GVC trade and the case for domestic economic policies

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    Today’s trading patterns are marked by global supply or value chains (GVCs) which forces policy makers to focus more and more on domestic economic policies that lie outside the traditional scope of trade barriers.  

    Global value chains

    In today’s world, production and trade takes place among multiple stages of a chain stretching many country participants around the globe. This encourages countries to specialise in a so-called ‘slice’ of the global value chain (GVC) which can be either at beginning, middle or end of the production process. For some analysts, GVCs opens a new area of wide research trying to understand new types of trade patterns across the globe. For others, trade in GVCs are nothing new, just a refinement of what we have actually seen in the last two decades. Regardless of these two opposing views, GVCs does however, force us to think beyond traditional trade barriers. Since splitting up the value chain prompts trade and production to be much more intertwined with each other than before, policies that countries implement for production directly impacts their GVC trade in conduction. Almost all countries participate in global supply chains through various industries in which they specialise. However, where exactly countries are positioned within the so-called wider GVC map with respect to trade and production remains to a larger extent an open question. Are countries really taking part in these value chains in different ways? If so, where are countries located within the overall spectrum of supply chains with regards to production and trade? Even more importantly, what does the location within the GVC mean for the set of policies each country pursues in order to take advantage of GVCs? These are questions that occupy many policy makers across the globe in developed as well as developing economies. Each of these countries’ priority is to reap greater levels of domestic value-added through these supply chains but how they determine which set of policies to focus on is largely unknown. Much depends on where countries are located on the map of supply chains.

    Where on the GVC map?

    On the one hand, countries can measure their location by the extent to which they participate in intermediates inputs trade. Since specialisation only takes place in a ‘slice’ of the entire chain, a country has to import for its exports whilst producing in between. This means that many inputs are imported only to be processed domestically so as to ‘add’ value to the input, which then in the next stage are shipped abroad. Some countries are participating in this intermediate inputs trade much more than others. Looking at the characteristics of countries, unsurprisingly many small open countries are naturally doing well in transhipping many inputs to and from abroad. For instance, countries such as Luxembourg, Slovakia but also Singapore and Taiwan score relatively well in intermediate inputs trade. Countries such as Turkey, the US, the EU (as a whole) but also South Africa and even Indonesia show relatively lower intermediate inputs trade compared to other countries. On the other hand, countries can also assess their location with respect to specialisation. This line of the GVC map relates to the side of production within the chain. The location of production matters a great deal since not all countries are involved in the same type of chain production where the value is added. The supply chain can be relatively long and depending in how many slices the chain is broken into, a country can produce in the relatively early, middle or later stages of the production chain. Looking at what countries look like, one could think that developing countries are placed at the beginning whereas richer countries are located at the end of the production process. However, that depends. Australia is rich and yet located relatively far away from final demand. Brazil is an emerging county but nonetheless located at the early stages of the chain production. In these two cases, both countries are resource-rich yet different in income-levels. Obviously then, many factors related to the level of development, size but above all underlying economic structures all play a role where in the chain a country has its slice of production and hence where it consequently trades.

    Room for policy?

    Is there room for policy? Actually, uncovering a country’s location on the GVC map is important as it can provide important policy guidance. This is because policies can influence the way in which countries are willing to ‘shift’ within GVCs. More importantly, with the rise of GVCs in recent years, various so-called ‘new’ policy measures going beyond traditional trade policy which are otherwise more related to production, have precisely become important factors for the slice in which a country produces and hence, trades. Examples of these new policy areas include investment barriers, labour market inefficiencies, or various obstacles to innovation. Hence, all these barriers which are usually key to production have now in addition, become important for trade within GVCs. Yet the scale and scope of these various policies for each country very much depend where a country produces and how many foreign inputs this country uses. Indeed, analysing what defines the high extent of a country’s intermediate inputs trade, policy factors such as human capital, product market regulations and logistical barriers do all explain high or low levels of this intermediate inputs trade. Some of these factors are unsurprising as there is a long trade literature that has indicated that most of these factors indeed do explain trade before the notion of GVC came in place. They are nonetheless important and precisely those smaller countries that depend on much intermediate input trade could prioritise the relative importance of removing these barriers. But there is more. There are additional factors that also explain high levels of intermediate inputs trade such as product market regulation, logistical barriers or factors related to R&D spending and the innovation climate. These categories are non-standard to the field of trade policy and seem to require further attention from policy makers as to how these measures can accommodate the smooth going-in-and-out of the many inputs countries trade. A different set of non-trade-related policies are also found to matter for the pattern of specialisation (i.e. production) in the chain. Factors such as ICT-capital or ‘knowledge’ capital, labour market flexibility or competition policy all seem to matter whether one produces at the beginning or at the end of the production process. Another example includes an effective competition policy which appears to matter more for countries at the early stages of the supply chain. Some of the policies influencing the location of production in the chain are more familiar to the world of trade policy. For instance, FDI restriction in both goods and services are strongly connected to production specialisation at the beginning of the value chain which also appears to be the case for services trade policies.

    What do we know?

    As one can see, there are many factors influencing a country’s position regarding where they are located within the range of GVCs in which they take part. Since participating in supply chains both affect production and trade, some of these factors are related to the traditional trade barriers whereas others are more connected to production. One issue that stands out is that both trade and domestic economic policies do matter in tandem with each other as supply chains forces us to think in terms of the narrow slice in which both policy aspects are intertwined. Policy makers would do well to understand where their respective economies are placed with regards to which specific supply chain and which policies can optimally increase the domestic value added so a country can reap. Moreover, GVCs are not static and countries follow a dynamic process in which they upgrade by moving up and/or down the supply chain to further increase value added. The set of policies that determine both production and trade, both traditional and non-traditional to trade, can further help these countries to move inside the chain. Undoubtedly other factors also play a role in explaining a country’s location regarding GVCs. However, more research will need to be done in order to explore these issues. This analysis has modestly introduced the many existing policy measures that are found and used to assess as to what affects GVC trade, but other policy disciplines which seem harder to quantify also matter. For instance, more and more industries are experiencing a so-called 'servicification' of the production process which requires the optimal allocation of information, often implying cross-border data flows. When more policy measures are at hand for economists to analyse, policy makers will be able to further scrutinise which domestic economic policies are in addition important for GVCs. Reference: Marel, E. van der (2015). Positioning on the Global Value Chain Map: Where Do You Want to Be? Journal of World Trade, 49(6): 915-950. About the author Dr. Erik van der Marel is Senior Economist at the European Centre for International Political Economy (ECIPE), Lecturer at the Université Libre de Bruxelles (ULB) and Consultant to the World Bank’s Trade and Competitive Global Practice.
    This article was published in GREAT Insights Volume 4, Issue 6  (December 2015/January 2016).

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