No island is an ‘island’ in the age of GVCs

Tommaso Aquilante, Marco Garofalo and Enrico Longoni

Over the past few decades production processes have become increasingly complex and integrated across national boundaries through so-called Global Value Chains (GVCs). With increasing trade tensions and uncertainty regarding future economic integration, the 400-year old words of the English poet John Donne captured in ‘No man is an island’ seem more topical than ever. In this BU we explore the UK’s position in GVCs showing that also no island is really an island! Using a sophisticated yet intuitive decomposition of UK’s trade flows we will show how GVCs matter for the UK economy, and in particular how they seem to matter more for what we export than imports.

What are Global Value Chains?

DFAIT (2011) provides a good general definition, adapted from the Global Value Chain Initiative at Duke University, of what GVCs are:“[a] global value chain describes the full range of activities undertaken to bring a product or service from its conception to its end use and how these activities are distributed over geographic space and across international borders.”

Basically, nowadays chances are that to create its products a firm requires several intermediate inputs from abroad at different stages of the production process. Think, for example, of the production of a car: some components of the final product that you enjoy driving around – say the engine – might be initially assembled in one country, before being shipped to another country for the next stages of production eg adding gear, wheels, and so on. The final product may then finally return to the initial country or be exported to others. With this simple example in mind, it may not sound too surprising the UNCTAD 2013 World Investment Report found that about 60% of global trade is in intermediate goods and services that are incorporated at various stages in the production process of goods and services for final consumption.

Economists generally use Global Input Output (IO) Tables to analyse GVCs. Relative to domestic IO tables, with which they share the same principles, Global IO have the advantage of accounting for interlinkages across all the economies in the world. For example, the ONS IO tables show for every sector in the UK which intermediate inputs it provides to all other sectors, and which final products to the domestic economy. The UK IO tables also show the value of exported products, both intermediate and final, UK firms export abroad. Finally, domestic IO tables also tell you how those products are made, ie how much of the sectoral output comes from domestic value-added (VA) and how much from imported inputs. Global IO Tables provide this information, but for every country in the world. This means that, for example, one can calculate the contribution – in terms of value-added – of the Italian manufacturing sector into manufacturing production in the UK, and how this was generated.

Beyond gross trade flows: the importance of trade in value added

Looking at trade from a GVCs perspective reveals how different economies can be linked in terms of the value-added flows they generate. This alternative perspective also shows that looking at the gross value of trade, as opposed to trade in value-added, might be misleading. Standard gross trade statistics show the entire value of a good or a service that is traded internationally. This includes the value of intermediate inputs that might have been added abroad rather than in the trading country and/or inputs provided by other domestic industries which in turn use imports as inputs in their production processes.

In our integrated world this can result in double-counting of trade flows if intermediate inputs cross borders multiple times, potentially overstating the importance of exports in GDP. For example, using the OECD TiVA dataset, one discovers that the UK’s top five export destinations are not necessarily the same when one looks at gross rather than trade in value-added flows. For example, exports to the US are larger when measured in terms of value-added (Figure 1).

Figure 1: Gross and value-added shares in total exports to UK top 5 export markets

Source: Department for International Trade (2019). ‘UK Trade in Numbers‘, February 2019.

There are several Global IO datasets out there. The following analysis is based on the World Input Output Dataset (WIOD). In its 2016 release (latest available), WIOD covers 43 countries (plus a model of the Rest of the World) and 56 sectors for the time period 2000-2014. Being consistent with National Accounts and covering a long time span, these data is widely used in the international trade literature.

Given its ability to account for all flows at the country-sector level, the WIOD is a great tool to understand how the production processes of one country relies on inputs from others. There are different measures to capture this.

For example, value-added trade (eg Hummels et al 2001) looks at the place where value is created rather than focusing on the exporting country. Furthermore, upstreamness (eg Antràs et al 2012) captures a country’s average position along the value chain, eg whether it mainly provides inputs to other countries supply chains or it is an exporter of final products.

 GVCs matter more for UK exports than imports

In our analysis we follow the approach in Koopman et al (2014) and decompose UK gross exports for the period 2002-2014 into seven value-added components and two residual double-counting terms, which we will sum into one for convenience (Figures 2 and 3). As mentioned above, the double-counting comes from intermediate inputs within final products crossing the border multiple times and thus double-counted by national statistics.

Figure 2: Koopman et al (2014) decomposition of gross exports into value-added components

Source: Koopman, Robert, Zhi Wang, and Shang-Jin Wei. 2014. ‘Tracing Value-Added and Double Counting in Gross Exports.’ American Economic Review, 104 (2): 459-94.

Components 1 to 3 in Figure 3 refer to value-added in direct final goods exports, value-added represented by exports in intermediates that are absorbed either by the direct importer or by third countries (ie these are re-exports). Their sum accounts for almost 80% of UK exports and it is stable over time. Importantly, trade in intermediates have by far the largest share (50% of gross exports), meaning that the UK is largely contributing to foreign supply chains, and this has been the case for a while.

Components 4 and 5 refer to domestic value-added in intermediates which return to the UK via imports of final and intermediate products, respectively. Figure 3 shows that their contribution is negligible. This means that the UK does not really re-import its own stuff.

Figure 3: Decomposing UK gross exports into value-added components

Source: WIOD-Release 2016 and authors’ calculations. USA, FRA, DEU and CHN are the 2014 shares in gross exports for the United States, France, Germany and China.

Components 6 and 7 in Figure 3 reflect foreign VA in final and intermediate exports respectively, with the former including UK re-exports of foreign final products. These two components account for about a combined 20%, of UK gross exports over the considered time period contributing 8% and 12% respectively. Taken together, this represents a significant portion of UK exports, but still, it’s less than half the UK contribution to foreign supply chains by exports in intermediates goods (components 2 and 3).

Perhaps expectedly, the decomposition of UK trade for the year 2014, the latest year in our sample, is not too dissimilar from other developed countries such as the USA, France and Germany. Interestingly though the UK exports more VA in intermediates than in final products. On the contrary, a country like China shows the opposite pattern. By being a processing country, China gets inputs from others and assembles final products to be exported. So China’s VA is more in exported final products than in intermediates (Figure 3).

More interestingly, WIOD also shows that the foreign content in UK gross exports has been stable over time, if not decreasing, since the financial crisis in 2008-9. Other large EU countries, such as France and Germany, have instead seen it increasing (Figure 4). This is in line with the results from IJtsma et al (2018), indicating that the UK is the only EU member state whose domestic VA in exports as a share of gross exports has not decreased from 2000 to 2014. Indeed, it has actually increased. In their analysis, they also use the WIOD to decompose UK gross exports, though in a less granular fashion as they do not separately report all the components in the Koopman et al (2014) decomposition, eg foreign VA in final and intermediate exports.

IJtsma et al (2018) explains their finding indicating that the UK has oriented its exports towards high domestic VA sectors. Between 2000 and 2014 there is indeed a large increase in the share of domestic value-added in UK exports of the final services sector compared to other EU countries. Indeed, services play an important role in GVCs accounting for between 25% and 40% of the content of manufacturing exports in most OECD and G20 countries.

Figure 4: Foreign content in gross exports – UK, France and Germany

Source: WIOD-Release 2016 and authors’ calculations.

Conclusion

Using a decomposition of UK gross exports into different value-added components, we have illustrated the UK position in GVCs. Being able to access and contribute to foreign supply chains seems to be important for the UK both on the exports and imports side. However, GVCs appear to be a more significant component of UK exports rather than imports.

 

Tommaso Aquilante, Marco Garofalo and Enrico Longoni work in the Bank’s Structural Economics Division.

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