I recently read two interesting reports on the state of globalization in 2019, one by The Economist, the second by the McKinsey Global Institute. They both agree on the facts, - globalization and global trade have been undergoing considerable changes since the 2008 global financial crisis. But, they differ in their explanations of the reasons for the changes.
“The golden age of globalisation, in 1990-2010, was something to behold,” notes The Economist in its overview article, The steam has gone out of globalization. “Commerce soared as the cost of shifting goods in ships and planes fell, phone calls got cheaper, tariffs were cut and the financial system liberalised.”
But now, we’ve transitioned to a so-called Slobalisation era. “Globalisation has slowed from light speed to a snail’s pace in the past decade for several reasons. The cost of moving goods has stopped falling. Multinational firms have found that global sprawl burns money and that local rivals often eat them alive. Activity is shifting towards services, which are harder to sell across borders: scissors can be exported in 20ft-containers, hair stylists cannot. And Chinese manufacturing has become more self-reliant, so needs to import fewer parts.” Finally, we have the well-publicized trade wars and tariffs of the past two years. All in all, the “rules of commerce are being rewritten around the world.”
A few measures have continued to rise. International parcels and flights have been growing fast over the past decade, and migration to the rich world has risen slightly. By far, the fastest growth is in the volume of data, which has gone up by a factor of 64 since 2007.
McKinsey argues that globalization is in transition rather than faltering, as reflected in the title of its report - Globalization in Transition: the Future of Trade and Value Chains. “The 1990s and 2000s saw the expansion of complex value chains spanning the globe. But production networks are not immutable; they continue to evolve.” To better understand the nature of this evolution, the report analyzed 23 global value chains spanning 43 countries as well as both proprietary industry data and national accounts data, and interviewed industry experts from around the world.
Major structural changes
McKinsey’s central finding is that global value chains have been undergoing five major structural changes over the past decade.
Goods-producing value chains have grown less trade-intensive. The years between 1995 and 2007 saw the rapid rise of trade across nearly all global value chains. But ever since then, trade intensity, - i.e., the ratio of gross exports to gross output, - has been falling in almost all physical-goods-producing value chains. Exports declined from 28.1% of gross output in 2007 to 22.5% in 2017. “Between 1990 and 2007, global trade volumes grew 2.1 times faster than real GDP on average, but they have grown only 1.1 times faster than GDP since 2011.”
Services play a growing and undervalued role in global value chains. In 2017, gross trade in services was $5.1 trillions, less than one third of the $17.3 trillion trade in physical goods. Trade in services has been growing more than 60% faster than the trade in goods over the past decade. Moreover, as has been the case with measuring the true GDP value of services, the cross-border trade in services generate far more economic value than what’s been captured in traditional trade statistics, including the contributions of value added services to physical goods, - e.g., R&D, engineering, sales and marketing, finance, HR; the intangibles companies send to foreign affiliates, - e.g., software, branding, design, IP; and free digital services made available to global users.
McKinsey estimates that such uncounted services “collectively produce up to $8.3 trillion in value annually - a figure that would increase overall trade flows by $4.0 trillion (or 20 percent) and reallocate another $4.3 trillion currently counted as part of the flow of goods to services. If viewed this way, trade in services is already more valuable than trade in goods [$13.4 trillion for services versus $13.0 trillion for physical goods] .”
Trade based on labor-cost arbitrage is declining in some value chains. Many of the decisions that led to the growth of cross-border trade in the 1990s and 2000s were based on labor-cost arbitrage, particularly in industries with labor-intensive goods and services. Today, less than 20% of such decisions are based on labor costs, with over 80% of decisions based on other considerations including access to skilled labor, natural resources, and proximity to consumers. Rising labor costs in developing economies are also influencing such decisions. In addition, advances in AI and automation will likely transform labor-intensive production into capital-intensive production, a shift with important implications for low-income countries.
Global value chains are growing more knowledge-intensive. Investments in intangible assets including R&D, software, IP and brands have been rising, from 5.4% of revenue in 2000 to 13.1% in 2016. The growing reliance on knowledge favors countries with highly skilled labor forces, strong innovation and R&D capabilities, and robust IP protections. This trend is increasing in a number of industrial sectors. It’s particularly pronounced in pharmaceuticals and medical devices which spend on average 80% revenue on R&D and other intangible assets.
Value chains are becoming more regional and less global. Until recently, long-haul trade was more prevalent as global value chains expanded into China and other countries with low labor costs. But the trend is now reversing, driven in part by the rising standard of living and consumption in emerging markets. Goods-producing value chains are becoming more regionally concentrated, with companies establishing production in closer proximity to their customers. “Regionalization is most apparent in global innovations value chains, given their need to closely integrate many suppliers for just-in-time sequencing. This trend could accelerate in other value chains as well, as automation reduces the importance of labor costs and increases the importance of speed to market in company decisions about where to produce goods.”
Global operation strategies
Given these major shifts in value chains, McKinsey recommends that companies reevaluate their global operation strategies.
Reassess where to compete along the value chain. “Business leaders need to continuously monitor where value is moving in their industry and adapt accordingly… For some companies, this might mean bringing more operations in-house. Those that outsource need close supplier relationships and greater visibility into lower tiers of the supply chain.”
Consider how to capture value from services. “Across multiple value chains (including manufacturing), more value is coming from services… To make this shift successfully, companies need to gain insight into customer needs, invest in data and analytics, and develop the right subscription, per-use, or performance-based service contracts.”
Reconsider your operational footprint to reflect new risks. “New automation technologies, changing factor costs, an expanding set of risks, and the increasing importance of speed to market in some industries are all driving localization in many goods-producing value chains.”
Be flexible and resilient. “Today companies face a more complex set of unknowns as the postwar world order that held for decades seems to be giving way… Building agile operations can help firms prepare for these types of uncertainties.”
Prioritize speed to market and proximity to customers. “Speed to market enables faster responses to what customers want and less product waste from forecasting errors.”
Build closer supplier relationships. “Arm’s-length relationships with suppliers across the globe involve hidden risks and costs. It makes sense to identify which suppliers are core to the business, then solicit their ideas and deepen relationships with them.”
“Globalization is in the midst of a transformation. Yet the public debate about trade is often about recapturing the past rather than looking toward the future. The mix of countries, companies, and workers that stand to gain in the next era is changing. Understanding how the landscape is shifting will help policy makers and business leaders prepare for globalization’s next chapter and the opportunities and challenges it will present.”
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