Being in a global value chain: Hell or heaven?

Antonio Accetturo, Anna Giunta, Salvatore Rossi, 15 December 2012

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The recent literature on global value chains has shown that the production of every good (from computers to retail trade services) now consists of a series of separate tasks (unbundling), each of which can be located outside the boundaries of the 'final' firm (Blinder 2006). It follows that international trade is increasingly in tasks rather than in goods (Miroudot and Ragoussis 2009; Baldwin and Robert-Nicoud 2010); value (or supply) chains linking together all these tasks have become global and form the core of a new international division of labour.

The most cited example of a product resulting from a long and complex supply chain is the iPhone (Xing 2011). Asia, namely China, is indicated as the area of the world where most of the manufacturing tasks needed to produce a final good such an iPhone are located.

How are firms in advanced countries reacting to this? They may either be 'Apples' (commanding a chain and all the strategic tasks therein, i.e. inventing, designing, engineering, deciding what inputs to buy and where, assembling, advertising, marketing), or 'Grapes', belonging to a bunch (chain) maneuvered by others. In the latter case, how can such 'intermediate' firms defend any advantage they may have with respect to competitors from the emerging countries?

A first possible answer is to offshore. An Italian firm producing, say, brakes for a car 'ModelT2.0', that is assembled and sold by a German firm, can move at least part of the manufacturing in China or Vietnam, opening new factories there and closing plants at home, in order to benefit from lower unit labour costs. Alternatively, the Italian can engineer a vertical disintegration replacing some components produced internally with others outsourced to an external supplier, possibly located in a low-wage country.

The latter kind of strategic decision has two implications: 1) The Italian firm's boundaries shrink; 2) the value chain producing ModelT2.0 acquires one more segment in a low-wage country so that the Italian firm moves upwards in the chain, being now relatively closer to the German one.

However, for a firm, there are other ways to adjust to a world where global value chains are the production paradigm, all related to the firm's positioning in the chains. As the firm 'improves' its positioning, it may even go to Heaven (gaining competitiveness and profitability) in spite of the competitive pressure coming from emerging countries. If not, it may fall to Hell (losing market shares, eventually exiting the market). But what does 'improving' mean in the global value chains context?

The whole set of global value chains in the world could be represented as a gigantic network, i.e. a collection of 'nodes' (firms) linked to each other by 'arcs', i.e. bilateral relationships directed from one node to another (supply of an intermediate input). A single node of the network of global value chains may be located at the periphery of it, supplying a basic component to just one big buyer, or it may be located close to the centre of the network, possibly being interconnected with many other nodes in both directions (a 'hub' with many buyers and many suppliers). We can expect a hub to have more market power vis-à-vis both its buyers and suppliers, typically due to technological superiority. In the extreme case, it will be a monopoly on the 'sell' side, and a monopsony on the 'buy' side. For an intermediate firm, improving its positioning within the network of global value chains means gaining competitive advantage and market power.

Existing data rarely allow measuring such phenomena. The database WIOD is a promising tool that deserves to be widely tested. Or one can rely on ad hoc survey data.

In Accetturo et al (2011), we use a sample of 1,500 Italian manufacturing firms based on the Bank of Italy's Survey on Industrial and Service Firms and identify four types of intermediate firms: those that upgrade in global value chains because they become multi-task and multi-relational ('advanced'); those that upgrade in only one respect or the other; and those that remain immobile ('marginal'). We find pronounced differences among those four types, in particular between advanced and marginal firms, in terms of efficiency, international competitiveness, human capital, size.

Heterogeneity among suppliers revealed crucial during the Great Trade Collapse of 2009 (Baldwin 2009). Global value chains proved to be a channel for the rapid transmission of real and financial shocks. Other studies have shown that the impact of the recession on firms’ performance was sensibly different according to the organisational mode of global transactions (Altomonte et al. 2012) and to firms’ positioning in the global value chains (Bekes et al. 2011).

We also use firm-level data from the EU-EFIGE/Bruegel-UniCredit Survey1  to study the impact of the recession on German and Italian intermediate firms. By comparing firms’ sales during the Great Recession and controlling for all other characteristics (e.g. firm size, sector), we find that: a) positioning in global value chains plays a role in explaining different performances; in particular, the decrease in turnover has been greater for firms located further from final customers (the cumulated fall was 3.7 percentage points larger for intermediate than for 'final' firms); b) intermediate firms that had carried out innovation activities before the recession have been somewhat sheltered (for this sub-group the drop in sales was smaller and similar to the one registered for final firms); c) the positioning within a global value chain and the firms’ strategies explain 10% of the large Italian-German firms’ performance gap during the recession (22.5% difference in mean between German and Italian firms' sales). This is not a small number, considering that this kind of explanation is generally overlooked by analysts and policymakers2.

Seventy five years ago Ronald Coase (1937) explained that a firm's raison d'être is to reduce the high transaction costs incurred by anyone who attempted to produce a good or service simply by purchasing on the market every single input or 'task' necessary for production. Since then, the theory has been refined, enriched and qualified, but until recently a firm still had to decide "whether to outsource or insource (i.e. integrate)" and, if it decided to outsource, "whether to offshore or not" (Helpman 2006). In the new competitive scenario, outsourcing and offshoring are now becoming obliged decisions for a growing number of firms in advanced countries. For them the problem is not 'if' anymore, but 'how'. Their positioning in the world network of global value chains determines whether they will find themselves in Hell or Heaven.

References

Accetturo A, Giunta A and Rossi S (2011), Italian Firms between Crisis and New Globalization, Bank of Italy Occasional papers, n. 86, January 2011.

Altomonte C, Di Mauro F, Ottaviano G, Rungi A, Vicard V (2012), "Global Value Chains during the Great Trade Collapse. A Bullwhip Effect? European Central Bank", Working Paper Series, n. 1412

Blinder A S (2006), "Offshoring: the Next Industrial Revolution", Foreign Affairs, n. 85/2, 113-128.

Baldwin, R (ed.) (2009), The Great Trade Collapse: Causes, Consequences and Prospects, VoxEU.org, November.

Baldwin, R and Robert-Nicoud F (2010), "Trade-in-Goods and Trade-in-Tasks: an Integrating Framework", CEPR Discussion Paper no. 7775

Békés, G, Halpern L, Koren M, Muraközy B (2011), "Still Standing: How European Firms Weathered the Crisis, The third EFIGE policy report", Bruegel, 22 December.

Coase R, H. (1937) "The Nature of the Firm", Economica, New Series, vol. 4, 16, 386-405

Escaith, H and Timmer M (2012) "Global Value Chains, Trade, Jobs, and Environment: The New WIOD Database", VoxEU.org, May.

Helpman, E (2006.) "Trade, FDI, and the Organization of Firms", Journal of Economic Literature, vol. 44(3), September, 589-630.

Miroudot, S and Ragoussis, A (2009) Vertical Trade, Trade Costs and FDI, OECD Trade Policy, Working Papers 89, OECD, Trade Directorate.

Xing, Yuqing (2011) “How the iPhone widens the US trade deficit with China”, VoxEU.org, 10 April.


1 The data have been collected within the EFIGE project – European firms in a global economy: internal policies for external competitiveness – supported by the Research Directorate General of the European Commission. The sample includes around 3,000 firms for France, Germany, Italy and Spain, more than 2,200 firms for UK, and 500 firms for Austria and Hungary.

2 These results are based on OLS regressions on the German and Italian firms of the EFIGE dataset. The detection of an innovation strategy is based on a principal component analysis. Results are available upon request.

Topics: Industrial organisation, International trade
Tags: global value chains, offshoring, trade network

Economist at the Bank of Italy
Professor of Applied Economics, University Roma Tre
Member of the Governing Board of the Bank of Italy