My mental model of what is exchanged in international trade is getting an attitude adjustment. Traditional discussions of international trade are often based on examples of countries exporting products which are then consumed in other countries: cars, computers, wine, clothing, and so on. But in the modern economy, what is often exported across national borders is an intermediate good, which is then used in production of other intermediate goods and exported again, so that the ultimate product was produced as part of a global supply chain reaching across countries. The collection of essays in Global value chains in a changing world, edited by Deborah K. Elms and Patrick Low, offers a nice overview. The book was published by the World Trade Organization, together with the Fung Global Institute and Nanyang Technological University.
The book has 16 chapters, covering various aspects of global supply chains like how to measure the value-added within each country, how to manage these production processes, and how low- and medium-income countries can find a niche for themselves to these production chains. Here, I\’ll focus on the nice overview essay by Richard Baldwin. He begins (references and footnotes omitted for readability, as usual):
\”Global supply chains have transformed the world. They revolutionized development options facing poor nations; now they can join supply chains rather than having to invest decades in building their own. The offshoring of labour-intensive manufacturing stages and the attendant international mobility of technology launched era-defining growth in emerging markets, a change that fosters and is fostered by domestic policy reform. This reversal of fortunes constitutes perhaps the most momentous global economic change in the last 100 years. Global supply chains, however, are themselves rapidly evolving. The change is in part due to their own impact (income and wage convergence) and in part due to rapid technological innovations in communication technology, computer integrated manufacturing and 3D printing.\”
Baldwin argues that these global supply chains represent a profoundly different form of international trade. In what he calls \”the first great unbundling\”–that is, the growth of world trade from the early 19th century through much of the 20th century–the gains from trade results from cheaper transportation costs combined with innovation, specialization, and economies of scale.The advantages of complexity and scale seemed to be coordinated best when production was clustered in a relatively few places. The result was that economic activity became clustered: for example, in the global North rather than the global South, and in certain regions and metropolitan areas rather than others.
The \”second great unbundling\” of global supply chains is driven by different factors: declining costs of communication and information technology made it possible to coordinate economic activities happening in many different locations, and the large differences in wages that had built up over the decades across the countries of the world meant that splitting up work could reduce costs. \”Some of the coordination costs are related to communication, so the `coordination glue\’ began to melt from the mid-1980s with ICT’s melding of telecommunications, computers and organizational software. … While technology transfer is an ancient story (gunpowder), ICT facilitated control that reduced the costs and risks of combining developed-economy technology with developing-nation labour.\” In this form of international trade, economic activity becomes less clustered, and expertise spreads out.
Baldwin describes the result this way: There are “headquarter” economies (whose exports contain relatively little imported intermediates) and “factory” economies (whose exports contain a large
share of imported intermediates). … The global supply chain is really not very global – it’s regional
… [in] what I call Factory Asia, Factory North America, and Factory Europe.\”
As one measure of these shifting patterns, Baldwin points out that the G-7 economies–the United States, Canada, France, Germany, Italy, Japan, the United Kingdom–represented 20% of global output in 1820, 40% of global output in 1870, and peaked at two-thirds of global output in 1988, but have now fallen back to 50% of global output.
Baldwin also argues: \”Internationalizing supply chains also internationalized the complex two-way flows that used to take place only within factories.\” Thus, decisions about how to invest that used to happen inside plant or perhaps in a certain local region are now decisions about foreign direct investment. Transportation of parts and supplies used to happen inside a company: now much of that transportation is outsourced to logistics companies that provide shipping services. Services like legal and finance that used to happen within a company, and often even within the same building, now often become international transactions. Decisions about how to move intellectual property into the production line used to involve people from neighboring buildings, but now it involves decisions about sharing intellectual property and appropriate training across international borders.
And the political economy of trade changed, too. In the older forms of international trade, there was always a temptation to protect domestic industries by shutting out imports. But in global supply chain trade, there is an incentive to make it ease for imports to arrive as part of the global value chain, and an expectation that other countries will behave in the same way.
This process of global value chains is really just getting underway, and it may turn out to be more of a kaleidoscope of shifting patterns than a unidirectional movement. There will continue to be advantages of proximity to suppliers of inputs and to sources of ultimate demand. On the other side, continuing improvements in information and communications technology will tend to encourage further separation of economic activity, along with the growth of products that are valuable and technology-intensive but are small and have low cost to ship–or in the case of products like software or certain services, the \”products\” can be shipped electronically at almost zero cost. These forces will vary for different products. They will change with new developments in technology, like computer-guided manufacturing or equipment that can be operated by specialists who are geographically far away (remote surgery, anyone?). The forces will also change according to the ways that areas specialize in different kinds of production.
My sense is that when economic historians 50 or 100 years from now look back at this time period, our daily policy concerns like the slow recovery from the Great Recession, health care finance, the euro, and others will have faded with time. Instead, the creation of global supply chains and the transformation of global economic patterns, along with what it means for countries and workers, will seem like the defining economic event of our time.