27/11/2017 Global value chains shed new light on trade

Order from Chaos

Global value chains shed new light on trade

David Dollar Monday, July 10, 2017

G
lobal value chains (GVCs) have complicated both the reality and the analysis
of international trade. On the one hand, they break up the production
process so that different steps can be carried out in different countries, and
in so doing have transformed the nature of trade. On the other, they’re complex, which
makes it harder to understand trade and to formulate policies that allow workers, rms,
and governments to capitalize on GVCs while mitigating negative side-effects.

To add to the challenge, today’s of cial statistical information systems were designed
to measure economic activity in a pre-GVC world, and they have struggled to keep pace
(with some notable exceptions). Conventional measures of trade—while still important
—measure the gross value of transactions between partners. As such, they don’t reveal
how foreign producers, upstream in the value chain, are connected to nal consumers
at the end of the value chain. For example, conventional statistics suggest that South
Korea exports a lot to China. In fact, much of this is components that are ultimately
destined for the European or U.S. market. So more accurately, South Korea exports a lot
to advanced consumer markets.

The GVC phenomenon has prompted researchers to develop statistics and analysis
based on the value added in trade. The phenomenon also demands that researchers
analyze how the production process is divided into discrete tasks or phases. Thankfully,
data on the value added traded among major economies is now available (for 1995-
2014). The World Bank, World Trade Organization (WTO), and a group of research
centers around the world have published a rst “Global Value Chain Development
Report” based on research using data on the value added in trade. The report highlights
some new ndings on the changing nature of international trade.

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One important nding is that many value chains take the form of a “smile curve”; for
example, the production chain for China’s exports of electrical and optical equipment
in 2009 (see gure).

These are basically all of your electronic gadgets. The circles (in which the letter
corresponds to a country and the number to a particular industry) indicate country-
industries that contribute to production, and their size represents the absolute value-
added gained by participating in the value chain (in millions of U.S. dollars, at constant
prices). On the vertical axis is compensation per hour for the workers in the country-
industry, indicating high- versus low value-added activities. On the horizontal axis is
distance to the nal consumer.

Here’s the logic of the smile shape: Early in the production process, there are research
and design activities for critical components; these knowledge activities tend to be high
value-added and in GVCs tend to be carried out in more advanced economies. The
Chinese industry that manufactures the good called “Chinese-Electrical and Optical
(CHN14),” is located at the bottom of the curve, meaning it’s assembly activity with low

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wages. Just upstream from China’s activity are contributions from the same
manufacturing industry in the United States, Germany, Japan, Taiwan, and Korea.
These are the more sophisticated parts that are then assembled in China. The activities
closest to the consumer are marketing, logistics, and after-product servicing. These
market-knowledge industries are also high-value-added (hence the upward-sloping
part of the smile), and also tend to be carried out in advanced economies where the
mass consumption products are eventually bought.

Interestingly, the gure captures anxieties felt by both rich and poor countries in
thinking about trade today. People in rich countries worry that manufacturing is being
hollowed out. That is, that semi-skilled production jobs have moved to the developing
world, and—to the extent that such jobs still remain in advanced economies—have
faced downward pressure on wages. Poor countries worry that they are trapped in low-
value-added activities and are locked out of the higher value-added found in design,
key technological inputs, and marketing.

The same changes in technology and global trade can be seen in overall statistics on
factor use and income distribution in industries affected by GVCs in developed and
developing countries. In the U.S. information communication technology
manufacturing sector, for example, labor productivity grew an impressive 200 percent
over the 15 years covered by the study. At the same time, there was a large shift in the
kind of labor used: The share of high-skilled labor (with college education and above)
increased sharply from about one-third to one-half (see gure).

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And proportionally more of the compensation went to high-skilled workers (right

panel). For low-skilled workers, it was at, and for the medium-skilled it increased but
in a smaller amount. These shifts match the overall transformation of the industry:
from initially producing in the United States to primarily designing and providing
supporting services, while still producing some high-tech inputs.

What about changes in China’s information communication technology industry?

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The rst thing to note is that labor productivity grew at a phenomenal rate: about 6-
fold over just 15 years. During the period, labor’s share of value added in the industry
dropped from over 40 percent to about 30 percent, while capital’s share increased from
less than 60 percent to nearly 70 percent. Clearly, capital was able to reap much of the
bene t of the productivity gain (as did consumers worldwide through lower prices). It
should be emphasized that the real gains were won by capital deployed in China,
including multinationals that play a critical role in managing GVCs.

There have been big wage increases in China as well, starting from a very low base.
Most workers in China’s information communication technology industry were low-
and middle- skilled, though this decreased over the period (from more than 95 percent
of hours to about 90 percent). Very few workers are high-skilled, and the hours they
work still amounted to less than 10 percent of total hours by the end of the period. As
for workers’ pay (right panel), real wages for all workers increased, although the big
proportional gain went to skilled labor (which nearly doubled). Compensation of

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medium-skilled workers, with high school degrees, also went up over the period, by
about 80 percent. Even low-skilled workers in this industry saw their compensation
increase more than 50 percent during the period.

These ndings—which illuminate how gains and losses in trade are distributed—shed
some light on the growing protectionist sentiment in the United States and other
advanced economies. They also help explain why globalization remains popular in
developing countries that are deeply involved in GVCs, such as China, Mexico, and
Vietnam.

The bene ts from GVC-related trade have been distributed highly unevenly. On the U.S.
side, the big winners appear to be high-skilled workers and multinational corporations.
GVCs have enabled them to bene t from enormous productivity gains in developing
countries such as China. Ordinary American workers have not seen much, if any,
bene t. In China, ordinary workers have bene ted. Even at the beginning of the
process, factory wages in China were far ahead of rural incomes; and those wages rose
signi cantly over 15 years. This is one of the driving factors behind the impressive
decline of absolute poverty in China. However, relatively speaking, the really big
bene ts in China accrued to the small number of high-skilled workers and to the
owners of capital, including foreign investors.

What does all this mean for policy?

First, about two-thirds of world trade now is involved in value chains that cross
borders during the production process. The United States is deeply involved in
supply chains with Asia, as well as with NAFTA partners. It would be dif cult and
disruptive to undo these supply chains. A policy that sounds straight-forward—
such as a 45 percent tariff on imports of “Chinese” products, as then-candidate
Donald Trump proposed during his campaign—would hurt many rms and workers
in the United States, as well as in allies such as Japan, Korea, and Taiwan.
Second, we can get more bene ts from GVCs by improving our infrastructure and
strengthening education at all levels.
Third, technological change and global trade will inevitably create economic
dislocation and we need to do a better job with adjustment assistance and the
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safety net to help workers and communities deal with the changes.

My next post will focus on how developing countries can bene t more from GVCs.

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