Global Value Chains: Is the Growth Engine Stuttering?

Motor Technology ©

Motor Technology ©

The global division of labour has contributed to prosperity worldwide. However, the internationalisation of global value chains seems to be losing momentum. A variety of factors is accountable for this – some bad, such as rising protectionism, and some good, such as digitalisation. All underline: The rules book for global trade and investment is in desperate need of modernisation!

Today, economies are closely interlinked through investment, knowledge exchange, and division of labour. Production processes extend beyond national borders; the production steps are often spread across many companies and several countries. Global value chains allow business to utilise the strengths of various locations. It also allows them to realise efficiency gains through international economies of scale. This makes it possible to operate more productively and often more sustainably.

Prosperity through International Integration

The globalisation of value chains would not have been possible without the end of the Cold War and the fall of the Iron Curtain. The creation of the World Trade Organisation (WTO), with the extension of the rules book to trade in services, trade related investment measures, and the protection of intellectual property, served as further important impetus in 1995. The same holds true for the accession of China and Russia to the WTO. Between 1990 and 2018, global economic output almost quadrupled (a factor of 3.7), although the world population only grew by a factor of 1.4. Over the same period, global trade flows increased disproportionately by a factor of six. The extent of cross-border economic cooperation becomes even clearer when looking at foreign direct investment (FDI): Stocks of FDI have increased by a factor of 14 since 1990 (UNCTAD).

The structural change in the global economy has contributed to the fact that millions of people have been included in industrial value creation and freed from poverty. According to the World Bank, the proportion of people living in extreme poverty has fallen from 36 percent (1990) to ten percent (2015).

Germany is also a clear winner of globalisation: according to the WTO, 43 percent of Germany’s net exports are embedded in global value chains. In its Global Value Chain Development Report 2019, the WTO also concludes that Germany is one of the three hubs of global value chains, alongside the United States and, increasingly, China. The success of German industry is therefore largely based on the openness of the German economy and the deep integration of industry into international value chains. One important reason is that the more technologically complex products are, the more relevant international supply and production networks become. And German value creation takes place particularly in these technology-intensive economic sectors.

De-Globalisation Trends since 2008

However, the globalisation of value chains seems to be losing momentum. The ratio of trade in goods to world GDP serves as a simple indicator, since the former largely consists of trade in intermediate products (according to the WTO, about two-thirds of world trade takes place within global value chains). Between 1970 and 1990, the ratio rose moderately from 19 percent to 30 percent and then steeply to 51 percent in 2008. Since then, the trend has been slightly declining; in 2018 it stood at only 46 percent.

Cause 1: Structural and Technological Trends

On the one hand, this is caused by economically unproblematic developments, such as the relative increase in structurally less trade-intensive services, compared to classic industrial production value added in GDP. Another, positive and rather welcome, economic trend is the increasing digitalisation of industrial production. In many industries, new technologies, such as 3D printing or selective laser melting (SLM), promote the relocation of production steps. At the same time, however, digitisation facilitates coordination in global value chains, which makes the division of labour more attractive. The net effect of technological change on global value chains is therefore open.

Cause 2: More Value Added in Emerging Markets

Another factor is technological advancement in major emerging markets. China, in particular, is becoming more technologically independent and is increasingly producing high-tech inputs itself rather than importing them. At the same time, the country is also moving up in technology-intensive value-added steps in areas previously dominated by industrialised countries. This is a positive development for the global economy. However, the closer China approaches Europe’s technological level, the more intense the competition between German and Chinese firms on the world market will become.

Cause 3: Protectionism and Nationalism

However, there are also economically damaging developments behind the decline in the integration of global value chains – and these have political roots. The foreign trade policy of the U.S. government under President Donald Trump is only one aspect of a global trend towards protectionism and economic nationalism. According to WTO data, at least 1,594 new trade-restrictive measures (such as tariff increases or import bans) were adopted by WTO members between October 2008 and May 2019. The subsequent trade distortions entail significant welfare losses. Innovative strength and potential are also damaged, as the world’s best minds cannot compete or cooperate at full optimum with each other.

Global Value Chains Challenge Politics

Changes in cross-border production networks and supply chains are not necessarily a threat to the German economy if they are caused by market developments. If resulting from government intervention and unfair global competition, they become a problem, however. The German government and the new European Commission must do everything in their power to combat protectionism. The reform of the WTO and the conclusion of new free trade and investment agreements are urgently needed. In addition, the global trade rules book needs to be modernised to create an environment that allows new technologies such as 3D printing to flourish, including rules for digital trade.