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By Professor Carlos A. Primo Braga

Economic globalization has been driven over time by a varying mix of technological progress, economic policies fostering outward-orientation, multilateral cooperation, and international politics. The expansion of global value chains (GVCs) has become an important aspect of the current stage of economic globalization, driven by new technological opportunities and the old benefits of economic specialization. Although GVCs can play an important role in the structural transformation of developing economies, the capacity of such countries to benefit from GVCs should not be taken for granted. These networks are quite sensitive to policy disruptions at home and abroad, to geography and to non-economic considerations (e.g., quality of country branding).

Moreover, trade rules (particularly at multilateral level) are currently not well matched to the needs of GVCs. As Baldwin (2012) points out, GVCs require a different style of trade rules and cooperation, which calls into question the relevance and ability of WTO rules in disciplining this dynamic component of global trade.1

Global Value Chains: A Primer

GVCs entail a series of interconnected markets for goods and services through which goods are produced outside the boundaries of the “final” firm. These networks rely on the unbundling (i.e., the slicing of tasks) of different stages of the production process.

GVCs have spread with great dynamism in industries where the slicing of tasks is easier, such as electronics/ICT, automotive and garments. Although the complexity, dynamism and “thickness” of these GVCs vary significantly across industries and regions, they do share some common characteristics:

They are dominated by Northern transnational corporations (TNCs);

They underscore the interdependence between trade and foreign direct investment (FDI) policies;

Their dynamism is greatly influenced by a different array of trade policies involving logistics, trade facilitation, technical barriers to trade, rules of origin, and commercial services (e.g., transport and distribution);

These networks are prone to display “small-world” properties in the sense that local disturbances can have global effects, and they can exhibit “tipping-point” characteristics beyond which systemic dislocation can be orders of magnitude greater than the size of initial shocks;

Foreign value-added in exports can be used as a proxy of the upstream involvement of a country in GVCs. But to get a full picture of a country’s dependency on GVCs one should also look into the extent to which the relevant exports are integrated further into international production networks (downstream perspective).

UNCTAD currently estimates that roughly 80 per cent of global merchandise exports are linked to TNCs, either in the context of intra-firm trade, or via non-equity modes of international production (contract manufacturing, licensing …), or arm’s length trade in which TNCs are involved.

As a general rule, countries with a higher presence of TNCs tend to display a higher GVC participation.2 At the same time, GVC participation is positively correlated with the degree of openness of the economy and the quality of its infrastructure and logistics. But despite their “global” tag, GVCs are mainly organized at regional level. The main trade hubs for intermediate goods components are organized around three main regions: an Asian pole structured around hubs in China, Japan, Singapore, Hong Kong (China) and Taiwan (China); a North American pole structured around the USA, Canada and Mexico; and a European pole around Germany.

Policy implications

GVCs will become increasingly influential in determining future trade and FDI patterns, as well as growth opportunities. The obvious question for policy-makers is how best to frame strategies that will facilitate a dynamic insertion of local companies into GVCs. In theory, the rise of GVCs is fostering an environment that facilitates convergence (i.e., economic catch-up) for countries that have the proper macro and regulatory environment. After all, GVCs involve the offshoring of factories/tasks from the North, promoting the transfer of technology and links between local firms and dynamic TNCs. Moreover, they lower barriers to entry to the international market as firms can specialize in tasks within GVCs instead of having to develop the whole chain of production to contest foreign markets.

In practice, however, there are different styles of engagement with these networks. At one extreme are countries whose firms specialize in tasks that rely on low-wage/unskilled labor and that have limited opportunities to benefit from technology dissemination and skill upgrading. At the other extreme are the so-called “headquarter” economies that host the hubs of GVCs, which exercise market power and control the knowledge-intensive tasks of the network.

In this context, it is important to identify not only how to make a country attractive for location of nodes of GVCs (i.e., integrating into GVCs), but also how to facilitate upgrading opportunities over time. Upgrading can involve enhancing domestic value-added (i.e., increasing the “thickness” of the domestic economic links of the node), capturing more nodes of the GVC network (i.e., upgrading within GVCs), and diversifying the number/sophistication of GVCs operating in the country (i.e., upgrading across GVCs).

Firms participating in these process benefit from adopting higher international production standards, engaging in process upgrading (e.g., by managing support services required for the GVC operation and the preservation of brands, including the adoption of best practices in CSR), and functional upgrading (e.g., by performing more sophisticated engineering and R&D functions).

In pursuing a strategy that promotes both integration and upgrading one should keep in mind the following:

Business as usual is not enough. Having solid fundamentals at macro level, reasonable infrastructure, a liberal trade policy, and a favorable investment and regulatory climate are necessary, but not sufficient conditions. Particularly with respect to GVC upgrading, the host country has to offer an innovation eco-system that facilitates technology dissemination and skills upgrading. In this context, the quality of the intellectual property rights regime is a key variable;

Not all GVCs are born equal in terms of their implications for industrial upgrading at country level. On the one hand, there is evidence that firms participating in GVCs associated with machinery and equipment tend to converge more rapidly to productivity patterns prevailing in industrialized countries than firms in GVCs associated, for example, with textiles and clothing. On the other hand, targeting sectors with higher productivity pay-off will not necessarily bring sustainable development as these sectors may not generate enough job opportunities to unleash substantive structural transformation and economy-wide convergence;

GVCs do not respond well to piece-meal approaches to policy change. It is important to adopt a “whole of the supply chain” approach addressing, for example, border management constraints, technical barriers to trade, and transport and distribution services. One of the main levers for GVC upgrading can be a well-designed policy of services liberalization since GVCs are particularly sensitive to the quality of commercial services available to its nodes;

GVCs can suffer from “bullwhip” effects (reflecting quicker adjustments in production and inventories), reacting faster to external demand shocks than is the case for arm’s length trade.3 As a consequence, disruption and recovery can occur much faster than usual and it is important not to overreact to these shocks;

GVCs greatly increase the premium on coherence of domestic policies. If trade and investment policies are not consistent, this will constrain the chances of expansion and upgrading.

In sum, GVCs offer a new opportunity for firms and nations to benefit from globalization. At the same time, relevant trade rules are still being negotiated mainly in the context of mega-preferential trade arrangements such as the US-led Trans-Pacific Partnership. This not only magnifies the risk of further eroding the relevance of the multilateral trade system, but also of antagonizing some of the large emerging economies (e.g., the BRICs) that are less open to engage in trade negotiations with “headquarter economies” such as the US, the EU and Japan. This tension may magnify the risks of a “cold trade war” as the world economy continues to grapple with the effects of deleveraging and fiscal austerity in response to the financial crisis.

1 See Baldwin, R., 2012, “WTO 2.0: Global governance of supply-chain trade,” CEPR Policy Insight No. 64 (December).

2 See UNCTAD, 2013, World Investment Report “Global Value Chains: Investment and Trade for Development”. New York and Geneva: United Nations.

3 See Altomonte, C., F. Di Mauro, G. Ottaviano, A. Rungi, and V. Vicard, 2012, “Global Value Chains During the Great Trade Collapse: A Bullwhip effect?” ECB Working Paper Series, No 1412 (January).

Carlos A. Primo Braga is Professor of International Political Economy at IMD, and Director of the Evian Group@IMD. This article relies on a paper prepared for the seminar “Markets, Democracy, and Transition,” organized by EBRD and the Growth Dialogue, Istanbul, 9 May 2013.