed economies. This is how Philippines initially came to global prominence in low-value-added IT-enabled services.8

Step 2: Why don’t you develop more expertise?

Another step is to develop expertise in a particular field. One way to do that is through the creation of sustainable industrial clusters. This helps small and medium enterprises (SMEs) tap into (mainly) the lower end of a GVC and avail the technological and managerial expertise of lead players in the GVC. Clusters also enable policymakers and other stakeholders to adopt modernization of practices within SMEs such as better accounting standards, upgrading of skills, social security, and environmental standards. Germany’s Mittelstand is a good example of how the country has leveraged the power of SMEs to develop expertise across key sectors.9 Others such as Bangladesh and Cambodia, with their large textile clusters, can draw important lessons from the German experience.

For example, the auto industry in India and China have hosted both foreign and domestic companies that have not only used inputs from local partners and suppliers but also catered to huge domestic demand. In 2010, China topped the United States as the world’s largest car market.

Step 3: Why wait there? Move up! 

GVCs often provide firms the opportunity to move up the value chain, either in partnership with lead firms or on their own. For example, South Korean firms have moved up the value chain in high-tech industries. As firms move up a GVC, they seek global reach to diversify their market and tap technology and financing opportunities. This, in turn, helps them capture more value. Acquisitions and stake purchases by Chinese and Indian businesses in Europe and the United States are cases in point.

Specialization and moving up a value chain are important for businesses eyeing the domestic market as well. For example, the auto industry in India and China have hosted both foreign and domestic companies that have not only used inputs from local partners and suppliers but also catered to huge domestic demand. In 2010, China topped the United States as the world’s largest car market.10

Step 4: Satisfied? Don’t be. 

While moving up GVCs in a sector is a good step for firms, it may not create sustainable gains for an economy. It could lead to concentration of economic power in a few successful firms (as in South Korea) or create vulnerability in a sector.11 In China, the global downturn of 2008–09 dented the country’s manufacturing-focused (export-dependent) growth model, thereby forcing it to turn to services and domestic demand for growth. Specializing in high-value-added activity across sectors also becomes important to address structural economic challenges, including demographics. For example, to ensure strong income growth for citizens and reduce the country’s dependence on low-skilled labor, Singapore is focusing on enhancing the productivity of industries across a wide range of sectors.12

Don’t forget the enabling factors

To utilize GVCs better, economies need to focus more on key enabling factors. First, economies need a pro-growth trade and investment agenda. Further liberalization of trade policy is critical through support for open and international markets. Asia, for example, has been (and will continue to be) a big beneficiary in this regard. The ongoing impasse at the WTO and multilateralism are worrying trends, but they are the political reality, and, as such, alternative approaches to trade expansion should be pursued. Indeed they are being pursued, through the proliferation of regional and bilateral accords that are working to bring economies closer together (for example, TPP, TTIP, RCEP) and updating specific sets of rules (as in services). Collectively, such initiatives can help—and are helping—make an international trade agenda that is fit for GVCs and a global system that is better able to deal with the demands of today’s global marketplace.

Second, countries also need a sound business environment to optimally utilize GVCs. A look at competitiveness and ease-of-doing-business rankings indicate that countries dominating the high-value-added part of GVCs also rank high in the above indicators (figure 6). Even for economies that do not make it to the top of the rankings, focusing on key components such as infrastructure have helped. For example, infrastructure is a big positive for China. Countries such as Indonesia and the Philippines are focusing ever more on infrastructure to attract investments in high-end manufacturing and services. Similarly, China would do well to create sound regulations and transparent institutions to promote services. Singapore’s experience might help in this regard.

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The APEC grouping is a standout in drawing the benefits of GVCs

The Asia-Pacific Economic Cooperation (APEC) is a forum of 21 Pacific Rim economies working together to promote economic integration and freer trade and investment throughout the region. It accounts for nearly half of global trade (figure 7).13 Currently, trade within APEC is focused on machine parts, high-tech electronics, and automobiles and related components. However, much of the opportunity for APEC lies in services and making service-related inputs embedded in products more competitive.

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The extent to which APEC economies are involved in a vertically fragmented production process can be seen from their participation indices (figure 8). As of 2009, Singapore and Russia had the highest backward and forward participation, respectively. Commodity exporters typically have high forward participation shares. The data also show that APEC countries have a much higher participation in GVCs compared with the European Union (figure 9). APEC countries have used the GVC engine to emerge as among the fastest-growing regions in the world, which include some of the erstwhile developing economies.

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APEC countries have also taken the lead in developing a charter on GVC development and cooperation. The charter focuses on the need to strengthen regional economic integration by removing impediments to trade and investment, enhancing supply chain connectivity, and improving the business environment. Key objectives include:

  • Better information sharing through single-window mechanisms
  • Improved data collection
  • Faster harmonization of procedures and regulatory requirements
  • Proactive efforts to remove non-tariff barriers

Indeed, enabling a more competitive GVC environment across APEC remains a top priority for leaders, if its objectives to create a more dynamic region are to be fully captured.14

Beyond the winners and losers debate

In the wider rhetoric of benefits from global linkages, talk of winners and losers overshadows the conversation. In developing economies, the arguments mostly pertain to the protection of domestic industries, while in developed markets, issues such as offshoring are sensitive as they are often linked to the loss of low-skilled jobs. In truth, much of such conversation does not take into cognizance the dynamic nature of GVCs and the advent of new technology that compensates for losses at one end with gains at the other. Policymakers should consider a focus on training, support for SMEs, and infrastructure development.

In addition, gains tend to happen in higher-value-added activity. For example, while there have been low-end job losses in the United States, the country has immensely benefitted by moving up the GVC in services. The domination of Silicon Valley in technology is a great example of this. In fact, the dynamic nature of GVCs opens up new opportunities for numerous entrants, even as other countries move up (figure 10).

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Data from TiVA reveal that GVCs have helped to lift all boats in the sea of international trade, and not some at the cost of others. For example, an analysis of the share in domestic value added in total exports for key economies shows us that the numbers have not changed drastically over time, especially in the last decade, even as total trade has shot up (figure 11).

 

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On a note of caution, tapping into GVCs without ensuring smooth interaction between different stakeholders may create problems. Here policymakers, nonprofit organizations, firms, and other key interlocutors at the high-value end of GVCs can play a major role. Ongoing dialogue to bridge differences not only enhances trust but also sets the stage for the exchange of information and technology that makes GVCs more efficient. It also serves as a platform to address and overcome local issues that may be hindering the GVC pipeline.

Interview with Anabel Gonzaléz of the World Bank Group

Sanchez-bio-blockThe authors are grateful to Anabel Gonzaléz, senior director of the Trade and Competitiveness global practice at the World Bank, who provided a few of her own insights on the GVC landscape. Previously, Gonzaléz served as Costa Rica’s minister of foreign trade.

Q. What is the new GVC paradigm all about, and why is it such an important area to note vis-à-vis countries’ economic growth agendas? What are the key takeaways for developed and developing economies?

Gonzaléz: While internationally fragmented production is not new, 21st-century GVCs represent the international flows of goods, services, people, ideas, technology, and capital, which together can boost employment and productivity across sectors in an economy. Instead of establishing the entire value chain domestically for an industry to become competitive internationally, developing-country firms can connect to GVCs by specializing in tasks where they have a comparative advantage. Subsequently, as they benefit from access to world-class technology, knowledge, and skills, developing economies can industrialize further by moving up the value chain. In developed economies, globally competitive lead firms use GVCs to carry out different tasks in the most cost-effective location. Firms, and countries, that don’t will likely struggle to compete.

Q. Trade policy is increasingly interlinked with GVC dynamics. Can you share some insights on how a pro-growth and active global trade agenda can better connect with GVCs, and what are some of the pitfalls to avoid? How can today’s proliferation of international trade and investment agreement negotiations consider GVCs as they work to set new rules of the road for the global marketplace? How does this fit with the advancement of the services agenda?

Gonzaléz: Tariff liberalization is, but naturally, important to bring down costs in a GVC world where imports are as important as exports. The same holds true for non-tariff measures, which are increasingly becoming the major impediment to participating in the world economy. We also must not overlook the fact that trade and investment openness are complementary in a GVC context, where the latter goes beyond eliminating FDI restrictions to fostering a sound business environment. This, in turn overlaps considerably with trade facilitation—another important item on the global trade agenda that influences celerity and, therefore, the ability of firms to connect to GVCs. Securing commitments across a number of trade-related (non-tariff) measures in international agreements can expand GVCs through their effect on policy certainty and the internalization of cross-border policy spillovers. Services measures are no different, given that transportation and banking services, for example, are important for the competitiveness of other exports.

Q. Considering your responses to questions 1 and 2, how does this mesh with the ambitions of the work program and current priorities for APEC?

Gonzaléz: International cooperation in the realm of trade and trade-related policies will need further consolidation. And with a slow-moving multilateral trade system, regional agreements and forums are often in the spotlight. As APEC further studies the possibilities associated with a future FTAAP [Free Trade Area of the Asia Pacific], it is worth noting that “deep” trade agreements that cover a range of non-tariff measures can underpin the continued expansion of GVCs. As a word of caution, however, there is the risk of divergent regulatory regimes segmenting markets and raising trade costs as well as limiting the diffusion of GVCs beyond nonmembers. Coherence between regional trade agreements and the multilateral trading system is therefore the need of the hour.

Q. The World Bank is obviously a key contributor to the GVCs discussion. Can you share some specific examples of how the bank is working with actors around the world to optimize participation in GVCs and what are some stories of success?

Gonzaléz: The World Bank provides analytical services to client governments—at times in collaboration with other development partners—including on linking GVC participation to growth diagnostics, conducting impact evaluations, and exploring the role of SMEs. It also targets capacity building through (1) technical assistance in the realm of trade and investment policy to governments, and (2) firm-level advisories, including on best practices in vocational training and management skills. Last, but not least, it provides financing when necessary through development policy lending, investment operations, equity financing of private sector firms, and innovative guarantee schemes for supply chain operators. Take, for instance, Bangladesh, where a combination of analytics/advisory services to firms and government, IFC credit lines and investments in firms, and World Bank lending is being used to improve the competitiveness of its garment sector.

Q. In your opinion, is today’s GVCs discussion just the tip of the iceberg as the world becomes ever more globalized and digitalized? If so, what comes next as it relates to movement of goods, services, capital, and people?

Gonzaléz: New technologies can bring down the costs of coordinating globally fragmented production further and push forward the development of GVCs as we know them today. Think of video and virtual reality conferencing, radio frequency identification technology, and cloud computing. At the same time, increased automation may eliminate low-skilled tasks that are easy to digitize and make the remaining tasks more skill- and capital-intensive. To the extent that this substitution occurs, technologies such as robotics and 3D printing will challenge the traditional GVC-based international division of labor. The reshoring of labor-intensive tasks may also be propelled by rising wages in China, high costs of doing business in low-income countries, and stagnant wages in developed economies. What about economic shocks? Energy price volatility and natural disasters, for example, can disrupt increasingly complex supply chain operations in an increasingly globalized world. The resulting losses to firms could, in principle, prompt a move toward near-shoring.