The (Greater) Wealth of Nations (Part 2)

Is trade enough?

Source: Brookings Institute

In order to understand the effect of trade on the global economy, it’s not enough to map out gross flows from one economy to another. Countries and companies are enmeshed in a complex web of relationships – called the Global Value Chain. Cars aren’t just built in Japan from Japanese steel and glass and plastic and then shipped to the US or Europe anymore. They might have Chinese steel and Mexican seats and a Canadian motor and software coded in India embedded in chips from Taiwan and Texas, all assembled in Kentucky.

The complexity of these global value chains make it more difficult to understand how trade works and who benefits. We’re accustomed to think of goods and services as two separate categories. But there is an increasing services component built into the goods shipped around the world. People don’t buy smartphones just speak with one another. The phone is just one app – and not even the most important one – in a complex supercomputer that we carry around with us. The software in our phones, and their connectivity to a network of relationships, is what makes them valuable to us. And they’ve become so valuable precisely because of all the programming and design and connectivity – services – that are embedded in the chips that run our phones.

By analyzing global value chains, policymakers and focus on choke-points that hinder growth. For example, poor transportation, inefficient customs clearance, bureaucratic red tape, and corruption all impede trade, but they’re most pernicious in sectors that require a lot of back and forth. Countries with high trade costs can’t participate in the chains, and are often limited to producing basic commodities.

There’s also a “smile curve” in global value chains, where countries at either end of the process – research and design on one end, marketing and retailing on the other – tend to earn most of the profits. The countries that assemble components and ship them off get the skinny part of the process. This tends to be more labor-intensive, which can be a mixed blessing: providing lots of jobs, but limiting company profitability.

Smile Curve from 2009. Source: Brookings

Global trade is complex today, and new approaches are needed to make sure people don’t get left behind. There’s no simple way to spread the its benefits around, but this is the world we live in. We can’t just put a car in reverse to simplify its production.

Douglas R. Tengdin, CFA

By |2017-08-18T06:17:08-05:00August 18th, 2017|Global Market Update|Comments Off on The (Greater) Wealth of Nations (Part 2)

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