Global Value Chains and Trade in Value-Added: New Insights, Better Policies

Ken Ash - March 2013


Speed Read
  • The high shares of intermediate inputs in world trade in goods and services is due to the growth of global value chains
  • Global value chains reduce costs and raise productivity enhancing competitiveness.
  • The OECD and WTO’s new value added database reveals that trade in services play a far larger role in manufacturing trade than indicated by conventional trade statistics.
  • Multilateral and regional trade and investment agreements will need to reflect the existence of global value chains to include action to increase competition and investment.



As world markets have become increasingly integrated, businesses are spreading their chains of production across the globe. Instead of producing goods in locations near major suppliers or consumers, multinational firms are 
benefiting from the sharp falls in transport and communication costs over the past two decades to establish global value chains (GVCs) across several countries.

 

One indication of such production fragmentation is the rising share of intermediate inputs in world trade. These inputs to the production process now represent 56 percent of trade in goods and 73 percent of services trade.

 

This trend presents new challenges for economic analysis and policy-making in developing and developed countries alike.

 

 

Global value chains lower costs

In many industries, global value chains have lowered the costs of production of the final goods and increased productivity of associated labour and capital. This has created an opportunity for developing economies as international firms offshore segments of their production chain to countries where labour is cheaper or where other benefits of a location confer a competitive cost advantage.  One such advantage is speed. Every day of delay in the movement of goods in the value chain raises the price to the final consumer and diminishes competitiveness.

 

Lengthy procedures for exports and imports hamper the ability of firms to enter export markets for the growing range of products – even in labour intensive sectors - that are particularly time-sensitive. Many developing countries urgently need to shorten lead times though streamlining administrative procedures and improving logistics in order to stay competitive in these sectors.

 

In some countries the time needed for administrative procedures related to exports and imports prevents local manufacturers from exporting time-sensitive products. For entrepreneurs in these countries time-consuming red tape and inadequate logistics constitute a substantial disincentive to invest in quality and to upgrade their products, since they cannot meet the reliability requirements typically found in markets for new and differentiated products. Consequently, firms are confined to the domestic market and to exporting commodities and low value-added standard products where customers are less demanding. Importing thus has to be as efficient as exporting, and services have to be competitive. 

 

Participation in GVCs confers considerable benefits. It may allow suppliers in developing countries to meet standards and regulations that give them access to rich country markets; it may allow imports under privileged tariff treatment for intra-firm trade; it may permit the utilisation of network technology that would not otherwise be available; and it may open up new sources of capital.   These elements together with sustained improvements in policy environments help to explain why developing countries have sharply outpaced high income countries in economic growth over the last quarter century.

 

In a world of GVC-dominated trade where production is allocated to the location with lowest cost, countries that try to industrialise through import-substitution are unlikely to reduce their costs to the point of being competitive on global markets. Quite the contrary. Tariffs and other barriers to trade are cumulative when intermediate inputs are traded across borders multiple times. Firms pay tariffs on their imported inputs and then face tariffs again on the full value of their exports, including on those same inputs. Tariffs can add up to a significant level by the time the finished good reaches customers, stifling demand and affecting production and investment at all stages of a value chain.

 

 

Trading success depends on imports of inputs 

Success in international markets today depends as much on the capacity to import world class inputs as on the capacity to export. Protection measures against imports of intermediate products increase costs of production and reduce a country’s ability to compete in export markets. Policies that restrict access to foreign intermediate goods and services also have a detrimental impact on a country’s position in regional and global supply chains.  Where foreign investment is a driver of export capacity, the cumulative effect of a number of seemingly small costs may discourage firms from investing, or from maintaining investment, in the country and may lead them to establish production facilities, technologies, and jobs elsewhere.

 

GVCs create opportunities for fast growth, but they also raise the penalties for maintaining inefficient border procedures, for imposing high tariffs and non-tariff barriers, for failing to allow information to flow smoothly or to lift impediments to foreign direct investment and restrictions on the movement of people.  Participants in GVCs can be powerful allies for reducing trading costs as they also share a political interest in reducing policy-induced delays and inefficiencies in the value chain.

 

New database reveals importance of services

There would be no GVCs without well-functioning transport, logistics, finance, communication, and other business and professional services to move goods and coordinate production along the value chain. A new Trade in Value-Added (TiVA) database launched by the OECD and WTO in January 2013 reveals that services play a far more important role in global trade than suggested by the standard measurement of gross flows of exports and imports. The TiVA initiative shows the value added by a country in the production of any good or service that is then exported, and offers a fuller picture of commercial relations between nations.


The value created by services as intermediate inputs represents, on average, over 30% of the total value added in manufactured goods (see Fig. 1). Liberalisation of services trade would allow for more efficient and higher quality services, thus enhancing the competitiveness of manufacturing firms and allowing them to better participate in global production networks.

 

 

Global value chains are changing the patterns and structure of international trade. Reaping their full benefits will require adjustments that go beyond the realm of trade policy to include action to increase competition and investment. Multilateral and regional trade and investment agreements will need to reflect the fact that goods and services are now from “everywhere,” rather than, as they are defined today, from “somewhere.”

 

Domestic firms can of course benefit from export opportunities, but they also depend on reliable access to imports of world class goods and services inputs in order to improve their productivity and their competitiveness.

 

But the gains are even greater when more countries participate and markets are opened on a multilateral basis. GVCs strengthen the economic case for advancing negotiations at the multilateral level, as barriers between third countries upstream or downstream matter as much as barriers put in place by direct trade partners and are best addressed together. A successful illustration of this approach is the 1997 Information Technology Agreement (ITA) which covered as many products and as many countries involved in the IT value chain as possible. The ITA also highlights the benefits of applying the Most Favoured Nation principle in plurilateral agreements, which eliminates ‘red tape’ related to rules of origin and their potential distortions on trade.

 

Sound economics is one thing; political feasibility is another. While multilateral agreements are widely accepted as the best way forward, most of the liberalisation outside purely unilateral opening has occurred at the regional level in the past two decades. To promote the expansion of GVCs, regional trade agreements (RTAs) are more effective when their membership is consistent with regional production networks. They also have a role to play in deepening integration provisions: the convergence of standards or the recognition of qualifications can start bilaterally or regionally. But the RTAs of the future should be careful to avoid the pitfalls of distorting firms’ choices and losing the connection with the rest of the value chain. More liberal rules of origin, for example, would make regional trade agreements more GVC-friendly and increase their impact on firms’ productivity. In the longer term, consolidating and multilateralising RTAs would help turn the spaghetti bowl of preferential agreements into a clearer and more efficient trading regime for all actors in GVCs.

 

Trade agreements must recognize Global Value Chains

Trade agreements have the largest impact if they cover as many dimensions of GVCs as possible. While abolishing tariffs is a starting point to offer companies new trade opportunities, the value chain also requires efficient services as well as the movement of people, capital and technology across countries. Policies should address obstacles at all points of the value chain and remain neutral between trade and investment, letting firms decide which mode is better for accessing foreign inputs and foreign markets. Multilateral agreements covering not only goods but also services, investment, competition, intellectual property and the temporary movement of workers are likely to create an environment where firms can build efficient supply chains. Such a comprehensive approach would amplify the impact of trade liberalisation on investment, growth and job creation.

 

The OECD is at the forefront of analysing what GVCs imply for government policies. It is clear that conventional wisdom on economic globalisation risks becoming outdated. We can no longer base policy analysis and decisions on conventional trade statistics that report the gross value of products and services each time they cross borders.

 

In addition to trade policy, public and private investments to upgrade supply side capabilities and the ability to exploit new market opportunities are also needed. Investments in people are particularly important – education and skills training, active labour market policies, and social safety nets are key ingredients in an effective package of complementary policies.

 

GVCs will have far-reaching policy implications. They should encourage us to have a more ambitious trade and investment agenda. And they should lead us to think about a host of other policies that will require adjustment in the interconnected world we live in today.