Global Value Chains, Volatility and Safe Openness: Is Trade a Double-Edged Sword?

Abstract

Modern production has become increasingly reliant on inputs sourced from abroad. These multi-country production processes are known as global value chains (GVCs). While it is generally accepted that GVCs increase productivity, by allowing producers to reap the gains from their individual comparative advantage, there is disagreement on the effects they have on macroeconomic volatility. In particular, some have argued that GVCs are a ‘double-edged sword’: they increase productivity, but also increase volatility. In this paper, we show that the relationship between GVC integration and volatility is ambiguous in theory, and insignificant in the data. This supports our headline conclusion that there is no compelling reason to fear the double-edged sword: a blanket reduction in GVC integration would impose economic costs without necessarily, or significantly, reducing economic volatility. Another feature of today’s GVCs is their concentration around a few central ‘hubs’. This has led to a discussion of alternative industrial policies that can reshape GVCs in the longer-run, in particular re-shoring and diversification. Within our model, policies to re-shore production lead to an increase in aggregate volatility, as they effectively increase the concentration of value chains on domestic sources. On the other hand, diversification of GVCs among foreign suppliers can lower volatility, by lowering the exposure to any single country. Finally, while the debate around the effects of trade on business-cycle volatility pre-dates the Covid-19 pandemic, recent events have increased the broader discussion of ‘safe trade openness’. We discuss the scope for policy actions to make trade safe and open, drawing out an analogy with the financial sector reforms enacted following the global financial crisis. We emphasise the merits of co-operation and multilateralism in order to underpin safe openness in the global trading system, and caution against direct policy interventions that are not targeted to address well-identified market failures.