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Policies Should Reflect Rise, Importance of Global Value Chains, Report Says

Thursday, July 24, 2014  Trade Report
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joint report issued by the World Trade Organization, the World Bank and the Organization for Economic Cooperation and Development July 19 finds that global value chains are becoming increasingly influential in determining future patterns of trade and foreign direct investment. GVCs reflect 21st century production and provide potential mechanisms for all countries to improve income, employment and productivity, the report states, but must be complemented with appropriate policy frameworks that allow countries and firms to capitalize on their existing productive capacities and spillover benefits from foreign investment, knowledge and innovations.

According to the report, the growth of GVCs has increased the interconnectedness of economies and led to a growing specialization in specific activities and stages in value chains rather than in entire industries. GVCs allow suppliers to upgrade production into higher-value segments of their industries, learn new processes, meet standards that enhance their access to markets, facilitate exports and imports in intra-firm trade, encourage the utilization of network technology, and tap into new sources of capital. They also enable countries to specialize in areas of comparative advantage, thus enhancing productivity growth and supporting wages and incomes. GVCs have become a dominant feature of the world economy, and a high share of employment now relies on foreign final demand and the smooth functioning of GVCs.

Policies should respond to this reality, the report states, by promoting business environments that not only make countries attractive for the location of GVCs but also facilitate upgrading opportunities over time. These include horizontal policies such as good infrastructure and connectivity, a business-friendly environment, flexible labor markets, access to credit, innovation and macroeconomic stability along with more targeted policies such as tariffs and other trade restrictions, subsidies, local-content or export-performance requirements, and restrictions on foreign exchange.

The report highlights the following lessons for policy from successful integration into GVCs.

Trade Policy. Trade policy should value imports as well as exports, seek to reduce time delays as well as tariffs, and address “behind the border” regulatory measures as well as “at the border” measures. Multilateral market opening is preferred over discriminatory arrangements, as barriers between third countries, upstream or downstream, can matter as much as barriers put in place by direct trade partners. G-20 countries should reinforce their standstill commitment against protectionism and wind back any restrictive measures implemented since the global economic crisis, with a particular focus on non-tariff barriers.

Policies that aim to artificially increase the domestic content of exports do not have a good track record and can shift resources to less productive activities, prevent local producers from outsourcing and having access to the most efficient inputs, and discourage knowledge spillovers on both the import and export side. Policies targeted to increase the competitiveness of local suppliers are likely to be more efficient.

Policies that artificially increase the participation of firms in GVCs through direct government incentives for specific activities and disincentives for other activities will most probably not generate sustainable benefits, the report asserts. Linking with lead firms can be a more solid foundation to build on for many small and innovative firms.

A well-crafted package of macroeconomic and structural policies is also required to stimulate growth, and the precise shape of these policies depends significantly on the specific situation in a given country.

Moreover, the report states, offshoring should not be viewed as a threat, as the jobs potentially displaced by new trade and investment opening are dwarfed by the jobs already depending on the operations of established foreign affiliates and on exports of value-added in GVCs. The real risk for employment is the disruption of value chains by natural disasters or other events. Policy should therefore protect workers, not jobs, by focusing on investment in education, skills and training as well as the development of adequate social safety nets for those facing difficulties in adjustment.

Trade Facilitation. Trade facilitation helps countries participate in GVCs by cutting costs, avoiding unnecessary delays and reducing uncertainty. The potential reduction in trade costs of fully implementing the WTO Agreement on Trade Facilitation is as high as 14 percent for some developing countries. The report therefore urges G-20 countries to implement and ratify the TFA as quickly as possible, consider implementing TF measures (e.g., streamlining customs procedures) even before the ratification process is finalized, and provide support to developing countries as they make TF commitments that require additional technical assistance.

Services. GVCs are particularly sensitive to the quality and efficiency of services, which account for 42 percent of the value-added in the exports of G20 economies and more than 50 percent for some countries. Improving logistics services, in particular, is essential to effective GVC participation, as high-quality logistics affect trade even more than distance or transport costs. For example, every extra day needed to ready goods for export and import could potentially reduce trade flows by up to four percent.

Regulatory Cooperation. International regulatory cooperation, including via mutual recognition agreements, can help mitigate compliance costs that arise as a result of unnecessarily complex or heterogonous regulations, enhancing the ability of firms to participate in GVCs.

Development. While developing countries are increasingly involved in GVCs, gains from GVC participation are not automatic. Strong social, environmental and governance frameworks and policies are important to maximizing the positive impact of GVC activities and minimizing risks in all countries, especially developing economies. These include sound public institutions that enforce contracts, adequately secure property rights and investor protection, ensure an impartial judiciary, and reduce corruption. For firms to upgrade in GVCs, countries should develop an efficient innovation system that facilitates investments in knowledge, technology dissemination, skills upgrading and entrepreneurship.