NS3040 Fall Term 2017 Value Chains Federal Reserve Bank of Chicago, Strong Dollar Weak Dollar

Overview I Marcel Timmer, et.al., “Slicing Up Global Value Chains,” Journal of Economic Perspectives, Spring 2014 Classic value chain study is of the iPod Assembled in China from several hundred components and parts sourced from around the world Production network led by Apple, U.S. company which captures between one-third and one-half an iPod’s retail price Asian firms like Toshiba (Japan) and Samsung (Korea) capture another major part of profits from manufacturing high value components – hard disk drive, display etc. In contrast, assembling and testing activities by Chinese workers estimated to capture no more than 2%

Overview II Other studies of tablets, mobile telephones and laptops suggest similar pattern of specialization Advanced nations deliver capital and high skilled labor capturing most of the value Emerging countries contribute low-skilled activities that add little value. Paper asks How pervasive is the process of international production fragmentation for a wide set of products? How does the factor content of these production chains change over time when fragmentation deepens? How do specialization patterns differ between high income and emerging economies that participate in these chains?

Overview III Paper seeks to establish a series of facts concerning the global fragmentation of production. Find four major trends: 1. International fragmentation as measured by the foreign value value-added content of production has rapidly increased since early 1990s When first appeared globally 2. In most global value changes there is a strong shift towards value being added by capital and high skilled labor and away from less-skilled labor Suggests a pervasive process of technological change that is biased towards the use of skilled labor and capital

Overview IV 3. Within the global value chains, advanced nations increasingly specialize in activities carried out by high skilled works The direction of this change follows the intuitive notion of comparative advantage driven by relative factor endowments across countries 4. Emerging economies surprisingly specialize in capital intensive activities The capital share in their value added is rising while the share of low-skilled labor in their value added is declining

Example German Cars I

Example German Cars II German Case German domestic value-added content includes value added in the car industry itself but also other German industries that deliver along the production chain including services Between 1995 and 2008 the domestic value added content dropped from 79 to 66 percent Foreign value added shares increased as intermediaries were increasingly imported generating income for labor and capital employed outside of Germany Foreign value added share is an indicator of international fragmentation of production

Example German Cars III Factor content of the global value chain of German cars changed as well Summing up value of all labor irrespective of its location and similarly for capital Value added by capital increased from 29 to 35 percent Drop in labor was almost exclusively for less skilled workers in Germany The share for high-skilled workers both within and outside Germany increased Pattern is representative of many other chains in manufacturing

Trend 1: Increasing Fragmentation I

Trend 1: Increasing Fragmentation II Extent of fragmentation varies greatly across products Petroleum products (diamonds in figure) have very high foreign value added shares Value chains for electrical equipment increased 33 to 40 percent Foodstuffs have relatively low shares as most of intermediates sourced from local agriculture – but even these have increased over time. In 1990s fragmentation mainly took place in regional blocks (NAFTA, EU, and Asia). In 2000s global value chains started to become truly global with the advance of emerging economies major suppliers of intermediate goods

Trend 1: Increasing Fragmentation III Whether this trend will continue in future depends on Developments in wages and productivity Costs of transportation and trading Coordination costs, risk considerations For the future: Certain high value added tasks may well remain clustered in space because of strong localized complementarities Offshored activates that are currently slow skilled labor intensive might be re-shored if technological progress makes mechanized production in capital abundant countries cheaper

Trend 2: More VA High Skilled Labor and Capital I

Trend 2: More VA High Skilled Labor and Capital II Opening of China, India and other emerging economies provided major increase in global supply of low skilled labor How has this affected factor income distribution in global value chains? Driven by the relative prices of various types of labor and capital Possibilities for factor substitution both within and across countries

Trend 2: More VA High Skilled Labor and Capital III Increase in shares of capital and high-skilled labor especially marked at end of 1990s, and from 2003-2006 Later period coincides with a step up in global presence of China after its accession to the World trade Organization in 2001 Quick reallocation of capital may have led to a decline in bargaining power of labor around world reducing its value share

Trend 3 I Enhanced Specialization in High-Skilled Labor in High Income Countries What happened to the location of value added in global value chains? Did specialization patterns vary between regions? Share of high income countries in total value added generated in all manufacturing chains declined from 74% in 1995 to 56% in 2008 Share of high income East Asia declined from 21% to 11% Shares in North America and high income Europe declined by around 4% each

Trend 3 II In Contrast emerging regions have rapidly increased shares by 18% China is responsible for half of this increase from 4% to 13% Shares also rapidly increased in other emerging economies, including Brazil, Russia, India and Mexico

Trend 3 III With this change in location of production, specialization patterns changed as well In traditional H-O model of trade countries will focus on producing those goods intensive in those factors that are relatively abundant As production chain fragments across countries, one might expect that standard H-O predictions will still hold Rise of China and other emerging economies accelerates the erosion of mature economies’ comparative advantage in labor intensive tasks While simultaneously offering new opportunities for offshoring Thus advanced counties will focus more on activities that require high-skilled labor and capital Other countries will specialize in less-skilled activities

Trend 3 IV As it has turned out: In high income countries share of capital increased from 36% to 39% while share of labor declined accordingly Major income shift is across labor categories. The value added by high skilled workers increased by 5% while combined share of medium and low-skilled workers declined by 8% Direction of this change is in line with the H-O theory However magnitude of change differs across countries Capital income shares increased in most countries except in U.K. and Italy Largest increases in Germany and South Korea (7% and 9%) Value added share by high-skilled workers increased in all countries

Trend 3 V

Trend 3 VI

Trend 3 VII Declining incomes and jobs for less-skilled workers have stirred manor policy concerns Often framed in terms of manufacturing decline Have prompted various initiatives for re-industrialization in a number of former industrial areas Important to note that with fragmented production sectors like “manufacturing” are becoming wrong way to evaluate economic performance and frame public polices. Competitiveness no longer solely determined by domestic clusters of manufacturing firms but increasingly on the successful integration of other tasks in the chain – both foreign and domestic.

Trend 3 VIII Specifically – production of final manufacturers involves not only jobs in manufacturing sector but also outside manufacturing – delivery of intermediate goods and services In 2008 latter made up about half of all jobs related to manufacturers production Specialization in global value chains might lead to declining jobs in traditional manufacturing but might also generate new jobs outside manufacturing In most high income countries the number of services jobs related to manufacturing production increased during the period with exception of U.S. and U.K In Germany and Italy increase even faster than decline in manufacturing jobs such to make net effect positive.

Trend 4 I Enhanced Specialization in Capital in Emerging Economies What happened to specialization in rest of the world Based on H-O theory one might expect the value added share of less skilled workers to increase in the region Did not happen The share of low skilled workers declined by 6% from 24% in 1995 to 18% in 2008 Share of medium-skilled workers increased by only 1% Not to say that the number of workers in global value chains in manufacturing declined China added 42 million, 20 million in India, 6 million in Brazil and 2 million in Mexico

Trend 4 II However in these countries as a whole wages remained relatively low and global value chain production mainly benefitted capital In 1995 value added share of capital in emerging economies already 55% compared to 36% in high income region Not surprising because these contrives have abundant labor. However capital share in these countries increased by 3% -- in China it was 10%

Trend 4 III Developments fit surplus labor model With capital being globally mobile it will relocate to locations with high rental wage ratios As long as a reservoir of unskilled labor that can be employed at wages well below their marginal productivity, rental wage ratios will remain high Thus income share of capital will increase in early stages of development rather than decline Value added share of high-skilled workers increased in almost all emerging economies

Trend 4 V Example – production chains with Mexican firms along border in 1980s U.S. relatively slow skill tasked offshored to Mexico and production in U.S. will become more high skilled further specializing in its abundant factor Average skill intensity in Mexico increased after fragmentation in 1980s However result in Mexico not deterministic, depends on many factors In general though shares of high skilled labor in value added of all global value changes has gone up

Trend 4 VI