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The role of global value chains in economic development

Dozens of Chinese manufacturing warehouses are visible through the morning fog.

Aerial view of Chinese factories clouded in pollution

Nov 10 2015

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China’s rise as the world’s leading manufacturing power is among the most striking developments of the 21st century and has put China at the forefront of the global production process. Chinese factories operate in all stages of production. Some Chinese manufacturers turn out finished goods that carry the “Made in China” label, using parts made domestically or imported from other countries. Others make components that go into products assembled elsewhere. In this way, China illustrates the growing complexity of global manufacturing, in which a single product may be designed, built, and sold in far-flung locations scattered around the world.

China’s place in these global value chains is a special focus for SCID. Researchers are studying whether the Chinese model of moving up from low-value processes like electronics assembly to more profitable and technologically sophisticated operations represents a workable example for other countries. Two recent papers illustrate the contributions of SCID scholars.

Credit constraints

Access to credit is vital for manufacturers, especially in the developing world where they may be thinly capitalized to begin with. Kalina Manova, formerly a Stanford assistant professor of economics and SCID Faculty Affiliate, now a professor of economics at Oxford University, has investigated whether problems obtaining financing keeps Chinese exporters stuck in low-value activities. Manova and co-author Zhihong Yu divide Chinese exporters into three types: (1) those that make their own products and carry out conventional trade; (2) those that process goods for foreign companies, but buy materials and components themselves; and (3) those that do simple processing with inputs provided by foreign partners. Conventional trade is most profitable, assembly for foreign partners is least profitable, and processing with purchased inputs is intermediate.

Manova and Yu find that companies with more available capital and less short-term debt tend to carry out conventional trade rather than performing processing work for foreign partners. And, among exporters doing contract work for foreign companies, those with more capital and less debt prefer to buy materials and components themselves instead of getting inputs from their partners. In addition, exporters are more likely to do contract work for foreign partners, especially pure assembly, in more financially vulnerable sectors of the economy. Their conclusion: limited exporter access to credit is a significant obstacle to development, an observation that applies widely in the developing world. “Our findings imply that credit constrained firms, and presumably financially underdeveloped countries as a whole, might be stuck in low value-added stages of the supply chain and unable to pursue more profitable opportunities,” they note. “Strengthening capital markets might thus be an important prerequisite for moving into higher value-added, more profitable activities.”

Greenhouse gas emissions

Controlling carbon emissions and limiting the effects of climate change represent one of the great challenges of our time. Yet, the proliferation of global value chains has complicated the task of tracing the sources of emissions. When a product is assembled in China using components produced in several countries and then sold to consumers in the United States, how can greenhouse gas emissions be measured? And how much responsibility should be assigned to countries at various stages along the production chain? SCID visiting scholar Zhi Wang and colleagues propose a new accounting system for analyzing the environmental effects of globalized production. Wang, an economist with the US International Trade Commission, and co-authors combine standard methods of measuring value added at each stage of production with environmental accounting techniques. Those methods can be used to calculate carbon emissions or other environmental effects, such as air pollution.

Wang and co-authors find that emissions created in developing countries at intermediate stages of production are the fastest growing source of greenhouse gases, rising from 5 percent of all trade-related emissions in 1995 to 20 percent in 2009. Intermediate trade between China and other developing countries is the largest factor in this growth. “A country’s pattern and level of emissions is crucially subject to its position and the extent of its participation, directly or indirectly, in (global value chains) through international trade,” they conclude.

Policy implications

The work of Manova and Wang offer important lessons for policymakers. Manova shows that strengthening credit markets in developing countries may be necessary to make exporters more competitive and profitable. Companies with access to capital are able to invest in more technically sophisticated production methods and occupy higher-value segments of the production process. Improving access to credit represents good development policy and good trade policy.

Wang and his colleagues provide a more precise way of measuring the environmental costs of globalized trade. Such information allows more accurate assignment of responsibility for greenhouse gas emissions and other environmental effects. An accounting system that analyzes each step of the production process would be instrumental in designing fair and well-targeted policies to control emissions.