Aircraft assembly line, accumulation of parts from across the world
Image: Xenotar via iStock photo.

What Are Global Value Chains and Why Do They Matter?

Production has become fragmented into networks of firms and workers across multiple locations, and has important implications for industrial development.

Global value chains (GVCs) refer to international production sharing, a phenomenon where production is broken into activities and tasks carried out in different countries. They can be thought of a large-scale extension of division of labour dating back to Adam Smith’s time. In the famed example attributed to Smith, the production of a pin was divided into a number of distinct operations inside a factory, each performed by a dedicated worker. In GVCs, the operations are spread across national borders (instead of being confined to the same location) and the products made are much more complex than a pin.

Cross-border production has been made possible by the liberalization of trade and investment, lower transport costs, advances in information and communication technology, and innovations in logistics (e.g. containerization). While cross-border production itself may not be new, it has expanded rapidly in many industries in recent decades. This development has largely been driven by transnational corporations (TNCs) in industrialized economies, which continuously restructure their businesses and reorganize/ relocate their operations for reasons of competition. The manifest example of relocation is the offshoring of labour-intensive stages of production from industrialized economies to low wage, labour abundant developing countries. Business operations are, however, also reshuffled among industrialized economies.

In addition to activities being sliced up and dispersed geographically, one feature that distinguishes GVCs from earlier waves of cross-border production is that production activities are also increasingly being undertaken by third parties with no equity links to the TNCs (in what is otherwise known as international outsourcing). In this regard, TNCs have consolidated their international operations in segments of industries reflecting their core strengths. They have also grown more powerful by controlling and coordinating their international production networks which consist of multiple firms. One estimate suggests that GVCs ‘governed’ by TNCs account for 80 per cent of world trade each year.1

Countries can participate in GVCs by engaging in either backward or forward linkages. Backward linkages are created when country A uses inputs from country B for domestic production. Firms in country A can source inputs from country B through direct as well as indirect imports, i.e. inputs are either supplied by local affiliates of TNCs from country B or by locally owned firms that import inputs from other countries. Being able to source foreign inputs is particularly advantageous if the inputs required for production are either not available locally or available but deficient in some aspects (e.g. quantity, quality and price).

Forward linkages are created when country A supplies inputs that are used for production in country B. The goods produced in foreign countries may be final products (for local consumption and investment) or intermediate products which are exported further elsewhere for use as inputs. Being able to produce and supply inputs for production to firms in other countries can be especially important for developing countries seeking entry into new industries and that are in the process of learning how to produce goods (however simple) for export markets. These inputs are, however, equally important for industrialized economies that supply complex, specialized and high value inputs. A case in point is China which accounts for 80 per cent of world production of ballpoint pens, but has had to import the pen tips required for production from Japan, Germany and Switzerland – the few countries that actually know how to properly produce pen tips.2

Products cross several borders in GVCs in different stages of production before they are turned into final goods. As such, trade in intermediate goods, which require further processing and are used as inputs for production – is often used as a proxy measure of GVCs. Since 1995, intermediate manufactures have consistently accounted for around half of manufactured exports and imports at the global level, providing evidence of the existence of GVC trade.

Intermediate goods in total manufacturing trade imports

Intermediate goods in total manufacturing trade exports

The performance is uneven across regions. Africa and Oceania (led by Australia and New Zealand) export more intermediate goods as a share of their manufactured exports than others. This is unsurprising given that the majority of their manufactured exports are resource-based goods ranging from minerals to agricultural products which are used as raw materials for production. Asia and Europe import more intermediate goods as a share of their manufactured imports) than other regions for a number of reasons taking into account the share of their intermediate exports. Europe’s intermediate imports and exports are more balanced than Asia’s, suggesting that the region may be importing relatively ‘generic’ intermediates for further processing into more ‘specialized’ intermediates.

By contrast, Asia imports noticeably more intermediates than it exports. This suggests that the region is more involved in ‘assembly’ than it is in processing intermediates into final products. An Asian Development Bank Institute study reports that China exported Apple iPhones to the U.S. at a unit price of US$ 179. Of each unit’s total value of US$ 179, approximately US$ 172 consisted of costs for imports of foreign inputs or parts (mostly from Japan, the Republic of Korea, Germany and the U.S.), i.e. the value added in China only represented US$ 6.5.3 China has since made some gains in relation to its efforts to move from being the final assembly point for components produced elsewhere.

GVC participation does not only lead to positive outcomes. Some of the risks include potential breakdown in social cohesion, erosion of labour welfare and environmental degradation, risks that are not confined to countries whose governance and regulatory capacities are weak. There is furthermore the risk of widening economic gaps between countries as a result of the division of labour. Countries participating in GVCs, for example, may find themselves locked into low value added activities in the long run. Furthermore, GVC participation increases local economy’s exposure—albeit not necessarily its ability to cope with—external shocks. In the aftermath of the phasing out of the Multi Fibre Agreement, the apparel industry in a number of African economies including Kenya, South Africa and Lesotho, experienced job losses and negative wage growth.4

Aerial view of cargo containers
Image: kokouu via iStock photo.

Notwithstanding the risks, GVCs represent a relatively attractive and straightforward option for countries seeking to industrialize. Due to the international fragmentation of production and unbundling of operations, countries no longer need to create complete products or value chains. Instead, they can create targeted industries by “inserting” themselves into a particular stage of production along the value chain that suits their existing level of capability. There are other benefits to participating in GVCs. Supplying inputs to firms that export raises the prospects of countries (especially those with a small domestic market) to rapidly achieve economies of scale. Production for exports contributes to economic growth, job creation, income generation and tax revenue. Participating in a GVC also opens considerable opportunities for knowledge transfers (and leakages) between firms. Such transfers may lead to industrial ‘upgrading’, resulting in the improvement of product quality, facilitating operations and processes, and fostering involvement in higher value activities in production. 

One common approach for developing countries to integrate into GVCs is by attracting foreign direct investment (FDI) through TNCs. There are numerous examples demonstrating that the presence of TNCs can transform host countries’ export profiles. In the 1990s, massive FDI (led by Intel) in the electronic components and parts segment boosted Costa Rica’s electronics industry. The top 5 exports of Costa Rica in 1995 were apparels, food and beverages, chemicals, machinery and equipment, and rubber and plastics. By 2016, the country’s top 5 exports included precision and optimal equipment, radio, television and communication, and electrical machinery and apparatus (all of which are segments of the electronics industry). Overall, the share of high-technology products in Costa Rica’s manufactured exports rose from 21 per cent in 1995 to an all-time high of 84 per cent in 2013, before retracting to 62 per cent in 2016.

Industry share of total manufactures exports (2016)

Manufactures exports by technology intensity (%)

Countries that decide to participate in GVCs as a vehicle for growth and development must plan their strategy accordingly. GVC strategy can be divided into three main components. The first is seeking integration into GVCs. This often involves identification of suitable tasks and activities within a targeted industry. Regardless of whether FDI is used as a means to achieve GVC integration, countries must have reached a minimum threshold in terms of local skills and infrastructure to participate in GVCs. The second component entails improving a country’s GVC participation once GVC integration has been successfully achieved.5 This typically requires efforts to improve the absorptive capacities of locally owned firms, the efficiency of local supply networks and the quality of the workforce. The third component focuses on pursuing sustainable development outcomes from GVC participation in terms of equitable distribution and environmental protection.

References

  1. UNCTAD. (2013) World Investment Report 2013. Geneva: UNCTAD.
  2. Taylor, Adam. Finally, China Manufactures a Ballpoint Pen All by Itself. The Washington Post 18 Jan. 2017.
  3. Xing, Yuqing and Detert, Neal. (2010) How the iPhone Widens the United States Trade Deficit with the People’s Republic of China. ADBI Working Paper 257. Tokyo: Asian Development Bank Institute.
  4. Bernhardt, Thomas. (2013) Developing Countries in the Global Apparel Value Chain: A Tale of Upgrading and Downgrading Experiences. Working Paper 22. Manchester: Capturing the Gains, University of Manchester.
  5. OECD-UNIDO. (2019) Integrating Southeast Asian SMEs in Global Value Chains: Enabling Linkages with Foreign Investors. Paris: OECD.