Global value chains, trade policy and Asia

Author: Razeen Sally, NUS

The defining feature of early 21st-century international trade is global value chains (GVCs).

Employees at a factory of LG Electronics in Gumi, South Korea, are busy working to meet the continuing demand for new products, undeterred by the summer holiday season. (Photo: AAP)

Trade in GVCs is the fastest growing part of international trade, and a critical driver of productivity, growth and employment in both developed and developing countries. This is especially true in East Asia, where 62.5 per cent of total manufacturing exports are GVC-related exports.

GVCs have transformed international trade in at least two major ways. First, exports depend more than ever on imports. In most economies, foreign value-added is about a third of the total value of exports — double what it was in 1990. It is 50 per cent and higher in many small economies. Second, services are much more important than hitherto believed. Their share of gross exports of goods is about 30 per cent on average — over 50 per cent in the United States and EU, and even 30 per cent in China.

Four core policy propositions follow. First, GVCs reward open borders and non-discrimination to trade and FDI, secure private property rights, and an efficient environment for doing business. Second, they make a nonsense of mercantilist trade policy — ‘exports good, imports bad’ — given that exports depend increasingly on easy, open access to imported inputs. Third, they increase the range and power of producer interests favouring freer trade, all the better to countervail old-style protectionist interests. Fourth, they severely weaken the case for one kind of industrial policy’ — selective protection for favoured sectors and ‘national champions’. These kinds of policies disrupt cross-border supply chains.

What are the main policy barriers to GVCs? Average import tariffs are now fairly low, but they impose higher costs on GVCs due to the fact that intermediate goods make multiple border crossings. Companies pay duty twice — once on imported inputs, and again on their exports.

Still, non-tariff barriers impose much higher costs. Complex, duplicative standards are especially burdensome for small and medium-sized enterprises. Protectionism in services sectors is much higher than on trade in goods. Then come FDI restrictions. Not least, onerous customs procedures cause delays at border entry and exit points. They account for about 10 per cent of trade costs — double the cost of import duties.

Now what does this means for trade policy on different tracks?

Start with unilateral measures, that is, what governments do autonomously, outside trade negotiations. This has been the main driver of trade and FDI liberalisation outside the West in recent decades. Decentralised liberalisation and competitive emulation, not trade agreements, are how East Asian countries opened up, inserted themselves into GVCs and became ‘Factory Asia’. But unilateral liberalisation has slowed down since the late 1990s. That leads many to argue that reciprocity trade negotiations — must be the main vehicle for future trade reforms.

This need not be the case. GVCs should make unilateral liberalisation more feasible, given that more producer interests have a stake in open and freer trade. The Nike strategy should apply: ‘Just Do It!’ — don’t wait for trade negotiations.

Yet the WTO can be a useful complement to unilateral measures. The Doha Round is silent on 21st-century trade issues — save for one item, ‘trade facilitation’, which covers customs procedures. That should be the main priority for a mini-Doha package by the end of this year.

Looking beyond Doha, the WTO should tackle at least three items of relevance to GVCs: a more ambitious Information Technology Agreement; deeper commitments in services; and new rules on FDI. None of this is going to happen without ‘plurilateral’ decision-making, whereby subsets of like-minded members from the OECD and emerging markets forge ahead. If that proves impossible inside the WTO, it should be taken outside it. The leading Asian trading powers should be in these ‘coalitions of the willing’. Indeed, they could constitute half or more of the membership of some of these coalitions.

That leaves FTAs. They discriminate against non-members, and their proliferation has created a ‘spaghetti bowl’ of overlapping, bureaucratic trade procedures. This contradicts the basic logic of GVCs — to expand seamlessly across borders. Also, the vast majority of FTAs, including most Asian FTAs, are ‘trade-light’. At best they eliminate tariffs on most products, but they hardly tackle the regulatory barriers that bedevil GVCs.

Now come three mega-regionals: the Trans-Pacific Partnership (TTP), the Trans-Atlantic Trade and Investment Partnership (TITP) and the Regional Comprehensive Economic Partnership (RCEP). Trade-light mega-regionals would do little to facilitate GVCs, but their discriminatory elements could disrupt them. RCEP risks heading in this direction. Yet, ‘deep-integration’ mega-regionals could spur GVCs by seriously tackling non-tariff and regulatory barriers, especially if rules are ‘multilateralised’ (ie, applied in a non-discriminatory manner). This is more likely with the TPP and TITP than with RCEP, though they could easily turn in a defensive direction that disrupts GVCs.

Overall, there is huge potential for the spread of GVCs — sectorally in manufacturing, services, agriculture and energy, and geographically beyond the present hubs of NAFTA, the EU and East Asia. The big geographic prize is the extension of GVCs to South Asia, where much labour-intensive manufacturing production could be located.

Razeen Sally is Visiting Associate Professor of the Lee Kuan Yew School of Public Policy, National University of Singapore