Adding Value

• Author: Bernard Hoekman
• Position: a Professor in the Robert Schuman Centre for Advanced Studies at the European University Institute.

The average car has thousands of components that are produced by hundreds of suppliers located in dozens of countries. For example, a Volkswagen might have an engine made in Germany, Mexico, or China; a wiring harness from Tunisia; and an exhaust filter system from South Africa.

Declining trade, transport, and communication costs have allowed companies to splinter their production lines geographically. Not only does each stage of production occur in a different facility, but each facility is often in a different country. This type of production, which results in the movement of goods and services from country to country through a supply chain, is a major reason that global trade in goods and services has grown so fast. Since 1950, the volume of world trade in goods and services has grown 27-fold, to about $20 trillion, three times faster than global GDP. Much of that growth has been in intermediate products and services that move from country to country in a company’s international supply chain. Value is added to a product in each of the countries that are part of the chain (a process called vertical trade or vertical specialization). By locating activities and tasks in different countries according to their comparative advantages, the total costs of production can be reduced.

Developing countries in Asia, transition economies in Europe, and a number of other countries, such as Mexico, have become active participants in supply-chain trade—not only for cars, but for such products as computers, cell phones, and medical devices. Overall, the share of manufactured goods in the total exports of developing economies has increased from 30 percent in 1980 to more than 70 percent today, with parts and components representing a substantial portion of the increase.

Supply-chain trade can bring great benefits but also new risks and policy challenges, as seen in 2008 when the volume of international trade collapsed during the financial crisis. The dramatic reduction in credit and demand caused by the crisis disproportionately hurt countries that were heavily dependent on supply-chain trade. An unexpected shock in a country that processes products used by plants in economies located “downstream” may have major negative repercussions—floods in Thailand in 2011, for example, affected a wide range of products, such as electronics, cars, and shoes.

Helps poorer economies

The supply chain allows poor countries to engage in manufacturing for the global market, because firms can locate labor-intensive and low-skill tasks in those economies—for example, the assembly of laptop computers and...