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World Bank: Global value chains risk pigeonholing developing nations

Developing countries have benefited from global value chains over the past two decades, but they remain at risk of becoming solely commodity and input producers if they do not reform policies in an era of trade tensions and automation, the World Bank says.

Global value chains, or GVCs, through which different stages of production occur in several different countries, have led to an "explosion" in trade, and they now account for nearly 50% of global trade, according to Pinelopi Koujianou Goldberg, the chief economist of the World Bank Group.

Global value chains took off in the 1990s and early 2000s due to lowered trade barriers that drove manufacturers to explore other regions for production, though GVC growth has slowed significantly since the financial crisis of 2007-08.

Goldberg, speaking Oct. 17 at the World Bank Group and International Monetary Fund annual meetings in Washington, D.C., said GVCs allow developing countries to grow their economies through increased production of smaller components, including raw materials and services inputs, that go into finished products. Before GVCs, countries would just import finished products to consume domestically or export finished products to be consumed in another country.

GVCs provide two main benefits, Goldberg said. The first is that they help firms and producers form long-term relationships, creating a natural engine for growth and a vehicle for technology transfer, including for goods such as cars, smartphones and textiles. Second, GVCs allow products to be assembled without quality deficiencies.

Breaking a product up into small components makes it much easier for developing countries to join global value chains and can help reduce poverty in those areas, she said.

"Think of a country that is relatively poor that does not have enough capital or capabilities to produce a car," Goldberg said. "But it's easier to produce just a few components. Because of that, GVCs make it easier to join and use trade as a means to develop."

While they provide benefits, GVCs can also create conflicts. Some countries in GVCs, especially developing nations, are stuck in the production of low-value-added content within the chain, making them susceptible to what Goldberg called the "middle-income trap," leaving them behind in the next era of development.

To combat the trap, developing countries need to invest in human capital and adopt open and predictable policies and reforms to minimize risks of economic stagnation.

The comments dovetail with the World Bank's annual World Development Report for 2020, which focused on trade for the first time since 1987. Goldberg said that decision was made due to the outsize role trade policies are playing in the global economy, most notably the ongoing trade dispute between the U.S. and China.

Elsewhere, Mexico plays a crucial production role for U.S. car companies. Components are often sent across the U.S.-Mexico border multiple times before the finished product hits the market. A stable trade agreement is needed for these value chains to remain steady, Arturo Herrera Gutierrez, Mexico's finance minister, said Oct. 17, but the United States-Mexico-Canada Agreement has yet to be ratified across North America.

"Value chains can be much more complicated than one could imagine even though we're closest to one of the largest markets," Gutierrez said. "We need stable agreements because even small changes can have very different impacts."

The World Bank cautioned in the report that trade barriers and trade spats could encourage protectionism, which would stifle firms' investment plans until uncertainty is quelled.

"The biggest benefit in agreements is not just a reduction in trade barriers and tariffs, it's providing a predictable environment," Goldberg said.

But the gains from GVCs have not been distributed equally, the bank said in its annual report. Consumers in developed countries have benefited significantly from cheaper labor elsewhere, while developing countries in areas such as Africa, Latin America and Central Asia still produce commodities for finished production in more-industrialized nations.

Goldberg said that although the obvious assumption would be that technological developments could draw production closer to consumers and reduce the demand for labor in developing nations, it could actually provide a boon for these countries. Automation actually has led to higher productivity and a larger scale of production, leading to increased demand for input imports from developing nations.

Much of the IMF and World Bank's 2019 annual meetings, which ran from Oct. 15-19, centered on initiatives to combat climate change, and Goldberg admitted that GVCs add to the growing climate crisis through increased levels of plastic, packaging and other waste as well as increased emissions from additional needed transport.

The IMF and World Bank warn that developing countries — both their populations and their economies — are most at risk from the negative effects of climate change.

IMF Managing Director Kristalina Georgieva said at the annual meetings that reforms are needed to modernize the global trading system, including further openings for e-commerce and trade in services amid a global growth slowdown.

Ville Skinnari, Finland's minister for development cooperation and foreign trade, said that recognizing how value chains work not only globally but also regionally is critically important to the future of commerce.

On top of that, identifying the importance of intellectual property through legislation and behavior at the local level is paramount to maintaining and growing GVCs. Finnish telecommunications giant Nokia Corp. thrives due to investments in human capital, education, and regional respect for intellectual property, he said.

"Unfortunately not all countries respect intellectual property," Skinnari said. "It's important to see the human capital side, and that was the strength of Finland and Nokia."