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Multiple crises threaten global value chains

We have seen a lot of recent headlines on global value chains (GVCs), mainly due to the COVID-19 pandemic, but also due to the convergence of several crisis events: The Russian-Ukranian war, inflation, food shortages, unwinding asset bubbles, debt crises in developing countries, and lingering effects of COVID-19-related shutdowns and supply chain bottlenecks. All these events contribute to increasing uncertainty and conflict. 

By Mark Knell, Research Professor, NIFU

The production process has become increasingly organized within GVCs. Outsourcing and offshoring became increasingly important in the 1970s and 1980s. By the 1990s, enterprises began dividing the production process between different countries and specializing in certain tasks. 

In 2020, the World Bank estimated that more than two-thirds of global trade was transacted through GVCs, where production will typically cross many borders before being assembled. Global networks of suppliers often support these multinational firms, offering tangible and intangible value-adding activities such as R&D, design, production, marketing, distribution, and support to the end user.

Cooperation and innovation

Cooperative production was one of Adam Smith’s greatest insights. In Smith’s view, increased labour productivity can be achieved by improving workers’ dexterity, reducing switching time between different tasks, and introducing new machines and organizational forms. 

Market size determines specialization and productivity growth for a particular commodity. International trade was vital in the argument because it overcame the narrowness of the domestic market, allowing tasks to be divided into clearly defined tasks. 

Over time, GVCs developed as tasks were specialized across countries, allowing businesses and organizations to develop differentiated knowledge and unique capabilities. This paralleled the rise American big business in the late 19th and early 20th centuries, when large vertically integrated corporations carried out the majority supply-chain activities and the “visible hand” of management replaced Smith’s invisible hand of the market. Alfred Marshall describes this knowledge as an externality that generates benefits either directly through innovation networks or indirectly through spillovers. 

Global value chains are not new, but their importance has grown over time, according to Chris Freeman. The digital revolution made it possible to organize value chains and build innovation networks. International trade in intermediate goods and services also grew rapidly. 

Upgrading technology

Technology upgrading is important for the GVC story. In classical theory of production and international trade, this becomes apparent when firms, regions, and countries shift from low-value to high-value activities. An upgrade can consist of matching the standards set by international buyers, satisfying strict logistic conditions and lead times, or providing a larger portfolio of products.

Focus is on tasks rather than product levels, allowing countries or regions to functionally specialize in those value chain stages in which they have a comparative advantage. In developing countries, these value chains play a growing and especially key role in accessing knowledge and enhancing learning and innovation. Developed countries tend to specialize in high-value-added intangible-intensive tasks such as R&D, management, and marketing.

Global co-learning

GVCs can also generate economic growth is by spurring a region or country’s global knowledge connectedness. 

The GVC literature has primarily focused on the upgrading opportunities that global knowledge connectedness generates for suppliers in developing countries. GVC linkages can help these suppliers to improve their technological capabilities by exposing them to new information and knowledge that can influence their dynamic learning paths and boost aggregate economic development. 

Current GVC literature emphasizes the centrality of tasks, linkages, and firms in the global economy. Researchers look at GVC-oriented policies that aim to upgrade economies to higher value-added tasks, and improve technological and operational capabilities through interfirm linkages. There is a need for upgrading local suppliers, ensure fair treatment of workers, adopt environmentally sustainable business practices, and build resiliency. 

New policies

These discussions have exposed a new set of market failures that provide a potent narrative for new policy rationales. These policies require a systemic approach that covers various domains including innovation, trade and industrial policy, infrastructure, education and training policies, and service provision. 

They also require assessing the heterogeneous impact of policies on firms, workers, and other stakeholders and considering both national and sub-national differences as well as supra-national concerns. And they extend far beyond the market-enabling interventions of the Washington Consensus, and often entail a vertical and selective approach.

Crisis after crisis

This shift in economic, trade and innovation policy thinking has been strengthened by the recent shocks to the global trade system.  The COVID-19 pandemic affected many industries, with tourism and travel being the obvious example, but it was also responsible for reshaping the perception of risk in international business and contributing to debates about relocating supply chains from East Asia to European locations.

During the pandemic, the rapid shutdown of the European economy created both demand and supply shocks. Lockdowns and job losses directly impacted demand; however, the rigidity and lack of resilience of modern supply chains led to supply chain disruptions, which adversely affected demand.

Supply chain disruptions led to a shortage in the availability of everyday commodities, a recurring risk for many businesses. The pandemic revealed the rigidity of supply chains in the face of crises, but it also illustrated how technological change is occurring rapidly in global supply chains. Technological lock-in is particularly likely to occur in R&D and design-intensive fields, such as aerospace and semiconductors. 

The pandemic was followed by more shocks, in particular the Russian invasion of Ukraine. This war has, for instance, affected the global food and energy supplies, created a new demand for military equipment, and created more uncertainty among investors. It has strengthened the desire of some governments to keep advanced technologies out of the hands of potential enemies. Russia is already blocked of from much of the global trade in advanced electronics, and the US is continuing to curtail China’s ability to compete in the semiconductor field. 

The global economy has experienced a mix of supply shocks and demand shocks since the pandemic began. Certain industries and regions experienced shortages and supply disruptions early in the pandemic. The automotive industry stopped production, the semiconductor industry shifted production toward chips for computers and games, and consumers shifted their spending to durable goods. Inflation can be cost-push or demand-pull and my guess is that it is still being driven mainly by supply disruptions in particular industries. In this context, monetary policy may not be very effective.

 Indeed, it is the complexity of these systems that makes it so hard to predict what might happen and what policy choices to make.

Suggested reading:

Gereffi, G 2018. Global value chains and development, Cambridge University Press.

Milberg, W and Winkler, D. 2013. Outsourcing Economics: Global Value Chains in Capitalist Development, Cambridge University Press.

Ponte, S., Gereffi, G. and Rej-Reichert, G. eds. 2019. Handbook on Global Value Chains, Edward Elgar.

Illustration: Forskningspolitikk Midjourney AI