Global trade is more connected than it looks

In an age of heightened geopolitical tensions, governments from Washington to Brussels have spent years trying to make supply chains less vulnerable to distant suppliers. Subsidies have encouraged production at home, companies have sought alternative suppliers, and terms such as reshoring and friendshoring–shifting production home or toward trusted partners–have entered the vocabulary of economic policy.

But moving a factory or replacing an overseas component does not necessarily move the productive capacity behind it.

A new report from the Organisation for Economic Co-operation and Development (OECD) suggests that a significant part of international economic dependence has been hiding in plain sight. By tracing physical and intangible capital across borders, the researchers find that average participation in global value chains among the OECD’s 38 member economies is about 11 percentage points higher than conventional measures suggest. 

“Before, we were only looking at intermediate inputs,” Sébastien Miroudot, an OECD economist and one of the report’s authors, told The Beiruter. 

But at some point, we began asking what happened to capital, and how important all these capital goods were in trade.

Some dependencies, the research suggests, are simply harder to see. As governments rethink the risks embedded in global supply chains, can economies truly decouple when foreign capital remains embedded in production?

What trade statistics leave out

Traditional trade statistics record the value of goods and services as they cross borders, but they reveal less about where the value embedded in those exports was actually created. Since 2011, the OECD and World Trade Organization have developed Trade in Value Added (TiVA) indicators to trace where the value embedded in exports originates, releasing their first results in 2013.

Consider a car assembled in Japan using components imported from elsewhere. Rather than treating the entire value of the exported car as Japanese, the system can identify foreign value added contained in those intermediate inputs.

But a factory may use a foreign-made robot for years or depend on software and R&D developed abroad. Conventional TiVA treats the robot’s contribution as domestic once it is used inside the importing country, obscuring where that productive capacity originated.

The OECD’s new methodology brings those previously overlooked contributions into the calculation, tracing machinery, equipment, infrastructure, software and R&D through production across borders, with estimates covering 2000 to 2022.

The change produces some striking revisions.

Including capital raises measured global value-chain participation from 45.1% to 62.5% in Japan and from 36.3% to 50% in China. It rises from 36.8% to 49.8% in the United States, 44.7% to 56.6% in the United Kingdom and 33.7% to 44.6% in the European Union.

The services inside a factory

While manufacturing may be associated with factories, machines and physical goods, much of the productive capacity behind it comes from services.

Once capital is incorporated, services account for 41.7% of OECD manufacturing exports, 9 percentage points above conventional measures. The share reaches 50.1% in Switzerland, 44.9% in the United Kingdom, 44.7% in the European Union and 43.7% in Japan.

The figures include purchased services and intangible assets such as software, R&D and other intellectual property, making access to such services an important part of manufacturing capacity.

“Capital goods include physical assets such as machines and robots, but also intellectual assets in the area of services,” Miroudot said. 

With AI and digital technologies, intellectual property assets play an important role in innovation and supply chains.

The pattern also differs considerably between economies. In information and communications technology and electronics, China’s specialization becomes stronger when domestic capital is included, as does Korea’s. Chinese Taipei and Viet Nam move in the opposite direction, indicating greater reliance on foreign capital.

“It’s really about specialization,” Miroudot said.

Some countries have refined specialized production over many years. Starting from scratch elsewhere requires considerable investment.

The limits of reshoring

Bringing production home is considerably easier to promise than to execute. A country can replace an imported component with a domestic one, but reproducing the machinery, software, expertise and intellectual property behind an industry can require years of investment.

Despite the political attention devoted to reshoring, Miroudot said the OECD sees no large-scale shift toward domestic supply chains in aggregate data.

“It takes easily five, six or seven years to reorganize a supply chain,” Miroudot said.

Governments also face constraints that policy cannot readily overcome. Critical minerals are concentrated in particular locations, while some processing must remain close to raw materials. Large economies also have greater scope than smaller ones to develop domestic capacity.

“The organization and division of labor in supply chains is not just the result of what governments would like,” Miroudot said. 

Economic and geographic constraints can place real limits on what governments can change.

Diversification still offers room to reduce exposure. Trade agreements, lower trade costs and trade facilitation can help diversify suppliers, Miroudot said, although only to a certain extent.

Living with interdependence

For the OECD, resilience also depends on where productive capital originates and how readily it can be replaced.

Other OECD economies account for the largest share of foreign capital exposure in OECD manufacturing, although China is also substantial. Exposure alone does not imply vulnerability, which also depends on supplier concentration, viable alternatives and switching costs.

Resilience, then, is less about achieving self-sufficiency than preserving options when disruption occurs. Trade agreements, lower trade costs, better infrastructure and easier movement across borders can give companies a wider range of suppliers, while cooperation between governments and businesses can improve preparations for disruptions.

“The first key to resilient supply chains is about anticipating risk.” Miroudot said. 

Many of these interdependencies will stay, so countries also need to be able to manage them through a crisis.

Machinery, software and research may be less visible than imported components, but they can bind economies together for years. Economic dependence runs deeper than trade statistics suggest.