Global Value Chains: ‘Factory World’ is emerging

Bart Los, Marcel Timmer, Gaaitzen de Vries 11 May 2014

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To measure international fragmentation of production processes, we introduce a generalisation of Feenstra and Hanson’s (1999) ‘broad’ offshoring measure (Los et al. 2014). We start from the notion that the value of a final product equals the sum of value added contributions by any industry that participated in the production process, both in the country of completion and abroad. The production of a car assembled in Germany, for example, does not only imply value added in the German car industry, but also requires business services activity in Germany and component manufacturing in Slovakia, among other things. These activities generate value added, as do activities required further upstream, like iron ore mining in Australia. We call all such value added generated outside the country where the last stage of production takes place foreign value added (FVA).

Before Baldwin’s (2006) ‘second unbundling’, the share of FVA in the total value of the final product used to be close to zero, since many stages of production were co-located to minimise transportation and coordination costs. Reductions in transport costs, lower trade barriers, and improvements in ICT led increasing numbers of firms to relocate stages of production abroad, causing value added creation in foreign countries. Hence, we propose the FVA share (expressed as a percentage of the value of the final product) as a measure of the international fragmentation of a value chain.

In our approach, global value chains of products are identified by the country-industry-of-completion, the country-industry where the last stage of production takes place before the product is sold for consumption or investment purposes. The computation of an FVA share requires the availability of global input-output tables, describing the world’s production structure. The WIOD database provides a time series of such tables, for the period 1995-2011 (www.wiod.org).

Global fragmentation dominates regional fragmentation

To study whether increased international fragmentation is predominantly due to regional fragmentation or global fragmentation, we split FVA into regional FVA (RFVA) and global FVA (GFVA). RFVA comprises all foreign value added generated in the trade bloc to which the country-of-completion belongs, while GFVA includes all value added contributed by all countries outside the trade bloc. In line with Baldwin and Lopez-Gonzalez’s (2013) idea of three regional ‘factories,’ and considering the country coverage of WIOD, we define three trading blocs: the EU27 (27 European countries belonging to the European Union), NAFTA (Canada, Mexico, and the US) and East Asia (Japan, South Korea, Taiwan, and China). Value added in Slovakia in the production of components for cars completed in Germany thus contributes to RFVA in this value chain, while the associated value added created in Australian iron-ore mining is included in GFVA. 

Figure 1 Foreign value added shares in output of final manufactures.

(a) Foreign value added from within the region (regional fragmentation)

Source: Los et al. (2014).

(b) Foreign value added outside the region (global fragmentation)

Source: Los et al. (2014)

Figure 1 shows how regional and global foreign value added shares evolved over the period 1995-2008. We distinguish between value chains for 14 manufacturing product groups and 40 countries-of-completion. Each dot represents one value chain. Dots located on the red, dashed 45-degree lines reflect value chains for which the RFVA share (panel a) or GFVA share (panel b) in 2008 was equal to that in 1995. The solid green lines have been obtained via output-weighted regression through the origin. The lines in both panels have slopes greater than one, which implies that both types of fragmentation increased over 1995-2008. The slope for the evolution of the global FVA shares (1.36) is considerably steeper than the line for regional FVA shares (1.01). This is a strong indication that global fragmentation has contributed much more to the growth of international fragmentation of value chains than regional fragmentation.

Why do our results differ so much from what, for example, Baldwin and Lopez-Gonzalez (2013) found? We speculate that the type of double-counting of value added when using gross trade statistics stressed by Wang et al. (2014a,b) is the culprit: if countries within regions mainly sell products in downstream stages of production to each other, the value added in far-away countries in more upstream stages will also be included in the value of within-region trade measured in gross value terms. This bias towards trade in the outputs of downstream stages of production is absent in our accounting framework.

Figure 2 provides further evidence for our finding that value chains are truly getting global. It presents results for eight large economies (see http://www.wiod.org/new_site/gvc.htm for detailed results for all countries present in the World Input-Output Database).

Figure 2 RFVA and GFVA shares for selected countries (1995-2008, in %)

Source: Los et al. (2014).

The results in Figure 2 refer to output-weighted averages of RFVA and GFVA shares over all 14 value chains for manufactures in the eight countries-of-completion. For global value chains with the last stage of production in Germany, for example, the share of foreign value added (the sum of RFVA and GFVA shares) has increased from 18.1 (=10.1 + 8.0) in 1995 to 30.1 (=14.4+15.7) in 2008. The share of domestic value added, which is the residual, has correspondingly declined from 81.9% to 69.9%. Interestingly, in 1995 the RFVA share was higher than the GFVA share, but in 2008 this was reversed. GFVA has grown much faster than RFVA.

In the majority of the countries, both regional and global foreign value added shares grew over the period of 1995-2008. We find that without a single exception, GFVA shares have increased considerably faster than RFVA shares, pointing to the emergence of truly global value chains. In 2008, value chains for each of the eight countries-of-completion contained more foreign value added outside the region than added in other countries of the same region. In Los et al. (2014), we show that global fragmentation is increasing at a much faster pace than regional fragmentation in smaller countries as well, but that their GFVA shares are often still smaller than RFVA shares as they still rely predominantly on regional networks with a big neighbouring country.

The global fragmentation trend continued during the Great Recession

At least two important questions remain to be answered. First, have value chains steadily become more global between 1995 and 2008, or have prominent jumps occurred? Second, what happened in the early part of the Great Recession? In this period, the popular press frequently referred to protectionist policies to support employment in domestic industries. Answers to both questions are provided by Figure 3, which depicts output-weighted averages of RFVA and GFVA shares for 27 EU countries, three NAFTA countries, and four countries in east Asia. These shares are measured along the left vertical axis, while their ratio is depicted by the solid green line and measured along the logarithmic right vertical axis.

Figure 3 Trends in regional and global fragmentation of value chains of final manufactures (34 countries-of-completion in EU, east Asia and NAFTA)

Source: Los et al. (2014).

The increasing importance of value added outside the own trade bloc clearly did not take off until 2003, but was very steady afterwards. As is well-known, international trade collapsed after the crisis partly as a consequence of international supply chain trade (e.g. Ferrantino and Taglioni 2014). Firms reacted to the uncertainty they faced by first depleting inventories, before ordering new supplies of materials and components. Our results show that global foreign value added shares were hit more strongly than regional foreign value added shares, but the considerably larger growth of GFVA shares after 2009 gives preliminary evidence that the trend towards further global fragmentation has not come to a halt after the crisis. Figure 3 even shows that global foreign value added shares had almost reached their pre-crisis levels in 2011, while regional foreign value added shares are still at lower levels and have not recovered much.

Conclusion

Our analysis shows that value chains have become considerably more global in nature after 2003. Increasing shares of the value of a product are added outside the region to which the country of completion belongs. ‘Factory World’ remains under construction, but this process is progressing at a fast pace.

References

Baldwin, Richard E. (2006), “Globalisation: The Great Unbundling(s). Globalisation Challenges for Europe,” Helsinki: Office of the Prime Minister of Finland.

Baldwin, Richard E. and Javier Lopez-Gonzalez (2013), “Supply-Chain Trade: A Portrait of Global Patterns and Several Testable Hypotheses”, NBER Working Paper 18957, National Bureau of Economic Research.

Feenstra, Robert C. and Gordon H. Hanson (1999), “The Impact of Outsourcing and High-Technology Capital on Wages: Estimates for the U.S., 1979-1990,” Quarterly Journal of Economics, 114, 907-940.

Ferrantino, Michael J. and Daria Taglioni (2014), “Global Value Chains in the Current Trade Slowdown”, VoxEU, 6 April.

Los, Bart, Marcel P. Timmer and Gaaitzen de Vries (2014), “How Global Are Global Value Chains? A New Approach to Measure International Fragmentation”, Journal of Regional Science, forthcoming.

Wang, Zhi, Shang-Jin Wei and Kunfu Zhu (2014a), “Gross Trade Accounting: A Transparent Method to Discover Global Value Chain-Related Information Behind Official Trade Data: Part 1”, VoxEU, 7 April.

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Topics:  International trade

Tags:  global value chains, global supply chains

Assistant Professor, University of Groningen

Associate Professor at the Faculty of Economics and Business, University of Groningen

Professor of Economic Growth and Development at the University of Groningen; Director of the Groningen Growth and Development Centre (GGDC)