Trade Policy Implications of Global Value Chains - …

1 @OECD Trade November 2015 Trade Policy Implications of Global Value Chains International Trade increasingly involves Global Value Chains (GVCs) where services, raw materials, parts and components are exchanged across countries before being incorporated in final products that are shipped to consumers all over the world. Exports from one country to another are now reflecting complex interactions among a variety of domestic and foreign suppliers and create income for firms and workers in widely separated locations. Trade is even more than before determined by international strategies of firms that engage in foreign outsourcing, foreign direct investment and carry out their activities wherever the necessary skills and materials are available at competitive cost and quality. In order to better account for the internationalisation and fragmentation of production, new Trade statistics have been developed that can identify the Value added by each country in GVCs ( ).

2 The OECD has undertaken comprehensive work that aims to shed light on the scale, nature and consequences of international production sharing. This note explores just one aspect - the Implications of GVCs for Trade Policy and Trade agreements. The growing fragmentation of production across borders highlights the need for countries to have an open, predictable and transparent Trade and investment regime as tariffs, non-tariff barriers and other restrictive measures impact not only on foreign suppliers, but also on domestic producers. It also highlights the importance of an ambitious complementary Policy agenda to leverage engagement in GVCs into more inclusive growth and employment. Global Value Chains have transformed world Trade Trade policymakers need to take stock of the reality of business in GVCs. Over the last two decades, there was an important shift in world Trade . Both the structure and patterns of Trade have changed, leading to a re-assessment of traditional Trade Policy objectives.

3 Trade consists mostly of intermediate and capital products When we think about international Trade , the traditional view is that each country is producing finished products that are exported to consumers in another country. This type of Trade represents only one quarter of total Trade in goods and services. Today, three quarter of international Trade is about firms buying inputs and investment goods or services that contribute to the production process (Figure 1). Protection measures against such imports increase costs of production and reduce a country s ability to compete in export markets and to participate in GVCs. Similarly, currency interventions which may aim at creating a competitive advantage for exporters lose relevance, as any export advantage gained from a cheaper currency is at least partially eroded by the cost of more expensive imported inputs and capital goods or services. Figure 1. Share of intermediate and capital products in total Trade (1995-2011) Source: TiVA database, June 2015.

4 0%25%50%75%100%1995200020052008200920102 011 IntermediateCapital @OECD Trade November 2015 Trade is becoming more Global While the focus of Trade Policy since 1995 has been on the negotiation of preferential Trade agreements - often on a regional basis - companies have increasingly diversified their sourcing strategies and have increasingly imported inputs from emerging economies, thus leading to an increase in the share of extra-regional Value added in the exports of Asia, Europe, North America and South America (Figure 2). It is only in the European Union that the share of intra-regional Value -added remains higher than the share of extra-regional Value -added. But the trend has been similar; EU companies are relying more and more on extra-EU inputs. Figure 2. Share of extra- and intra-regional Value added in exports (1995 and 2011) Source: TiVA database, June 2015. What Trade policies for engagement in GVCs? The globalisation of supply Chains calls for a more coherent view of Trade and Trade -related policies.

5 The fragmentation of production has created potential new opportunities for developing economies and for small and medium-sized firms to access Global markets as components or services suppliers, without having to build the entire Value chain of a product. At the same time, GVCs place new demands on firms, in particular as regards the need for strong coordination and efficient links between production stages and across countries. Tariffs: Removing barriers at the border that are cumulated along the Value chain After more than a half a century of Trade liberalisation, nominal tariffs on manufactured products in developed economies are generally low, and the overall trend has also been towards lower tariffs in developing countries. But in a world characterised by GVCs things are not so clear-cut: tariffs and other protection measures at the border are cumulative when intermediate inputs are traded across borders multiple times.

6 As shown in Figure 3, adding the tariff on final exports to tariffs on inputs (including all tariffs on inputs more upstream in the Value chain) can lead to high average ad valorem tariffs in some industries. Moreover, where foreign investment is a driver of export capacity, the cumulative effect of a number of seemingly small costs may discourage firms from investing, or from maintaining investment, in the country and may lead them to take production facilities, technologies, and jobs elsewhere. 0%10%20%19952011199520111995201119952011 AsiaEuropeNorth AmericaSouth AmericaExtra-regional VAIntra-regional VA @OECD Trade November 2015 Figure 3. Average ad valorem tariffs along the Value chain, selected industries, 2011 Source: OECD, 2015. Based on average applied tariffs. Trade facilitation: Transforming border bottlenecks into Global gateways As goods now cross borders many times, first as inputs and then as final products, fast and efficient customs and port procedures are essential to the smooth operation of supply Chains .

7 To compete globally, firms need to maintain lean inventories and still respond quickly to demand, which is not possible when their intermediate inputs suffer unpredictable delays at the border. A country where inputs can be imported and exported within a quick and reliable time frame is a more attractive location for foreign firms seeking to outsource production stages. As such, Trade facilitation measures are crucial to foster integration into Global production networks and Global markets. Figure 4. Trade facilitation measures: Potential cost reduction in goods Trade (%), most beneficial areas for reform, by main income group Source: OECD, 2015, covering 152 countries. The OECD Trade Facilitation Indicators (TFIs) correspond closely to the provisions of the WTO Trade Facilitation Agreement and measure the potential impact of implementing the Agreement. The potential cost reduction of all the Trade facilitation measures combined totals up to for some countries, with the greatest gains for lower income countries.

8 The TFIs also enable countries to identify priority areas for reform. As shown in Figure 4, harmonising and simplifying documents, streamlining border procedures and automating processes are among the most beneficial areas for many countries. 0%2%4%6%8%10%12%Basic metalsTextiles & apparelChemicalsOther manufacturingMotor vehiclesMachineryDirect tariff on inputsIndirect tariffs on inputsTariff on final 0%1%2%3%4%Low-income countries Upper-middle income OECD Lower-middle income @OECD Trade November 2015 Standard setting: Avoiding unnecessary restrictions The rising number of quality and safety standards is in part driven by concerns about information, coordination and traceability which are more acute in a world dominated by GVCs. While the need to protect final consumers through appropriate quality standards should not be understated, their complexity and above all their heterogeneity has become one of the main barriers to insertion into GVCs, in particular for small- and medium-sized enterprises.

9 Upstream firms supplying intermediate inputs to several destinations may have to duplicate production processes to comply with conflicting standards, or to incur burdensome certification procedures multiple times for the same product. In agro-food Value Chains , meeting public and private standards has been identified as the main obstacle to participation in GVCs. Increasing international regulatory cooperation, including via the convergence of standards and certification requirements and mutual recognition agreements, can go a long way to alleviate the burden of compliance and enhance the competitiveness of small-scale exporters. Efficient services markets: Improving competitiveness behind the border Global production networks rely on the logistics chain, which requires efficient network infrastructures and complementary services. There would be no GVCs without well-functioning transport, logistics, finance, communication, and other business and professional services to move goods and coordinate production along the Value chain.

10 Trade flows in Value -added terms reveal that services play a far more significant role than suggested by gross Trade statistics: accounting for the Value added by services in the production of goods shows that service sectors contribute 55% of total exports in OECD countries and 42% in the People s Republic of China. The Value created by services as intermediate inputs represents over a third of the total Value added in manufactured goods, as shown in Figure 5. More efficient service sectors enhance the competitiveness of manufacturing firms and allow them to better participate in Global production networks. Figure 5. Services share of Value added in manufacturing Trade , all countries, 2011 Source: TiVA database, June 2015. The OECD Services Trade Restrictiveness Index (STRI), which covers the major services sectors and suppliers, is a practical tool for diagnosing where reform might be most needed and how desired reforms might be best achieved.