The Shifting Geography Of Global Value Chains: Implications For Developing Countries And Trade Policy

World Economic Forum report on Global Value Chains

The Shifting Geography Of Global Value Chains: Implications For Developing Countries And Trade Policy*

Context

Two contradictory trends are at work in the global economy. First, globalization through multinational corporation (MNC) production networks continues apace. This promotes convergence and integration. The global value chains they operate have become the world economy’s backbone.

The second trend pertaining to economic crisis policy responses is one of divergence. Associated with this is the threat of a spiral of protectionism and consequent disintegration, impacting the most vulnerable and trade-dependent states in particular. This highlights the role the World Trade Organization (WTO) has played in stemming the tide of protectionism.

Unfortunately, WTO members remain unable to conclude the Doha Development Round, throwing the WTO’s centrality to the trading system into sharp relief. Fortunately, most governments realized the futility of discriminatory stimuli and the cost of raising barriers on intermediate goods on which whole segments of domestic industries depend.¹

The importance of global production chains is reflected in the rising trade in intermediate inputs, which now represent more than half of OECD imports and close to three-fourths of the imports of large developing economies, such as China and Brazil.²

Imported inputs also account for a significant chunk of exports, blurring the line between exports and imports as well as between domestic products and imports. Products at different stages of value added may be imported and re-exported multiple times, increasing the size of reported exports and imports relative to global and national value added. In advanced countries, this effect is reinforced by the fact that imports can contain inputs – including intellectual property, brand-development, etc. – originally sourced at home; in developing countries, imports of components and machines are crucial vehicles for absorption of technologies.

Shifting Geography of Value Chains

Fundamental changes to global value chains are afoot. In the next decade the underlying cost structures driving their location could change dramatically. At least five drivers are evident:

1. Energy and associated transportation costs are likely to continue rising as the cost of fossil fuels increases and policy measures targeted at carbon emissions intensify. These cost pressures promote reductions in the ‘length’ of value chains.
2. As new players from emerging markets secure access to resources for input into production processes, competition will increase and prices are likely to rise. Export restrictions designed to secure supplies of industrial inputs, if not regulated through the WTO, should also intensify upward pressure on prices.
3. China is at the centre of global value chains in manufacturing, particularly in labour-intensive sectors. But as China shifts its growth model away from reliance on exports towards domestic consumption, wage costs could rise and the currency continue its appreciation. Other domestic costs, such as land, are also rising. However, while the ‘China cost’ increases Chinese productivity growth is huge. Thus some caution is appropriate in predicting sharp changes.
4. Information technology costs are likely to be driven lower through intense technological competition. This opens up opportunities for countries wishing to grab a slice of the value chains action.
5. Southern markets will continue to grow in relative importance, while Europe is likely to remain structurally repressed for the foreseeable future. This is likely to drive value chain reorientation and relocation, in unpredictable ways.

Therefore the geography of value chain location is likely to shift within the next decade, with major implications that will play out differently in different contexts: developed countries are concerned about retaining jobs; developing countries are either looking to retain their existing value chain niches or others are looking to plug into them.

A recent report by the World Economic Forum’s Global Agenda Council on Trade³ explores these issues, and their implications for trade policy. We consider the political economy of value chains in different country and regional contexts; the forces promoting the ‘unbundling’ of production; how two companies in different manufacturing sectors are reacting to them; the role of services in manufacturing value chains and the emergence of services value chains in their own right; and the broader dynamics centering on growing trade in intermediate products.

Implications for developing countries and trade rules

Governments need to recognise that exports are only part of the development story. Policy makers need better measures of trade flows net of intermediate imports, and a better appreciation of how the economy fits into global production chains. Failure to do so can lead to inaccurate policy conclusions about bilateral trade imbalances, and to underestimate both the cost of protection and the importance of bilateral or regional trading relationships. The growing trade in intermediates, which is associated with foreign direct investment and the globalization of production, raises the stakes for countries to have open and predictable trade and investment regimes, including efficient logistics. ‘Old’ policy approaches, for example trade remedies applied to save jobs, may backfire disrupting supply chains and costing domestic jobs.

This is inherently a unilateral perspective. While to some it may be attractive to promote import replacement or restrict exports for industrial policy reasons, such policies will inhibit both trade in intermediates and inward investment into value chain niches. However, an open trade regime is not enough on its own to benefit from insertion into global value chains. Countries need to invest in horizontal policy measures, notably education, infrastructure, and technology transfer in order to enhance access to global value chains and the long-term benefits they offer. Domestic governance and institutional reform are also essential. MNCs pay close attention to these ‘softer’ issues when taking long-term decisions about where to locate key aspects of their global value chains.

Current trade rules are based on the notion that firms in one nation sell things to customers in another nation. Hence the rules framework concerns product-trade rather than process-trade. As such they do not account for a range of policies and barriers that do not inhibit selling things per se, but do hinder moving things.

This problem afflicts the WTO in particular, which has struggled to advance beyond its traditional focus on market access barriers to trade in goods. The nature of production chains that intermingle exports of services, goods, movement of capital and of specialized workers; and the role played in them by efficient trade logistics, all point to the importance of comprehensive multilateral disciplines to facilitate their operation. The WTO’s contribution potentially spans services, intellectual property, trade facilitation, and tariffs on imported inputs. Furthermore, trade and investment are two sides of the same economic coin; trade rules cannot work without investment rules - and vice versa.

Our global trade rules fall short of the 21st century, and global investment rules are, alas, non-existent. Furthermore, value chains evolved historically as southern export platforms to service northern markets, but now we are seeing shifts in southern locations and increasing targeting of other southern markets. Yet the Doha round is predicated on a north-south negotiating dynamic. As value chain relocation takes hold, driven by emerging market growth, so the new dynamics need to be reflected in how the WTO conducts its business.

How can WTO rules be advanced in the absence of a conclusion of the Doha round? Other approaches need to be explored, including plurilateral or small group negotiations under the auspices of the WTO⁴. The politics of this approach are challenging, but the systemic implications of continued stasis in the WTO are arguably worse.

Two further implications relate to services trade and investment. First, trade rules should be updated to promote modal neutrality in services trade and investment. Specifically, modes 1 (cross-border trade) and 3 (cross-border investment) should be open and therefore facilitate modal switching. Second, regulators need to promote regulatory coherence across borders so as not to establish bottlenecks in the value chain creation process. This could be done through the adoption of general or sector-specific principles, or both.

Given the difficulties with updating WTO rules, more progress has been made in PTAs and bilateral investment treaties. Production chains are even more intense at the regional level, and thus regional agreements can more easily respond to the challenge, complementing multilateral disciplines. Nonetheless, PTAs could add to transactions costs. Furthermore, PTA rules are based on an antiquated understanding of where goods are ‘from’ - hence the Byzantine networks of ‘rules of origin’.  But goods are now ‘from’ everywhere - because of global value chains.

Therefore new approaches to negotiating PTAs, with a view to making them more compatible with actual global value chain operations and ultimately WTO disciplines, are required. At the very least this suggests an approach rooted in reducing transactions costs, not raising new barriers to trade. A key question is how these ‘bottom-up’ changes could be incorporated into the WTO’s architecture. This is a subject our council has also previously considered, and the interested reader is referred to our recommendations in this regard.⁵

*Peter Draper: Immediate past chair and vice-chair, World Economic Forum Global Agenda Council on the Global Trade System

Council Members

¹Global Value Chains in A Post-crisis World: A Development Perspective (2010) Washington: The World Bank, PP10-11.

²Shimelse Ali and Uri Dadush (2011) ‘The Rise of Trade in Intermediates: Policy Implications’, International Economic Bulletin, Carnegie, February 10th.

³Available at http://www3.weforum.org/docs/WEF_GAC_GlobalTradeSystem_Report_2012.pdf

⁴See the council’s 2010 report on plurilaterals, available at
http://www3.weforum.org/docs/GAC10/WEF_GAC_Trade_Paper_2009-10.pdf.

⁵See the council’s 2011 report on PTAs, available at
http://www3.weforum.org/docs/GAC11/WEF_GAC_Trade_Paper_2011.pdf.