How important are Global Value Chains for development?

This month the World Bank has launched its 2020 World Development Report entitled Trading for Development in the Age of Global Value Chains, a topic arguably of particular interest to the maritime industry.

How important are Global Value Chains for development? The World Bank team approached this topic objectively, determined to address both the pros and cons of GVC-led economic growth in the face of rapid technological change and policy uncertainty.

An important component for an economic revolution

The reality is that global value chains have powered an economic revolution over the past three decades: growth accelerated, incomes rose, and poverty rates plunged to an historical low of 10 percent.

This enabled an unprecedented convergence since the late 1980s: poor countries grew faster and began to catch up with richer countries. The steepest declines in poverty occurred precisely in those countries that became integral to global value chains—China, Vietnam, and Bangladesh, among others. The reason is that an increase in GVC participation boosts per capita income levels by more than twice as conventional trade.

One of the most compelling findings of the World Development Report is that all empirical evidence – from cross-country, to sector, to firm-level – supports a picture of GVCs greatly boosting productivity and incomes.

To understand the Global Value Chains revolution let’s take a bike, the world most popular form of transport and a relatively simple product. Bicycles today are heavily traded (USD 20 billion in bicycles only in 2018), and 163 countries trade the parts and components needed to build them.

Once bicycles used to be made mostly in one country, in smaller volumes and with lower profit margins. Then companies began working with one another across borders. Bikes are now assembled using parts and components from all over the world, especially Asia and Europe. For example, Bianchi carries its design, prototyping, and conception work in Italy, and then assembles most of its bicycles in Taiwan China, using parts and components from China, Italy, Japan, Malaysia and many other parts of the world.

Today, over 50% of global trade involves GVCs (figure 1).

While GVCs have existed before, their fastest growth was from 1990 to 2007 as transport and communications infrastructure advanced and trade barriers dropped significantly.

But the expansion of GVCs has plateaued since 2008 due to a decline in overall economic growth and the slowing pace of reforms. The absence of major trade initiatives and increased trade conflict could make it more difficult for developing countries to benefit from GVCs.

The fundamental reasons for GVC growth

There are two fundamental reasons why GVC deliver more growth than trade. The first is hyper specialization that allows companies to produce at large scale. The second is firm to firm relationships, that make tech transfer more viable. Firms have a shared interest in specializing in specific tasks, exchanging technology and learning from each other.

In addition, there are four set of determinants that matter: endowments of labor and capital, institutions, geography and access to a large market.

Countries participate in GVCs in different ways

Another important finding is that all countries participate in GVCs, but in different ways (figure 2). Some countries such as Algeria, Nigeria, and Venezuela engage at the base of most value chains, selling predominantly unprocessed commodities and agriculture to trade partners. Honduras, Ethiopia, and Bangladesh, among others, are mostly engaged in simple manufacturing tasks. Malaysia, Poland and the Philippines specialize in more complex manufacturing segments of the value chain or in services tasks that have become increasingly traded. Advanced economies and some emerging countries such as the Czech Republic specialize mostly in innovation intensive goods and tasks.

But current conditions do not need to dictate destiny. Policies that lead to openness, connectivity, and cooperation can go a long way to improve the drivers of GVC participation. For example, countries transitioning to limited manufacturing GVCs from primary product specialization typically need foreign development investment. This makes it essential to focus on offering competitive labor costs, addressing business climate constraints, and assuring basic political stability and rule of law.

For an economy to transition to advanced manufacturing and services global value chains is a bigger challenge. This typically involves such sectors as motor vehicles, medical devices, aerospace, and precision instruments. Countries that have recently been successful in one or more of these sectors include Poland and Turkey. Costa Rica and Vietnam are right now in the middle of this transition. Moving into these activities requires a step-change in the policy environment. For example, while labor costs still matter for some parts of the value chain, advanced manufacturing GVCs typically require a more highly-educated workforce and improvements in managerial practices.  If countries fail to invest in human capital, they may end up in a middle-income trap and miss out on this next stage of development.

Finally, as countries transition to high income, innovation becomes the main determinant of GVC participation.

A need for inclusive and sustainable development

Of course, not all the WDR’s findings are positive. There is evidence that the gains from GVC trade are not being distributed equally within and across countries. The report reflects an improved understanding from this research of why some workers, firms, and communities have been hurt by globalization as well as where environmental risks have arisen.

For the environment, GVCs have been a mixed blessing. On the negative side, the scale of growth and the crisscrossing of parts and components across countries has led to excess pollution, transport and waste. But GVCs also contain the seeds for the solutions, thanks to the relational (firm-to-firm) nature. GVCs allow innovation and diffusion of environmental goods and techniques, and GVC lead firms push higher standards across the entire value chain.

In conclusion, are Global Value Chains still important for the world economy and particularly for development? Our report shows that Global Value Chains are still an important path to development. In fact, for small economies, trade may be the only possible path to development and economic growth.

But we need to make sure we create the conditions for inclusive and sustainable development.

Three conditions for sustainable and inclusive development

What we conclude is that GVCs can continue to be a force for sustainable and inclusive development if three conditions are met:

First, developing countries speed up trade and investment reforms and improve connectivity.
Second, advanced economies pursue open, predictable policies.
Third, all countries strengthen social and environmental protection, to ensure the benefits of GVC participation are shared and sustained.

The report also clearly finds that the benefits from international coordination (and the costs of not connecting) are much greater in a world of GVCs. And by converse, the need for greater international cooperation is particularly urgent. The reason is that public policies and economic conditions in one country strongly affect trade partners through production linkages. The benefits of coordinated policy action are even larger with GVCs than conventional trade, as goods and services cross borders multiple times.

All countries need to work cooperatively to address policies that distort trade and to keep markets open.