Global Value Chains under Pressure

Motor Technology ©

Motor Technology ©

The global division of labour has enabled worldwide gains in prosperity. But even before the corona pandemic, the interdependence of global value chains seems to have lost momentum. This is linked to protectionism that has been spreading worldwide for years. At the same time, digitalisation fuels structural changes. In both areas, the European Commission and the German Federal Government must work to establish sustainable and future-oriented rules.

Modern economies are closely interlinked through investment, knowledge exchange and division of labour. Production processes extend beyond national borders; production steps are often spread among many companies and multiple countries. Such global value chains allow the strengths of various locations to be optimally utilized and efficiency gains to be realized. This enables a more productive and often more sustainable production process. Without globalized value creation, our todays level of prosperity would not be possible.

Prosperity through International Interlinkage

An important precondition for the globalisation of value chains was the opening of many national borders for trade and investment, which gained momentum after the fall of the Iron Curtain. As a result, global economic output almost quadrupled between 1990 and 2019 (with a factor of 3.8), although the global population grew only with a factor of 1.5. In the same period, global trade flows increased disproportionately by a factor of five. The extent of cross-border economic cooperation becomes even clearer when looking at foreign investment: here, according to UNCTAD, stocks have even increased by a factor of 14 since 1990.

Globally operating industrial companies have strong production networks worldwide: supplier networks, foreign branches on-site, joint ventures. The structural change in the global economy has contributed to the fact that over the course of globalisation, millions of people have been included in industrial value creation and lifted 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 in globalisation. Hardly any other country has experienced income increases due to globalisation comparable to ours (Bertelsmann/prognos). The reasons here are multifaceted. The success of German industry is based on the openness of our economy and the deep integration of German industry in international value chains. This makes Germany, alongside the United States and China, one of the three most important centres of global value chains (WTO). According to data of the World Trade Organisation (WTO), 43 percent of net exports from Germany are made possible by participation in global value chains.

De-Globalisation Tendencies since 2008

However, the globalisation of value chains seems to be losing momentum. The trend of growing world trade has indeed continued in principle over the last decade; nonetheless, when comparing world trade to global production (global GDP), it is clear that world trade is losing relative importance for the world economy (World Bank). This ratio rose from 19 percent (1970) to 30 percent (1990), up to 51 percent in 2008. Since then, the trend has slightly declined, with the ratio standing at 46 percent in 2018. If we examine the entire trade – including the global exchange of services – a similar development can be observed as a slightly higher level. For example, trade in goods and services in relation to GDP amounted to around 27 percent of GDP in 1970, rising to around 39 percent in 1990; this increased to 61 percent in 2008, with stagnation ever since (in 2018: 59 %).

However, this trend is by no means evidence that the global mode of production has not proved itself to be useful or that globalisation is scaled back. There are several reasons behind changing global value chains.

Cause 1: Structural and Technological Trends

First, goods that require less physical trade, such as services, are gaining in importance for the global economy. Digital services are playing an increasingly important role here, in the form of software, data or artificial intelligence. Digitalisation is also changing industrial production in a way that often makes international merchandise trade obsolete. New technologies such as 3D printing or selective laser melting (SLM) facilitate production on-site. While digitalisation initially promoted global coordination of value chains since the 1970s, today it increasingly enables local production and thus, more often the shortening of value chains. Globalisation and global division of labour continue to advance, while trade volumes fall.

Cause 2: More Value Creation in Emerging Markets

Another factor in the declining importance of global trade is the increasing technological self-sufficiency of large emerging economies. China, in particular, has become more technologically independent and increasingly manufactures high-tech products itself rather than importing them. At the same time, China is moving into areas previously dominated by traditional industrialised countries, even in technology-intensive stages of the value chain. In principle, this is a positive development that boosts global prosperity and thus also benefits Germany. However, at the same time, China’s industrial independence escalates competition for German companies on the global market.

Cause 3: Protectionism and National Independence

The global division of labour is also changing because of state interventions in the marketplace. Increasingly, artificial barriers to trade are erected. For example, between October 2008 and May 2020, at least 1.728 new trade-restrictive measures (such as tariff increases or import bans) were adopted by WTO members (WTO). A prominent example of this shift towards protectionism and economic nationalism is the foreign economic policy of the U.S. government under President Donald Trump.

Politicians around the world are increasingly willing to sacrifice the prosperity generated by trade; this has been impressively demonstrated by the corona pandemic. In order to ensure supply of crisis-relevant goods, many countries sealed themselves off from foreign trade in early 2020, for example by imposing investment and export bans in the healthcare sector.

Politicians can use trade restrictions to delay job cuts in certain areas or to ensure the supply of specific goods. But on the whole, such policies lead to a loss of innovative strength, prosperity and ultimately to a greater susceptibility of economies to crises. The corona pandemic has indeed shown that the supply of crisis-relevant goods is only possible through international division of labour and the use of international suppliers.

Cause 4: Business Resilience

Independent of political measures to ensure national supply security, companies have a business interest in a certain degree of security in their supply chains. The worldwide corona pandemic has led to changes for many globally-positioned companies. In many industries, it has become apparent that globally ramified supply chains can quickly lead to production losses, a slump in sales, and a threat to the company’s existence in the event of a crisis. Only in a few cases, however, would a renationalization of production be the most sensible solution from a business management perspective. Other options include diversifying supplier networks, contractual safeguards, or expanding warehousing.

Global Value Chains Challenge Policy

Changes in cross-border production networks and supply chains are not necessarily dangerous for the German economy. Our companies have often proven that they can emerge as winners when global conditions change. From a business perspective, technological and structural changes in the global environment can also be seen as an opportunity. One serious danger, however, is the worldwide trend toward protectionism. Although German industry is innovative and globally competitive, it needs open access to foreign markets in order to be able to demonstrate these capabilities. At the same time, it is just as dependent on supplies and capital from abroad and it is on access to sales markets abroad.

In the coming months, the German federal government and the European Commission must make every effort to take action against protectionism. This includes setting a good example and maintaining their own openness to trade and investment. There is moreover an urgent need to reform the WTO and conclude new trade and investment agreements. In addition, an unbureaucratic framework is crucial to enable German industry to make rapid progress in implementing future technologies, such as 3D printing. This includes, in particular, a practical legal framework for international data transfer and massive investment in the expansion of the digital infrastructure.