Wednesday, 28 February 2018

Supply chain complexity, ICT and trade

A recent McKinsey report notes that the intensity with which firms employ Information and Communication Technologies (ICT) depends on four factors: (1) size of the firm; (2) supply chain complexity; (3) skill levels inside the firm; and finally (4) threat of competition. 

Deployment of ICT facilitates reaches higher productivity levels inside the firm. The four determinants therefore seem reasonable as the firm-level literature shows that generally these four points are indeed factors that are strongly associated with greater firm performance. However, in my view, the second factor of supply chain complexity merits some elaboration and refinement, especially with regards to international trade.

It seems intuitive at first sight to think that ICT tools and instruments smoothen the supply chain network. And so, the more complex this network becomes the more this chain uses ICT to solve complex hold-up problems related to trade. This is because ICT allows for geographically dispersed production and management activities. However, the data tells something different: some supply chain trade, which requires greater ICT, may actually be related to lower supply chain complexity. 

This can be seen by a measure that computes the “length” of the value chain by accounting for the number of production stages (Fally, 2012). The more stages of production involved, the lengthier the chain becomes, the more complex one can assume the supply chain is. The figure below plots the average of this indicator of supply chain complexity across a like-minded set of OECD economies for each sector on the vertical axis. The horizontal axis plots the ICT-intensity indicator from van der Marel et al (2016) to see for any meaningful pattern.

Source: US BEA; OECD TiVA. Sector numbers follow ISIC Rev 3.

Thursday, 15 February 2018

FDI Screening: Implications for the Future

Two weeks ago, I spoke at an event where I commented on a very interesting paper from Copenhagen Economics (CE). The paper assesses the economics of EU Foreign Direct Investments (FDI) and the need to undertake screening in the EU. Economists are generally weary of setting up screening measures for foreign investments as it increases substantial costs for little economic reason.

Therefore, the recent proposal of the EC to introduce screening measures has more to do with political economy, wider geopolitical or even security reasons. For instance, one of the biggest concerns is that some of the recent FDI coming into the EU is from various emerging economies such as China, Kazakhstan and Russia, which still have many State-Owned Enterprises (SOEs) in their economies.

This according to economists is a problem, but a simple back-of-the-envelope calculation tells me that the share of this FDI in some sensitive sectors flowing from these countries with much SEOs involved is at most 3.5 percent of EU’s total incoming FDI. Hence, a first question appears: does that warrant an overall screening measure? Some trade-offs are involved as obviously economics doesn’t stand on its own here.

However, my intervention was about the future of foreign investments. In particular, the changing nature of investments the EU has received in recent years, namely investments in digital sectors. This should force policy makers to think about when proposing investment regulations, including screening.

First, although it is right to state that FDI brings along a great “footprint” as economist say, this is in fact much lower for digital investments. With “footprint” we mean economic activity such as employment, value-added and greater output. Footprints for tangible investments such as manufacturing are known to be high, but the recent UNCTAD (2017) report shows that this footprint from multinational digital companies is actually much lower.

This can be seen in the figure below that measures this footprint by taking the ratio from foreign sales over foreign assets. For manufacturing and telecoms this ratio is actually 1:1 (in case of telecoms the assets are high because of infrastructure investments). Yet for FDI coming from digital multinationals, foreign assets are typically lower leading to a much higher ratio (because of higher sales), which means a lower footprint.

Source: UNCTAD WIR (2017)

Thursday, 25 January 2018

LCRs versus tariffs: The see-saw of trade barriers?

You may have not noticed it, but the use of local content requirements (LCRs) has gone up for years. They are used by developed as well as developing countries. LCRs aim to promote the use of local inputs. They also serve the purpose of fostering domestic industries. BRICS and many other emerging countries are frequent users of LCRs, together with the US.

However, LCRs can be highly damaging for the economy. While LCRs might have the perceived benefit of creating industry activity and local employment, these gains or often generated in the short-term. LCRs are most likely to have a damaging economic impact that is wider in the long run. This harmful impact therefore evolves over time, which eventually outweighs any specific short run gain they can create.

ECIPE’s new study with undersigned contribution estimates the damaging impacts of LCRs for BRICS countries. Our team has translated their negative effects into so-called ad valorem equivalents (AVE). This is a methodological concept that allows one to readily compare the adverse impact of any non-tariff barrier (NTB) such as an LCR with a tariff. Our study has taken LCRs in the heavy vehicle sector as a case in point.

The results are presented in the figure below. They show that Brazil and Russia apply the most distortive LCRs for heavy vehicles. The two countries have an estimated increase of their import price of 15.6 and 11.1 percent respectively. China and South Africa both show low AVEs of 4.5 and 3.3 percent respectively. India’s LCRs are least harmful as it shows an AVE estimate of 2.2 percent.
Source: ECIPE calculations, based on ECIPE LCR BRICS database; WITS/UNCTAD TRAINS

Tuesday, 16 January 2018

Are services really not helping the economy?

Bullocks! That is the conclusion that came to me when I participated in the roundtable conference on services and economic development in Tokyo last month. This conference was organized by the Asian Development Bank Institute (ADBI) and discussed with experts the positive role of services in the world economy.

It’s high time for this discussion. In recent years there has been a slight backlash against services as a contributing factor to the economy, particularly for developing countries. One reason for this set-back against services stems from a recent article by Dani Rodrik in which he drives the point that many developing countries are de-industrializing faster than before and therefore moving into services too quickly.

This premature de-industrialization, he argues, prevents them from using the manufacturing sector as a tool for rapid economic growth. According to Rodrik, in large part this is due to globalization and trade itself because globalization has produced changes in relative prices in advanced countries. This can have serious negative consequences for developing countries’ growth potential because, in the future, they would be much less able to capitalize on manufacturing exports.

There are, however, a couple of remarks that in my view must be made here.

First, these conclusions are most probably based on aggregate figures between countries’ services and manufacturing activities, which in great part mask the fact that many manufacturing sectors have already become “servicified” to a high degree. This means that a lot of gains by manufacturing firms are earned though services, not manufacturing. For instance, is Zara a garment manufacturer nowadays or just a retailer? Most probably it comes close to the latter. Such servicification is not yet picked up and properly classified in aggregate figures – and this is true also for developing countries.

Second, there are surely economic meaningful sectors in a country’s services economy. The old way to look at services is that they don’t show a great economic role as they are not receptive to productivity improvements. That assertion seems to be out of date. Even though productivity for services is hard to measure, European micro-level data suggest that productivity varies hugely across services, and therefore their contribution to the overall economy is also varied. (see figure below). This should also be the case for non-developed economies.

Source: Data taken from Van der Marel, Kren and Iootty (2015) "Services in the European Union: What Kinds of Regulatory Policies Enhance Productivity?", World Bank Policy Research Working Paper No. 7919, World Bank, Washington DC.

Friday, 12 January 2018

Productivity, Manufacturing and Trade

A very interesting piece by Robert Lawrence on manufacturing productivity and trade. Three very interesting conclusions come out: 

(a) that not trade is the major contributor to a decline in the share of manufacturing employment, but faster productivity; 

(b) that therefore productivity growth is in large part the factor that has contributed to losses of manufacturing jobs (together with our habit to not consume more goods but more services when we get richer); and 

(c) that there seems to be a trade-off in recent times between the share of manufacturing employment and productivity growth: more of the one is less of the latter -- or reverse. 

For economists dealing with this topic, the first two conclusions are not entirely new. In fact, this is how I have learned it from my textbook economics. The latter is new to me and very interesting. 

The last conclusions also raises some questions. For instance, is the historical leveling off of economic growth we have seen in the past (i.e. previous wave of globalization) related to this fact? Can new technologies in other sectors such as services we currently seeing reduce this trade-off? 

Some questions to think about. 

Monday, 11 December 2017

Brexit and supply chain trade

Last week I was invited to talk about supply chain trade and Brexit at Sidley Austin in London. They asked me to focus my intervention on the how the rest of the world, in particular the bigger countries, thinks about Brexit in connection to supply chains. My answer was short: on the whole, not so much.

The simple reason for providing this short answer is straightforward if reasoned from an economic point of view. The figure below shows that most global supply chain trade takes place around three blocs of countries, namely one centered around NAFTA and neighboring countries with the US in the middle, one in Asia with China as the lead country, and one in Europe with Germany as the focal point. The thickness of the lines between countries indicates their  level of supply chain trade. 

As one can see, countries clustered around each of these three core countries are mostly trading within their bloc, not between them. The UK, circled in orange, clearly features inside the EU bloc and doesn’t have as strong trade linkages across the other two non-EU groups of countries. Therefore, from an economic perspective, when the UK leaves the EU, on the whole, other countries outside the European bloc are likely to remain unaffected.

Further research using formal economic models underscores this line of thought. In GDP numbers, countries such as China, Japan, Brazil or Korea may not be so much affected after all. That does not mean, however, that changes in trade may take place in several supply chain industries. A reshuffling of trade is likely to happen for some but would simply not be as big enough of an issue to create a serious dent in their economies.

Source: Santoni and Taglioni (2015) with author's addition. 

However, economics is not everything. Especially regarding Brexit. If reasoned from a political economy point of view outsiders in the rest of the world may be a little bit more concerned, as for example regarding food tariff quotas. But the extent to which they are disturbed as part of these re-negotiations is likely to be related to one thing: market size.

For instance, it’s no surprise that precisely a bigger country like the US vocally oppose the tariff quota plan which is a harbinger for what’s coming. If bigger countries come in the position of negotiating a new trade agreement with the UK, the US and other countries such as China, Korea, Japan conveniently have a lot of market weight on their side. Again, this fact hardly gives bigger counties in the rest of the world a reason to be very much concerned.

By the way, fun-fact of the week: when looking at the figure, can you see in which of the three blocs Ireland is placed? Click on the figure to enlarge. 

Thursday, 5 October 2017

Who Underperforms in Digital Services Trade?

For the past 40 years or so, developments of information and communication technology (ICT) have transformed much of the way producers and consumers connect with each other. ICT reduces costs of distance between producers – and between producers and consumers. This has resulted in the fact that international trade has grown faster than before.

Only a short while ago, it was simply unimaginable to export services. Thanks to new technologies and ICT, services have become tradable and, moreover, have hugely expanded the scope of exports and imports. Nowadays, services represent around 23 percent of total cross-border trade. Moreover, the figure below illustrates that trade in total services has grown faster than trade in goods, particularly in the last 5 years.

Rapid growth rates of trade in services and digital services (1995-2016)
Source: World Development Indicators

However, the figure also shows that ICT finds its strongest effect on digital services trade. Indeed, a more impressive growth rate is observed for digital services. Since 1995, this type of digital flow grew with a factor of more than 5! With the current trend of digitalization, it is very likely that these trade patterns will not just continue but even accelerate.

Ultimately, this will rapidly change the way we perceive globalization. The digital economy is moving fast, and a large part of future trade and growth lies in this digital area. This development will favor the EU as traditionally, it has been a strong exporter in services. 

However, not all countries in the EU capitalize on the digital developments such as Germany and France. This is worrying as these two countries are the two largest economies after Brexit. In large part, Europe’s future growth based on digital services needs to come from these two countries, which includes digital services trade as well.

Moreover, one should bear in mind that digital technologies do more than enabling services to become tradable; services themselves are also becoming more and more digital-intense. The essence of this profound change is that any type of services is increasingly developed with the help of digital assets and means such as big data, internet-of-things and other ICTs.

A new Bertelsmann report performed by ECIPE finds that developing an attractive infrastructure for digital technologies to facilitate digital services trade is not a given. On the contrary, some countries are still lagging behind in some or many of these infrastructural “endowments” which enables digital services trade to happen in the first place.

The endowments specific to digital services trade will both relate to invested capital such as telecom infrastructure, network-access capacities and the skills among the workforce to use digital technologies. These are the factors that will determine a country’s future success in digital services trade and the next frontier of globalization.

The report compares the performance of European and OECD countries, against their own predicted capacity. It therefore enables us to understand if countries over or underperform in cross-border digital services trade over the internet. One takeaway point from this analysis is that precisely Germany and France underperform in digital services trade.

The report also sheds light on the potential for countries to trade digital services indirectly as an embodied item in other industries and sectors using digital services, which extends the scope of trade in digital services even further. Here too, France and Germany could be doing much better.

That begs the question: why?

The conclusion of this study is that while Germany for instance has great potential to increase digital trade in services, and along with that output and jobs connected to digital services, that potential can only be realized in the economy if German firms get better at utilizing existing digital endowments and capabilities, including digital services themselves.