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A manufacturer works at an assembly line of Vingroup's Vsmart phone in Hai Phong, Vietnam December 4, 2018. REUTERS/Kham - RC19DC39DA10
Order from Chaos

How global value chains open opportunities for developing countries

Global value chains break up production processes so different steps—for building your smartphone, your TV, or your car—can be carried out in different countries. More than two-thirds of world trade today takes place within value chains that cross at least one border during production, and often many borders.

Traditional trade statistics measure the gross value of trade. When a smart phone goes from China to the United States, what is recorded as an export is the full value of the phone. It would be more accurate to say that the United States is importing different types of value added from different partners: labor-intensive assembly from China, more sophisticated manufacturing inputs from South Korea, and services from the United States, since even foreign-brand phones have a lot of U.S. technology.

In recent years, major economies have produced annual input-output tables that deconstruct production into its many constituent parts. There is a growing amount of research into the value added in trade, as well as into the stages of the value chain. These studies provide new perspectives on trade. The Global Value Chain Development Report 2019, produced by the World Trade Organization and other partners, has a wealth of findings, some of which are especially relevant to developing countries.

The cases of China and Vietnam

Global value chains have been a boon to developing countries because they make it easier for those countries to diversify away from primary products to manufactures and services. In the past, a country had to master the production of a whole manufactured product in order to export it. With value chains, a country can specialize in one or several activities in which it has comparative advantage.

Listen to Dollar and SenseFor example, the global value chain phenomenon enabled China to export products that are often labeled as “high-tech,” such as computers, smart phones, and televisions. However, China’s role initially was largely that of assembler. Looking at the whole production chain, at the beginning are high-value design and financial inputs from advanced economies. Then come some sophisticated parts from Japan, the United States, Korea, and Taiwan. China’s value added in this sector mostly comes from assembly at low wages. China also has quite a few backward linkages from electronics to metals, plastics, and other sectors whose outputs are inputs into the production of electronics. The high-value inputs at the end of the chain are mostly services, as products are brought to market in the United States, Europe, and Japan. China’s role in value chains has enabled it to employ a large number of low-skilled workers, and this has made a key contribution to China’s growth and poverty reduction. For China’s export of these products to the United States, a bit less than half of the total value added comes from China. The point is that breaking up the production process in this way enabled a large number of different labor-intensive activities to settle in China and enhanced the country’s ability to exploit its comparative advantage.

Vietnam is another good example of a developing country deeply involved in global value chains. Through its reform and opening, Vietnam has attracted a large amount of foreign investment that is mostly involved in labor-intensive assembly. Policymakers worry that they will be stuck with only low-end assembly, but input-output analysis shows that there are more backward linkages than is generally recognized. In Vietnam, manufacturing and agriculture each have about 5 million workers directly involved in exporting. Manufacturing, however, generated an even larger number of employees, 7 million, indirectly exporting—meaning that they worked in firms that sold to exporters.

These linkages have important implications for policy. Developing countries still tend to have more import protection than advanced ones. Countries recognize that exporters need access to the best-imported inputs if they are to be competitive globally, and a popular measure is to have special economic zones in which exporters can have duty-free access to inputs. However, it would be much better to liberalize the whole economy so that all the indirect exporters had access to the best inputs as well—not to mention that products for the domestic market will be better under an open regime.

The growing role of services in international trade

Most of what is traded directly in the world—about 80 percent—is merchandise; that is, manufactures or primary products (food, oil, minerals). It is interesting that this ratio has not really changed for 40 years. There is some direct trade of services such as tourism, overseas college students, international finance, but it remains about 20 percent of overall global trade.

The picture is somewhat different when the analysis shifts to value added. Services’ share of the value added in trade has gone from 31 percent in 1980 to 43 percent in 2009. What this means is that there is growing services content in merchandise. Some of this reflects smart products; their software is the output of a service industry. Also, managing global supply chains involves more transportation, finance, and insurance than was involved in traditional trade. This data is in current prices, so a final factor is that—because of more rapid productivity growth in manufacturing—prices of services have tended to go up while prices of manufacturing value added have tended to go down.

The fact that services contribution is larger in value-added terms than in gross-value terms is true for all major economies. Viewed in value-added terms, exports of advanced economies such as the United States are about half services. Developing economies well integrated into global value chains—such as Mexico, China, Vietnam, and Thailand—generally have about 40 percent of the value added of their exports coming from services. It is also the case that advanced economies use a lot of imported services as part of their production chains. This is less true for developing countries because they tend to have more restrictions on imports of services and inward direct investment in the service industries. Recent research has shown that using imported services enhances manufacturing exports of developing countries, which makes sense because access to the best inputs in the world has to improve productivity.

Lessons learned

The rise of global value chains does not fundamentally change trade theory, but it does provide some nuanced understandings. Breaking up the production process provides new opportunities for integration of rich and poor economies, with potential benefits for each—but with homework as well. I have mentioned some of the developing countries deeply involved, but large parts of the developing world are left out. Globalization is like a fast train and you need a platform to get it to stop at your location. Building the platform requires all the basics: rule of law, infrastructure, education, and health. Developing countries that have succeeded even just moderately well have seen impressive growth and poverty reduction.

For rich and poor countries alike, free trade is the best policy. We have achieved reasonably free trade in manufactures, at least until the recent bouts of protectionism. But there is much less freedom of trade and investment for service sectors, especially in the developing world. Given the growing role of services in production and value chains, this is a logical next focus of liberalization.

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