Global value chains, what they are and what they show.

What Global Value Chains are and how can they be used 

This entry is a revision of a note I wrote during my time at DG ECFIN. Its aim was to illustrate how global value chain indicators could be used in competiveness analyses. At that time WIOD only contained data until 2011. It now contains data up till 2014. So, if I hadn’t been so lazy I could have updated all the figures not only the first.

WIOD and other multi-country input-output tables can be used for several purposes for which it is important to take the interrelationships between industries located in different countries into account. Two much debated issues where this is important is of course Brexit and Nordstream2.

Brexit means that UK will leave the Single Market and trade will no longer be free between the UK and the EU. Firms and industries which have built long-term buyer-supplier relationships will have to decide whether the higher costs due to Brexit will mean that they have to abandon existing markets and find new suppliers and customers or if they can bear the costs.

Whether Nordstream2 will mean that Germany and other countries will import more of Russian energy or not remains to be seen. In any case, the existing dependence for Germany and other countries on Russia as a supplier and the Russian dependence of the German market, can be analysed with the aid of input-output analyses.

This entry is the first of three (or more) about Brexit. It introduces the concept of Global value chains (GVCs) which are mentioned in the entries on Brexit.

The first section below briefly discusses differences between gross trade and value added trade. The following section presents indicators for both total trade for countries and for industry trade.

Measuring trade in gross terms vs trade in value added terms

Analyses of competitiveness and industrial change that do not take the increased specialisation within and between countries into account often produce misleading results. The reason is that the emergence of global value chains (GVCs) means that data on industry gross exports contain less and less information about the industries’ contributions to overall GDP in a country.

The increased participation of firms and countries in GVCs mean that the value of trade that is recorded in gross terms provide less and less information on how much of total wages and profits that accrue to the exporters of the final products. Measuring exports in gross terms mean that the whole value of sales of a product accrues to the country from where the final product was delivered.

Table 1 below shows the differences of measuring competitiveness with gross exports compared to measuring it with value added exports for a number of Swedish manufacturing industries. The Revealed Comparative Advantage, (RCA) index is used as the measure of competitiveness, where an index above 1 indicates a comparative advantage. For some industries, there are large differences between the two measures. That concerns especially the three industries which have comparative advantages according to the value added measure but not according to the gross measure; Chemicals, Non-metallic minerals and Electronics.

The value added measure shows that the value added generated at home is larger than the value added generated abroad for those industries. The value added measures are lower than the gross measures for Wood, Pulp and paper and Machinery industries. The differences between the values of gross exports relative to wages and profits are larger for these industries that to a large extent produce final goods and to a large extent rely on imported intermediate products.[1]

Table 1. RCA-indices for Swedish manufacturing industries 2011 based on value added and gross exports.

Table 1. RCA-indices for Swedish manufacturing industries 2011 based on value added and gross exports.

Source. Lind, D. (2016). Calculations based on The World Input-Output Database, http://www.wiod.org.

Measuring exports in gross value also means that gross values of intermediate products are recorded and added every time they cross a border. The number of borders increase the difference between the final value of sales of the good and the value added that is generated in the production process at different locations, Johnson & Noguera (2012). In the example in the Box below, only two borders are crossed but the principle is the same.

Box 1. Measuring trade in value added.[2]

box 1

The China-US trade balance is a well-known example of how gross trade can distort the true picture of trade between countries. In 2009, China’s surplus was 25% smaller in value added than measured in gross terms since a large share of the Chinese exports consisted of high value added imports from other countries while the final goods were assembled in China. This last part of the value chain generates a relatively small share of the total value added.

Bored already? So is my furry friend.

waris

Ignoring bored and sleepy cats, these findings inspired the construction and use of multi-country Input-Output tables from which a number of indicators have been developed in order to gauge trade in value added terms by decomposing a country’s gross exports into value-added shares by source countries.

Countries and firms participate in GVCs by using foreign intermediate goods in its exports of goods for final consumption and by supplying intermediate products for the use in production of other countries’ exports. Koopman et. al. (2010) refer to this as direct and indirect participation [3]

Using the example in box 1, firms in the exporting country, B, participate directly in GVCs when some of the intermediate goods which the firms need to produce exports are sourced in other countries.[4] For that purpose, labour and capital in those countries need to be paid. This means that part of the value added of country B’s exports’ is generated abroad, in country A. This part is denoted foreign value added exports.

In the case of indirect participation, it is the other way around. Firms in the exporting country, B, provide intermediate goods to another country, C, where the goods are further processed before being shipped to final consumers in third countries.[5] Part of country C’s value added exports are thus generated in country B and makes up a share of country C’s foreign value added exports.[6]

Global value chain indicators

Koopman et.al. (2010) refer to these flows from country B as foreign value added exports and indirect value added exports respectively.  Koopman et. al. (2010) proposed an indicator, the GVC participation index, which combined a country’s foreign value added and indirect value added exports.  Figure 1 shows the GVC participation index for 40 countries and a Rest of the World aggregate in 2011. Since foreign value added exports and indirect value added exports for every country are added together into the participation index, they are expressed relative to total exports for the countries.[7]

Figure 1 shows that indirect value added exports dominate in large countries while the opposite is the case for small countries. Small open economies like Luxembourg, The Czech Republic and Slovakia source more intermediate goods from abroad.

The relatively lower use of foreign imports in larger countries is what one would expect since such countries can harbour more industries. The probability of finding natural resources is also higher in large countries. This is illustrated by the very large indirect value added share in total exports for Russia.

Figure 1. GVC participation indices 2014.

figure 1
Source. The World Input-Output Database, http://www.wiod.org. Note. At the time of Lind’s (2016) analyses, used in Table 1, 2011 was the latest available year in the WIOD database.

Figure 1 also indicates that size is not everything. Portugal is equally integrated backwards and forwards as France and Germany. A closer look at industrial structures in different countries is needed to explain this.

Countries are located in different parts of the value chains depending on their specialisations. Countries located upstream (in the first stages) in value chains may produce raw material or engage in R&D and product development and countries downstream (last stages) in value chains might be specialised in the assembly of products or customer services. Koopman et. al. (2010) proposed an indicator, GVC position index, for determining countries’ positioning in GVCs.[8] It is based on the foreign value added and indirect value added shares for countries. The index tends to be positive for countries with high indirect value added shares and low foreign value added shares and negative for countries where the opposite situations apply. See the annex for a comparison of countries’ position indices with the foreign and indirect value added shares.[9]

A country’s foreign value added share of exports implies that there also is a domestic value added share of the country’s exports. The countries’ domestic value added shares can be read from Figure 1 even if they are not included there. The domestic and foreign value added shares of a country’s exports add to 100. Since the foreign value added share of Luxembourg amounts to 61%, domestic value added share of Luxembourg exports equals around 39%.

Domestic and foreign value added shares can also be calculated for sectoral exports. Figure 2 shows foreign value added shares for manufacturing exports in 2011. The pattern with larger countries have smaller foreign value added shares is visible also for manufacturing exports. Firms in smaller countries do not in general have access to an equal large supply of different intermediate products as firms in large countries. Imports of intermediate may therefore be an important means to compete for firms in small countries.

Figure 2. Foreign value added shares in EU manufacturing exports in 2011 (%).

figure 2

Source. The World Input-Output Database, http://www.wiod.org.

A closer look at the French manufacturing industry shows that its firms increased their use of foreign intermediates between 2001 and 2011 as the foreign value added shares increased from 27% to 32%. The lion shares of the foreign value added shares are created in manufacturing and market services, c.f. Table 2.

Table 2. Domestic and foreign value added content shares of French manufacturing exports 2000 and 2011 (%).

table 2

Source: The World Input-Output Database, http://www.wiod.org.

Services account for about two thirds of GDP in most developed economies but only seem to account for some 25% of total trade measured in gross terms OECD (2013). However, when measured in value added terms, the shares of services increase substantially. Market services makes up most of these shares and one of the reasons for that is the increased use of market services by manufacturing firms.

Manufacturing firms use and offer more services since it can improve their competitiveness in essentially two ways. The first way is through increased productivity and/or reduced costs, the second through upgrading or developing new products, thereby making customers willing to pay a premium for them. Domestic and foreign market services value added shares of EU manufacturing exports amounted to between 24% and 42% in 2011. Foreign market services are especially important in small countries such as Ireland, c.f. Figure 3.

Figure 3. Domestic and foreign market services value added content shares of EU manufacturing exports 2011 (%).

figure 3

Source: The World Input-Output Database, http://www.wiod.org.

Indirect value added shares for industries can be calculated in the same way as for countries as illustrated in Figure 1. However, it should be kept in minds that since direct exports for some industries are zero or very small, the indirect value added shares can be infinitive or very large.

Summary and conclusions

Value added exports provide another picture of bilateral trade balances and RCAs than gross exports. Using value added exports instead of gross exports is useful also for determining how much income is generated in different countries. Value added exports can also be decomposed and show the contributions of different industries to total exports or industry exports. As is the case with other indicators, GVC indicators sometimes raise more questions than they answer as the example of Portugal in Figure 1 shows. GVC indicators therefore need to be complemented by other indicators.

Indicators of competitiveness are often discussed in terms of means to compete and the results of competition. Manufacturing firms use inputs of different kinds to lower costs, increase productivity and the quality of their products.  Decomposing value added exports into contributions from different domestic and foreign sectors can be done in order to see whether for example an increased use of inputs from knowledge intensive market services industries increases the competitiveness of manufacturing industries. These use of means will hopefully result in increased market shares.

References

Antras, P., D., Chor, T., Fally and Hillberry R. (2012). “Measuring the Upstreamness of Production and Trade Flows”. NBER Working Papers Series No. 17819.

De Backer, K. and S. Miroudot (2013), “Mapping Global Value Chains”, OECD Trade Policy Papers, No. 159, OECD Publishing. http://dx.doi.org/10.1787/5k3v1trgnbr4-en

Fally, T. (2011). “On the Fragmentation of Production in the US”, University of Colorado-Boulder.

Johnson, R C och G Noguera (2012), ”Accounting for Intermediates: Production Sharing and Trade in Value Added”, Journal of International Economics, vol 86, s 224–236.

Koopman, R., W. Powers, Z. Wang and S.-J. Wei (2010). “Give credit to where credit is due: tracing value added in global production chains”, NBER Working Papers Series No. 16426.

Lind, D. (2016). “Svensk export – komparativa fördelar och specialiseringsmönster sedan 1990-talet”. Ekonomisk Debatt, årg 44, nr 3, s 73-85.

Timmer, M.P., Los, B., Stehrer, R. and de Vries, G.d. (2013). “Fragmentation, Incomes and Jobs. An Analyses of European Competitiveness”. Europea       n Central Bank Working Paper Series, No 1615, November 2013.

Annex.

The position index is measured on the right axes in both panels in Figure A.1. Small open countries where industries source relatively more intermediate inputs from abroad tend to be positioned in the lower parts of the value chains. These countries have in general high foreign value added shares and low, or negative values, of the position index. The opposite pattern tends to apply for large countries which harbour more industries and have larger endowments of natural resources.

Figure A.1. Comparisons of the GVC position indices with backward (right panel) and  forward (left panel) participation rates 2011.

figure a1

Source: The World Input-Output Database, www.wiod.org.

Examples of other indicators that are related to the indirect value added shares, are Fally’s (2011) indicators: The number of production stages and Distance to demand, and an index gauging the “upstreamness” by countries,  developed by a Antras et. al. (2012).[10]

[1] The difference between the two measures should be small for industries that produce final goods with a relatively small share of imported intermediate products.                      [2] The example has been adapted from OECD (2013).                                                              [3] See Koopman et. al. (2010) for a more detailed decomposition of gross exports.
[4] The notations of countries as A, B or C are from Box 1.
[5] The production of intermediate products in country B may of course be dependent on imports of raw materials and intermediate products from A.
[6] Following the notations of Box 1, country C would export to third countries D.
[7] Alternatively, they can also be expressed relative to GDP which is relevant if one is interested in to know how much value added is generated in exports relative to total GDP for a country.                                                                                                                                        [8] The GVC position for a country is calculated as ln(1+indirect value added exports – ln(1+foreign value added exports).
[9] Countries GVC position indices are strongly positively correlated with their indirect value added shares. This is due to the facts that exports of countries that are positioned upstream in the value chain include only a small share of foreign value added but contribute with a large share of value added embodied as intermediate inputs in other countries’ exports. The GVC position indices are consequently strongly negatively correlated with foreign value added shares.                                                                                    [10] Fally’s (2011) indicators for the number of production stages and distance to demand aim to gauge countries’ positions in value chains. Antras et. al.(2012) developed an index showing how far upstream countries or industries are in the value chains.

4 thoughts on “Global value chains, what they are and what they show.

  1. Pingback: Brexit and UK integration in EU supply chains. | Globalisation, furry animals and anything but fishing

  2. Hi there! I’d also love to hear your thoughts about China’s monopoly of manufacturing consumer electronics, laptops etc.

    Is it possible, that within some time China will not need USA/EU market that much as developing countries(+ Russia or something) is the emerging market, where China has opportunity of be the only supplier of everything they can produce.

    I assume, in theory, the factors boosting that process could be their expansive investments with the ability to buy everything, the bribery, the collusion with the governments. Is that probable?

    Like

    • Can China become selfsufficient and become the monopolist of those things? Probably not. Its development has been driven by trade. And trade is essentially a technology. By trading with others we get products that are produced more efficiently than if we tried to do it ourselves. Even if big countries and harbour more industries which can produce more products than small countries, there are other factors at play.

      Authoritarian countries like the Soviet union can be good at producing a few high-tech things such as the nuclear bomb, tanks or Sputnik but it was useless to produce things ordinary people needed, hence the long ques and empty shells in the shops.

      China has tried to mimic market economies by liberalising part of its economy. But most of its large firms are subject to control by the Communist party dependent on its political agenda. But in order to have sustained innovation, you need a market economy.

      Like

  3. Pingback: Brexit and EU integration in UK supply chains | Globalisation, furry animals and anything but fishing

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