#150 Value Chains and International Trade

Though tariffs dominate the headlines, important changes in the nature of globalization of trade have been unnoticed. The global financial crisis of 2007-08 has obscured such shifts. Now the dynamics of global trade is revealing new transformations. 

Gross global output, as measured by GNP, continues to increase in the share of output that is traded. But the share of goods that are produced is declining because services and data now play a bigger role in the global economy. The trade in services is growing faster than the trade in goods. Services are now creating value beyond what the national GDP accounts measure. Alternative measures are finding that services already constitute more value in global trade than goods.

Global value chains are becoming knowledge-intensive. Low-skill labor is becoming less important as the basis for international trade. Only 18% of global trade is now driven from sources of low labor costs.

The growing consumer demand in China and in the developing world now make it possible for these countries to reduce the export of their output to start consuming more of what they produce. Attention has now shifted to domestic supply chains. China and developing countries have reduced imports of goods and started investing in new labor-saving technologies to lower costs to consumers. In the past digital technologies accelerated trade by reducing transaction costs. The next generation of technologies will fuel an expansion into consumer services such in health, education and an improved quality of life. 

This post is based on the report by the McKinsey Global Institute (https://www.mckinsey.com/featured-insights/innovation-and-growth/globalization-in-transition-the-future-of-trade-and-value-chains). The post analyzes 23 global value chains, spans 43 countries and covers 1995 to 2017. The report accounts for 96% of global trade, 69% of global output and 68% of global employment. 

What are Value Chains?

Global value chains reflect millions of decisions made by businesses regarding where to source inputs, where to establish production and where to sell goods. These decisions shape the movement and volume of global flows of goods, services, finance, people, and data. The simplest value chains involve a sequence of production steps that process inputs and raw commodities from firms located in different countries. Complex value chains can involve hundreds of inputs from dozens of countries and consist of subassembly of more elaborate components. Two-thirds of world trade is therefor in intermediate inputs and not in final goods and services, engaging the scale and intricacy of cross-border networks. The output and employment of different sectors that make up value-chain is shown below:

Global Innovation Value Sector

Chemicals, automotive, computers, machinery, electronics and transport equipment are the most valuable, highly traded, and knowledge-intensive value chains. They account for 13% of global output and 4% of global trade. More than 50% within these value chains is in intermediate goods. One-third of the workforce in these value chains is highly skilled. Spending on R&D averages 30% of revenues. Participation in this value chain is concentrated in 12 locations and accounts for 75% of the value of global exports.

Labor-intensive Goods Sector

Textiles and apparel, toys, shoes, and furniture are highly labor- and trade-intensive. More than two-thirds of income goes to labor, most of which is low-skill. Production shifts to developing countries and accounts for 3% of global output and employs only 3% of the global workforce.

Regional Processing Sector

Fabricated metals, rubber, plastics, glass, cement and food and beverage are included in this value chain. It accounts for 9% of global output and employ 169 million people, or 5% of the global labor force. This value chain is often overlooked but is essential.

Resource-intensive Goods Sector

Includes agriculture, mining, energy, and basic metals. These value chains generate $20 trillion of gross output, nearly as much as global innovations value chains. Much of this output goes to other value chains as intermediate inputs. Access to natural resources and proximity to storage and transportation infrastructure determine where production is located. Countries around the world participate; 19 countries account for 75% of resource-intensive goods exports. The top five countries make up a lower share of exports in this group than in any other, at just 29%. While agriculture employs almost 870 million people globally, the other value chains in this sector employ only 49 million people in total. Mining and energy have the highest value added per employee among all the value chains we studied.

Labor-intensive Services

These value chains include retail and wholesale, transportation and storage, and healthcare. Given the personal nature of these services trade is growing faster than in any other   sectors. Sector e value chains are the largest job creators after agriculture, employing more than 740 million people (23% of the global workforce), two-thirds of whom are in wholesale and retail trade. These sectors are an important part of all economies. The value added per employee is the same as in labor-intensive manufacturing (roughly $25,000), and they employ seven times as many people.

Knowledge Intensive Service

This sector includes professional services, financial intermediation, and IT services. Over 50% of its people have bachelor’s degrees or above. Growth in this sector is constrained due to regulatory barriers. International trade can span the entire globe since costs are not directly related to distance. Country participation is highly concentrated with advanced economies. 21% of exports come from developing economies. The high concentration among countries reflects significant investments in a skilled workforce required to succeed in this sector.

Summary:

Though the Global Innovations sector is receiving much attention in the media its output is so far only 13% of the global economy and 4% of global employment. Any country that wishes to increase GNP must first pay attention to improving the productivity of its Resource-Intensive and Labor-Intensive sectors. Attractive sectors, such as the Global Innovation and Knowledge Intensive economies will prosper only if linked directly to profitable gains. GNP growth will occur only if there is an balanced approach for combining sectors to increase overall efficiency.

The primary objectives of global trade in the future will be to harness the benefits that accrue from technological innovation in order to deliver gains that will occur in all of the remaining five sectors.