Will the economy collapse in 2016?

Global economy in transition

How digitization, trade conflicts and China's rise are changing global trade interdependencies

After the globalization boom that began in the 1990s, international trade in goods, investments and value-added interdependencies have clearly lost momentum since the financial crisis, including in Germany. At the same time, trade in services is increasing. Do we see a structural change in trade integration? What causes and what consequences could this have?

The export boom is over (for a long time)

At the beginning of the 1990s, the fall of the “Iron Curtain” and falling transport costs led to a rapid globalization surge. The result was a hitherto unique global boom in the cross-border trade of goods and services. Between 1990 and 2008, the share of goods exports in global gross domestic product (GDP) rose from 14% to 25% (see Figure 1). A similar export boom began in Germany in 1993 and continued almost continuously until 2008. At this point in time, almost a third of Germany's GDP was accounted for by exports of goods.

The strong upward trend ended after the financial crisis. The share of global goods exports in GDP initially fell by five percentage points to around 21% in 2009, and in Germany to 26%. After that, the share rose again, but did not continue to grow at the rate previously observed.

A look at the development of trade elasticity shows, however, that a trend reversal had already occurred at the turn of the millennium - and thus long before the financial crisis. Trade elasticity measures the relationship between export growth and GDP growth and is usually given in moving averages due to strong fluctuations. In the 1990s, global exports of goods grew on average more than twice as fast as GDP, but export elasticity has declined steadily since the beginning of the 21st century (see Figure 2). Over the past five years, it has been below one on average, which is roughly the same as in the mid-1980s. For the first time in three decades, global GDP growth has exceeded global export growth over a longer period of time.

Cross-border investments and value creation links have also declined

In addition to international trade, cross-border investments (FDI) and global value chains are important indicators of global economic ties. FDI differs from other cross-border capital flows in that the investor receives ownership of the foreign company and thus a say. The reasons for this can be varied and include, for example, better access to sales markets and suppliers, low labor costs in the host country and knowledge transfer. Overall, FDI are generally more volatile than trade in goods, as they are usually carried out once at a specific location. Therefore, this data is also shown here in average values ​​in order to better capture the long-term trends. The picture is mixed: worldwide, including Germany, outward FDI in relation to GDP will rise significantly up to the turn of the millennium and will decline sharply with the bursting of the dot-com bubble in 2001 (see Figure 3). Shortly thereafter, another increase begins, which ends with the global financial and economic crisis. Since then, FDI has been around 2–2.5% of GDP worldwide. In the US, and even more so in China, cross-border investments abroad only begin to grow more strongly in the mid-2000s. While FDI from the US has been falling steadily since around 2011, FDI from China did not experience any decline after the financial crisis; they have even overtaken US investments at the current edge.

Global value creation interdependencies have played an important role in the wave of globalization since 1990. The export boom was essentially based on the fact that, as a result of falling transport and telecommunications costs, the international division of labor changed and part of the production could take place where it was cheapest. Scientific evidence shows that the outsourcing of upstream production stages abroad ("offshoring") increased productivity, export volume and also the wages paid in the home country in export-oriented companies. A value-added-oriented consideration of the trade is therefore essential, since conventional trade statistics only show the gross values ​​of exports and imports. This does not take into account that part of a country's export performance is based on intermediate products that have already crossed national borders several times. [1]

Figure 4 shows that the contribution of foreign added value to the total export volume of the manufacturing sector has initially increased since 2005 (so-called "backward participation"). [2] During the financial crisis, value-added entanglements experienced a short-term decline and then rose again to the previous level. Since 2011, the share has fallen again slightly, but continuously. In Germany, the ratio of foreign value added to the export volume of the manufacturing sector fell from 27.7% in 2011 to 24.4% in 2016; the decline is therefore somewhat less pronounced than in other countries. For comparison: In the G20 countries, the share fell from an average of 27.8% in 2011 to 22.7% in 2016.

The rise of China and global value chains

A closer look at Figure 4 shows that, contrary to the global trend, China experienced a decline in foreign added value in total exports from the manufacturing sector well before the financial crisis. Behind this development lies an important structural upheaval that has had a strong impact on the world market.

China's economic rise in the 1990s began with the national economy specializing in the final assembly of imported intermediate products and further exporting them to the world market. The own added value share was quite low. The most prominent example of this, if not from the 1990s, is the production of the iPhone:

Designed in the USA, the various individual parts - from the chip to the display - were produced in various places around the world, mostly assembled in China and then sold all over the world from the USA. While the Chinese assembly workers received only 1.8% of the sales price of the iPhone 4 in 2010, most of the income went to Apple and multinational companies, which produced the essential inputs (Kraemer, Linden, Dedrick, 2011).

Due to the specialization of China "at the end of the value chain" - such as B. in the case of the iPhone - the foreign value added share of China's exports was comparatively high at almost 30% in 2005. But since 2001, the year China joined the World Trade Organization, the share of domestic value added in Chinese production has started to increase (Kee and Tang, 2016). The authors explain these developments by the fact that China has increasingly replaced the previously imported inputs with its own production and thus gradually reduced the export share of foreign added value. As can be seen in Figure 4, the share of foreign value added in Chinese exports in the manufacturing sector was only 17% in 2016 - just above the USA (15%) and well below Germany (24%). In the meantime, China itself is a supplier of self-developed, high-tech products that are in direct competition with the products of western industrial nations (e.g. Huawei smartphone). With the economic rise, wages in China have also risen significantly, which in turn increased domestic consumption in China and thus reduced the focus of the Chinese economy on world market production.

With the rise in wages in China, the motivation to relocate individual production processes there for cost reasons is also becoming less important. At the same time, digital production processes are making production in industrialized countries more attractive again. According to an OECD study (De Backer and Flaig, 2017), the advancing digitization favors the reshoring of international production processes and thus contributes to the revitalization of the competitiveness of industrial nations in certain economic sectors that were previously at the center of production relocations ("Offshoring “) Stood. However, the assembly activities are increasingly being carried out by robots instead of human workers. Automation could thus bring about a significant structural change, the core of which is based on a conversion from labor-intensive production abroad to capital-intensive production at home.

A sectoral analysis also shows that the global interlinking of production in various branches of the economy has developed quite differently in recent years. A look at the demand in German industry for intermediate products and services from Germany and abroad shows that in the motor vehicle industry, for example, the relocation of production to non-European countries hardly changed between 2005 and 2015. In contrast, a significant increase in value added from East and Southeast Asia in the corresponding period can be observed in final demand for computers, electronics and optical products. There has been an increase from 13% to 35% (Figure 5). Whether and how global value creation interdependencies will continue to change in the future is directly related to changes in production technology and relative factor prices, but also to product innovations and will therefore vary from sector to sector.

Digitization and growing trade in services

New information and telecommunications technologies (e.g. digital translation software, e-commerce and blockchain) not only enable the digitization of production, but also make it easier to coordinate production abroad. Ultimately, email, lower telecommunications prices, and other developments in the ICT space have also been major drivers of the rapid growth of multinational corporations and are considered to be the engine of global production fragmentation. A study by the McKinsey Global Institute (2019) sees a new motive for relocating production processes abroad in the digital age: International value creation is already less determined by the arbitrage of labor costs, but is increasingly based on comparative advantages in the case of knowledge-intensive preliminary work. The qualifications of the workforce at home and abroad seem to be gaining in importance compared to wage costs.

Technological progress also has an impact on trade in services: While the geographical proximity of producers and consumers was decisive for the service sector in the past, digitization facilitates the cross-border trade of services such as retail, software development or outsourced business processes. In contrast to trade in goods and foreign direct investment, trade in services in relation to GDP continued to grow even after the financial crisis, rising from 11% in 2005 to 13% in 2018 and even more so in Germany, from 13% to 18% in the same period (Figure 6). In addition, since 2011 the importance of trade in services as a percentage of GDP has grown faster than trade in goods.

The role of services is often underestimated when analyzing global trade links. This is due to the fact that, due to technological developments, the distinction between services and goods has become more blurred and in some cases cannot be precisely represented in traditional trade statistics. In Germany, almost half of the added value of total exports comes from domestic and foreign services. In manufacturing it is almost a third. Here, a total of around 11% of the added value can be traced back to foreign services (Figure 7). Overall, the importance of services to German export performance has decreased slightly since 2005. When looking at the service content of exports, however, in contrast to the domestic value added share, the foreign value added share rose slightly, in relation to exports in the manufacturing sector by 1.3%.

Global uncertainties and trade tensions are leaving their mark

In addition to the emerging structural change, political and economic factors also play a role in the changes in trade interdependencies, particularly with regard to the global architecture of world trade. After the World Trade Organization (WTO) was founded in 1994, the average tariff rates applied worldwide fell from 9% in the early 1990s to 3% in 2006. [3] In the past decade, however, tariffs have hardly fallen any further, which points to a stagnation in trade liberalization. In addition, no further round of negotiations has been concluded since the Uruguay Round, which ended with the creation of the WTO. At the multilateral level, no further progress has been made on important issues such as subsidies for agricultural products or trade in services. Instead, there have been increasing protectionist tendencies since the global economic crisis: In recent years, an increase in so-called non-tariff trade barriers (NTHs) has been observed. NTH non-tariff barriers are more complex than tariffs and include all measures - apart from tariff barriers - that can affect trade flows. NTH-non-tariff trade barriers can occur, for example, in the area of ​​technical regulations, subsidies or licenses for imports and exports. Further challenges for multilateral trade policy arise from the emergence of new economic heavyweights such as China. The Chinese economy exhibits a hybrid economic model with state-owned companies in strategic sectors and thus also influences international competition. Further challenges can be traced back to the ongoing conflict of interests between industrialized nations and developing and emerging countries. These developments raise questions about the future viability of the WTO regulations and have further strengthened the tendency towards protectionist action. Current trade tensions are related to this.

More recent data shows that the G20 countries' trade in goods has continuously decreased since the first quarter of 2018, by a total of 3.7% for exports and 3.3% for imports by the second quarter of 2019. [4] However, the exports and imports of the G20 countries overall continued to be above the values ​​for 2015–2017. However, the overall effects of the current trade tensions can only be assessed more precisely in the next few years, as global trade chains can only adapt gradually. However, there are already indications that the political uncertainties are causing many producers operating on the world market to rethink their global orientation. In view of the increased risks, domestic and regional markets appear to be a safer alternative and make production in close proximity to demand more attractive again (McKinsey Global Institute, 2019). The longer the uncertainties persist, the more companies will adapt their production processes due to increased trading costs and the more sustainable changes will be made to the trading structures.

The increased global uncertainties also seem to be making themselves felt at FDI. In 2018, FDI flows from the US were negative (-0.3% of GDP); H. more FDI stocks were reduced abroad than new investments were made (dis-investment). However, this is in large part due to the US corporate tax reform in 2017, which made the relocation of corporate patents and licenses tax attractive. But also in China, Germany and on a global average, FDI from these countries declined in terms of GDP in 2018, albeit not negatively. Data so far suggest that the global decline in FDI will continue in 2019: Globally, FDI flows fell 20% in the first half of 2019 compared to the last half of 2018. The global investment climate has cooled noticeably. [5]

The end of globalization?

The empirical evidence presented does not suggest that the “end of globalization” has been reached. However, they certainly point to a significant restructuring of the global trade and investment interrelationships. Instead of de-globalization, the Economist speaks of “slowbalization”, since so far there has only been a slowdown in the integration of the world economy. Peter Vanham from the World Economic Forum (WEF), however, sees the beginning of a new “wave of globalization 4.0” since the financial crisis (Vanham, 2019). In place of the global value chain that shaped the third wave of globalization between the 1990s and the financial crisis, there has been trading in digital goods and services, particularly favored by e-commerce, artificial intelligence and 3D printing.

For Germany, global value creation links and international trade remain of central importance. Higher tariffs, non-tariff trade barriers or other trade restrictions would not only hit consumers, but also many German exporters, as they would make access to imported intermediate goods more difficult and result in significant productivity and welfare losses. A continuation of the rule-based system of the WTO and a de-escalation of current trade tensions are therefore particularly in the German interest. In addition, a diversified economic structure with a well-established industry and a strong service sector is necessary to ensure the competitiveness of the German economy in a globalized world in the future.

Contact: Juliane Stolle
Presentation: Economic Policy Analysis

[1] In contrast to export and import values, global value creation links are not part of the national accounts. At the macro level, they are often calculated in practice on the basis of national input-output tables (IOT) by linking disaggregated international trade data with national IOTs to form a “global IOT”. These show at the country and branch level from which countries individual industries obtain their inputs and where individual industries resell their outputs. In the absence of direct global measurements, this approach represents a sensible approximation for mapping global value-added linkages, but it also has disadvantages: On the one hand, the calculations are based on estimates and, in some cases, on assumptions. On the other hand, they are only available in aggregated form at the sectoral level and therefore hide different developments within an industrial branch (see Sturgeon, 2015). There are currently various sources that measure global value creation interdependencies on the basis of linked IOTs. The analyzes in this article are based on the Trade in Value Added (TiVA) database of the OECD, which contains information for 64 countries, including all OECD, EU28 and G20 member states as well as numerous countries from Southeast Asia and South America.
[2] Earlier comparable data are not available, but it can be assumed that the increase began as early as the 1990s.
[3] These figures are weighted mean values ​​for all products, which are based on World Bank estimates based on data from UNCTAD and the WTO.
[4] The calculations in this paragraph are based on data from the OECD G20 International Merchandise Trade Statistics.
[5] The data in this paragraph comes from UNCTAD and the OECD FDI database.