> Return to Network of Global Agenda Councils 2011-2012 report
After focusing on Regional and Preferential Trade Agreements in 2010-2011, the Members of the Global Agenda Council on the Global Trade System, chaired by Peter Draper, recognized that the evolution of global value chains is a very important, often misunderstood issue. Since involvement in global value chains offers the possibility of rapid export-led industrial development for developing countries, the policy implications for these countries need to be better specified. Council Members also identified a need for more accurate data about value creation along an evolving global value chain, which in turn would shed new light on national trade balance sheets. Consequently, the Council decided to consider these matters in more detail and to publish a report entitled The Shifting Geography of Global Value Chains: Implications for Developing Countries and Trade Policy. The report outlines the consequences of the global value chain transformation over the next decade and provides some recommendations. A short summary of the report is included below.
Two broad, contradictory trends are at work in the global economy. First, economic globalization through multinational corporation (MNC) production networks continues apace. This promotes global economic convergence and integration. The global value chains they operate have become the world economy’s backbone and central nervous system.
However, the second trend pertaining to economic crisis policy responses is one of divergence. It is the ever-present threat of a destructive spiral of protectionism and consequent disintegration, which would have serious consequences for the global economy, particularly the most vulnerable and trade-dependent states. This highlights the critical role the World Trade Organization (WTO) has played in stemming the tide of protectionism. Unfortunately, WTO member states remain unable to conclude the Doha Development Round, throwing the WTO’s continued centrality to the global trading system into sharp relief. Fortunately, the resilience and increased interdependence of the global economy also played a key role in containing protectionism: governments quickly realized the futility of discriminatory stimuli and the cost of raising barriers on intermediate goods on which whole segments of domestic industries depend.2
The increasing importance of global production chains is reflected in the rising trade in intermediate inputs, which now represent more than half of the goods imported by OECD economies and close to three-fourths of the imports of large developing economies, such as China and Brazil.3 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. As part of global production chains, 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 a significant portion of inputs – including intellectual property, brand-development, etc. – originally sourced at home; in developing countries, imports of components and machines are crucial vehicles for the absorption of technologies.
But fundamental changes to global value chains are afoot. In the next decade, the underlying cost structures driving value chain location could change dramatically. At least five drivers are evident:
- 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. The fracas over airlines associated with the EU’s emissions trading scheme is an early harbinger of the kinds of issues that may arise. Related to these pressures is the danger of growing trade protectionism. Collectively these cost pressures promote reductions in the “length” of value chains.
- Similarly, as new players from emerging markets secure access to various resources for input into production processes, so competition will increase and prices of those resources are likely to rise. Export restrictions designed to secure domestic supplies of key industrial inputs, if not properly regulated through the WTO, are also likely to intensify, placing further upward pressure on prices.
- China is at the centre of global value chains in manufacturing, particularly in labour-intensive sectors. But as China continues to shift its growth model away from reliance on exports towards domestic consumption, so wage costs are likely to rise sharply and the currency should continue its appreciation. Other domestic costs, such as land, are also rising. Hence the “China cost” is likely to continue mounting. By contrast, Chinese productivity growth is amazing, and the western provinces have hundreds of millions of workers eager to join the “new China”, so some caution is appropriate in predicting sharp changes.
- Information technology costs are likely to be driven lower through intense technological competition. Information technology promotes just-in-time and flexible production processes, critical elements of value chain operations, and enables the coordination of dispersed activities. This opens up opportunities for countries wishing to grab a slice of the value-chain action.
- Southern markets will continue to grow in relative importance, while growth in Europe is likely to remain structurally repressed for the foreseeable future. This is likely to drive value-chain reorientation and relocation, potentially in unpredictable ways.
Therefore the geography of value chain location is likely to shift, potentially fundamentally, within the next decade. This has huge implications for those countries that have specialized in value-chain niches, and for developing countries looking to secure new niches. This will play out differently in different contexts: developed countries are increasingly concerned about retaining jobs; some developing countries are looking to retain their existing value-chain niches while others are looking to plug into them.
Recommendations for Developing Countries and Trade Rules
It is clear that governments must recognize that exports are only part of the development story. Policy-makers must develop better measures of trade flows net of intermediate imports and more generally develop a better appreciation of how the economy fits into global production chains. A failure to do so can lead to inaccurate policy conclusions about the importance of bilateral trade imbalances, to significant underestimates of the cost of protection, and to a failure to appreciate the importance of bilateral or regional trading relationships. Generally, the existence of large and growing trade in intermediates, which is associated with foreign direct investment and the globalization of production, greatly raises the stakes for countries to have open and predictable trade and investment regimes, including efficient logistics. If they do not adopt this perspective, then “old” policy approaches can have serious consequences. For example, trade remedies often backfire by frustrating the efficiencies occasioned by intermediate trade, disrupting supply chains and costing domestic jobs when the aim of applying trade remedies is to save them.
This is inherently a unilateral perspective. The developments described here present challenges for industrial policies and require new thinking. While it may be attractive to some policy-makers and domestic constituents 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. For example, they point to the serious inaccuracies that occur when products and trade balances are classified as “high-tech” or “technologically intensive” with a view to drawing implications for industrial policies or indicating technological prowess. For instance, the United States is said to have large deficits in “advanced-technology” products with many developing countries, especially China. Yet the failure to appreciate that US imported products that are attributed to developing countries may actually contain large amounts of value added elsewhere – indeed in the United States – leads to seriously erroneous conclusions. More generally, the chains pose difficulties for industrial policies since industries have become more fragmented and unbundling suggests that they are not necessarily appropriate units for policy analysis. And the greater the number of times products cross borders in the course of their manufacture, the more significant trade facilitation policies become. If only 20% of the value of the final product is produced in a country, a 5% trade cost is the equivalent of a 25% tax on that activity.
However, an open trade regime is not enough on its own to benefit from insertion into global value chains. Countries must 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 preconditions, particularly in developing countries. MNCs pay close attention to these “softer” issues when taking long-term decisions about where to locate key aspects of their global value chains.
Currently the rules that govern global value chains 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 global nature of today’s production chains; the intermingling they imply of exports of services, goods, the movement of capital and of specialized workers; and the essential role played in them by efficient trade logistics, all point to the increased importance of comprehensive multilateral disciplines to facilitate the operation of such chains. Furthermore, trade and investment are two sides of the same economic coin; trade rules cannot work without investment rules – and vice versa.
Unfortunately our global trade rules fall considerably short of the 21st century, and our global investment rules are, alas, nearly non-existent. Furthermore, value chains evolved historically as southern export platforms to service northern markets, but now there are shifts in southern locations and increased targeting of other southern markets. Yet the Doha Round is largely 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. This argues for concluding the outstanding agreement on Trade Facilitation at the WTO as soon as possible, so that some of the logistical barriers to the operation of global value chains can be removed and the costs lowered. Despite the stasis in the Doha Round, a positive outcome on a Trade Facilitation Agreement would go very much in the right direction to facilitate the 21st-century paradigm of world trade.
These issues raise an obvious question: how can WTO rules be advanced in the absence of a conclusive multilateral trade round? In our Council’s perspective, the key is for the WTO’s membership to pursue plurilateral, or small group, negotiations under the auspices of the WTO.4 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 these problems with updating WTO rules, trade rules have advanced faster in PTAs or related vehicles, such as bilateral investment treaties. Production chains are even more intense at the regional level, and regional agreements can more easily deal with the complexity they imply – pointing to regional negotiations as an important complement to multilateral disciplines. Nonetheless, PTAs could add to transactions costs in the absence of multilateral disciplines advancing in the WTO. 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. In a world of supply chains, the least developed countries (LDCs) have increased opportunities to enter into processing activities, potentially on a large scale, but this implies their adding relatively small amounts of added value to any particular product. Under these circumstances, rules of origin that require 30% or 40% of local value-addition or an extensive array of local production processes, for example yarn-forward rules for clothing, may well preclude underdeveloped countries from taking advantage of such opportunities. This would mean that such assembly operations would not qualify under many rules of origin for preferential treatment. This demonstrates the need for rules, such as those developed in the African Growth and Opportunity Act (AGOA), that allow much greater use of imported inputs by LDCs.
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 also required. At the very least it 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.5
Report on The Shifting Geography of Global Value Chains
Taking into account the challenges outlined above, Council Members published a report entitled The Shifting Geography of Global Value Chains: Implications for Developing Countries and Trade Policy. The first chapter of this report was adapted and reproduced as a chapter of The Global Enabling Trade Report 2012.
Recommendations on the G20/B20 trade agenda
The Council Chair, Peter Draper, and Council Member, Professor Robert Lawrence, presented a series of recommendations to the Minister of Economics and Finance of Mexico, Bruno Ferrari, at the World Economic Forum Annual Meeting 2012 in Davos-Klosters to advance the trade debate in the G20. Council Members specifically proposed that the G20’s mandate should be revised to explicitly recognize the centrality of trade to the global economy. They also recommend that G20 trade ministers meet regularly – as do the finance ministers – and focus on the “beyond Doha” agenda incorporating inter alia plurilateral negotiations and PTAs. They finally suggest that the private sector, participating through the B20, could make an interesting contribution to G20 leaders if they reflect on the consolidation and shifts of global value chains and how certain trade policies, inefficient logistics and insufficient infrastructure are affecting their operations. The Forum’s Global Agenda Councils on the Global Trade System and on Logistics & Supply Chain are working together on these matters.
Supply chain approach to trade cooperation project
The strategic objective of the Supply Chain Approach to Trade Cooperation project is to introduce a supply chain approach to trade negotiations and cooperation by identifying and quantifying the impact of trade regulation and policies on the functioning of international supply chains.
This is a joint project between the Global Agenda Councils on the Global Trade System and on Logistics & Supply Chain, and the World Bank.
The opinions expressed here are those of the individual members of the Council and not of the World Economic Forum or any institutions to which they are affiliated.