About 30% of global trade consists of trade in intermediate goods and services that are incorporated at various stages in the production process for final consumption. The fragmentation of production processes and the international dispersion of tasks have led to the emergence of borderless production systems, or global value chains (GVCs).

The last half-century of international production has seen a unidirectional travel route: more international production and more GVCs. A simultaneous movement towards fragmentation of tasks (unbundling) and geographic distribution (offshoring) has been the underlying force shaping modern GVCs. Increasing moves to outsourcing and hybrid modes of governance such as non-equity have further expanded the possibilities of GVCs. Unbundling, offshoring and outsourcing were the powerful mix that enabled GVCs to take a dominant role in international production, investment and trade.

Global value chains in a perfect storm

In the last ten years, however, the process of expanding and deepening of GVCs has come to a halt, as documented by the slowdown in indicators such as FDI, trade and GVC participation. The current crisis caused by the COVID-19 pandemic thus arrives on top of existing mega-challenges to the system of international production arising from the new industrial revolution, growing economic nationalism and the sustainability imperative.

These challenges were already reaching an inflection point. Adding the sudden demand, supply and policy shocks caused by the pandemic – and, longer term, the need to create more resilient supply chains combined with greater pressure from governments and the public to increase national or regional autonomy in productive capacity – is expected to strike aperfect storm in the system of international production and GVCs (Figure 1).

Figure 1. Global value chains in a perfect storm

Source: World Investment Report 2020 (UNCTAD)

Climbing the GVC development ladder

From a development perspective, GVCs have the potential to spread value addition, employment and technologies across multiple locations at different stages of development. As such, they can accelerate the “catch-up” of developing countries’ income levels and lead to greater convergence between economies. However, the development benefits of GVCs are not automatic. GVC participation can cause a degree of dependency on a narrow technology base and on access to value chains coordinated by multinationals for limited value-added activities.

While the majority of developing countries are increasingly participating in GVCs – their share in global value-added trade increased from 20% in 1990 to over 40% today – many of the poorest are still struggling to gain access to GVCs beyond natural resource exports. Thus, a priority for developing countries, and least developed countries (LDCs) in particular, is to set into sustainable GVC development paths whereby participation in GVCs enhances rather than inhibits the opportunities to grow and capture value-added in domestic economies.

The right balance between integration into global networks (GVC participation) and the capture of domestic value-added (GVC upgrading) is at the core of the GVC development strategies of developing countries and LDCs. In practice, GVC development paths are not one-off moves along the participation and upgrading dimensions, they are rather a sequence of steps or a gradual climbing of the GVC development ladder: from no or poor participation into GVCs, often limited to downstream integration for commodity supply, to full participation as producers of intermediate inputs, with upstream and downstream linkages; and from low value-added GVC tasks to higher value-added and more sustainable activities.

For most countries (approximately 65%), increasing participation in GVCs over the past 20 years has implied a reduction in domestic value-added share, with the increase in GVC trade outweighing the decline in value-added share such that the result in terms of absolute contribution to GDP was positive. Some countries (about 15%) have managed – often after initial rapid increases in GVC participation – to regain domestic value-added share, mostly by upgrading within the GVCs in which they gained strong positions and by expanding into higher-value chains (Figure 2).

Figure 2. GVCs development strategies

Source: World Investment Report 2013 (UNCTAD)

Challenges and opportunities for developing countries and LDCs post-COVID

The main trajectories of GVC transformation all have different implications for development policymakers. The push for reshoringwill cause a shock for economies that depend on export-led growth and GVC participation. Diversification and digitalisation will imply a challenge to value capture in GVCs but will also lead to new opportunities to participate in them. Regionalisation will make cooperation with neighbours on industrial development, trade and investment of critical importance. And replicationwill change the model of investment promotion focused solely on largescale industrial activities.

Each of these macro-scenarios will bring both challenges and opportunities for developing countries at different income levels and at different stages of development and GVC integration. For LDCs willing to climb the development ladder from bottom to top – i.e. from simple commodity supplier up to global producers of value-added manufacturing and services – specific sets of challenges and opportunities will arise at each step of the development journey (Figure 3).

Figure 3. Climbing the GVC-development ladder: challenges and new opportunities

Source: Author’s elaboration based on material in UNCTAD WIR13 and WIR20.

At the bottom end of the development ladder, the quest for resilience through more localised and regional production and the impact of Industry 4.0 on labour cost differentials will exert a downward pressure on global efficiency-seeking FDI, traditionally the main route into global production networks for LDCs. These countries will generally find it equally difficult to benefit from a larger pool of market-seeking investment, which will favour larger middle-income and high-income countries. Low-income countries could face increased risks of an absolute decline in foreign investment and reduced participation in global production networks.

For these countries, the consolidation of regional value chains becomes very important. It breaks dependency from developed economy markets, capital and technologies, stimulating the process of local development. It fosters internal specialisation within the region, higher diversification and opens more opportunity to structural transformation and value chain upgrading.

Regionalisation is not the only ammunition for LDCs to counter the dismantling and hollowing out of traditional GVCs. Increasing market segmentation and the growing demand of low- and mid-range consumer goods in emerging markets open opportunities to enter GVCs for low-cost producers. The spread of digital technologies improves access to global markets, including for small businesses. The diversification of the supply base to build resilience may lead to a relocation of activities from Factory China and Factory Asia to alternative low-cost manufacturing hubs, such as in Africa.

At the next step of the ladder, the trend towards GVC reshoring and divestment may threaten established GVC positions. In addition, digitalisation along the value chains further amplifies the value-added gap between a bulk of increasingly commodified, low-cost activities and few highly strategic, knowledge- and technology-intensive ones. Not only are developing countries capturing an ever-shrinking share of value addition, but they also face a steeper gap to reach the next level.

As a response, developing countries need to broaden their industrial base, refocusing from highly concentrated, narrowly specialised global manufacturing hubs to fully integrated clusters, leveraging local ecosystems and linkages for resilience. From the service industries, a whole new set of opportunities – in software development, technology, marketing support and professional services for example – arises for developing countries to boost participation into GVCs. High and medium value-added services – such as accounting and creative activities – will be increasingly delivered offshore through teleworking, making services the new frontier of offshoring driven by labour cost arbitrage.

Further opportunities in digital services arise from building up new economic activities in local content development, and leapfrogging in industries ranging from telecommunication to financial services becomes a viable option. A paradigm shift in value-added creation from mass production to mass customisation supports value capture of smaller countries specialising in specific segments and niches. Finally, environmental vulnerabilities will exert pressure for international production to comply with the sustainability imperative, with the green and the blue economies emerging as increasingly attractive venues for GVC development and upgrading.

Given the importance of GVCs for post-pandemic recovery, economic growth and job creation, and for the development prospects of LDCs, policymakers need to clearly leverage these opportunities to promote a policy environment that is conducive to a gradual adjustment of international production networks to the new realities.

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Bruno Casella is Senior Economist at UNCTAD.