World trade in the 21st Century

National Board of Trade, March 2014 – First Edition. ISBN: 978-91-86575-78-6

www.kommers.se

The National Board of Trade is a Swedish government agency responsible for issues relating to foreign trade, the EU Internal Market and to trade policy. Our mission is to promote open and free trade with transparent rules. The basis for this task, given to us by the Government, is that a smoothly function-ing international trade and a further liberalised trade policy are in the interest of Sweden. To this end we strive for an efficient Internal Market, a liberalised common trade policy in the EU and an open and strong multilateral trading system, especially within the World Trade Organization (WTO).

As the expert agency in trade and trade policy, the Board pro-vides the Government with analyses and background material, related to ongoing international trade negotiations as well as more structural or long-term analyses of trade related issues. As part of our mission, we also publish material intended to increase

awareness of the role of international trade in a well functioning economy and for economic development. Publications issued by the National Board of Trade only reflects the views of the Board.

The National Board of Trade also provides service to compa-nies, for instance through our SOLVIT Centre which assists companies as well as people encountering trade barriers on the Internal Market. The Board also hosts The Swedish Trade Procedures Council, SWEPRO.

In addition, as an expert agency in trade policy issues, the Na-tional Board of Trade provides assistance to developing coun-tries, through trade-related development cooperation. The Board also hosts Open Trade Gate Sweden, a one-stop information centre assisting exporters from developing countries with infor-mation on rules and requirements in Sweden and the EU.

1

Contents

1. Introduction .................................................................................................................................................. 2

2. International Production Networks ............................................................................................................. 32.1 ”The great unbundling” ...................................................................................................................................................... 32.2 The trend towards international production networks ........................................................................................ 5

3. The Servicification of Production and Trade ............................................................................................. 73.1 Increased service content in production ..................................................................................................................... 73.2 Increased service content in sales ................................................................................................................................. 93.3 Increased service content in trade ................................................................................................................................. 93.4 Servicification, international production networks and digitalisation .......................................................... 10

4. Digitalisation ................................................................................................................................................. 124.1 Digitalisation, the Internet and trade ............................................................................................................................ 124.2 The transformation of industries and business models........................................................................................ 134.3 Growing number of cross-border transactions ........................................................................................................ 134.4 More and smaller firms trade .......................................................................................................................................... 134.5 The importance of data – transfer, collection and analysis ................................................................................. 14

5. Trade in the 21st Century ............................................................................................................................ 15

Bibliography ...................................................................................................................................................... 16

2

The traditional image of international trade as a phenomenon where goods are produced in one country and exported for consumption in another is becoming increasingly outdated. To start with, production no longer takes place at one specific geographic location. Instead it is spread out in international networks that stretch across national borders. Moreover, trade is not necessarily about goods. Services currently account for more than 50 per cent of Swedish exports. Finally, it is not even certain that anything is dispatched physically at all. Trade in the 21st century is often about download-ing computer programmes or streaming movies.

As the development toward more specialised and network-based production continues, it becomes increasingly difficult to associate a prod-uct or service with a specific geographic location. More than half of all goods traded internationally are subsequently used as input in further produc-tion. This development is described in the aca-demic literature as ”trade in tasks”, rather than trade in goods and services. It also means that temporary cross-border movement of personnel is becoming increasingly important. A higher degree of personal contact and various key competences are required in order to perform certain tasks, or instruct others how to perform them.

1. Introduction

In this report, Kommerskollegium (the National Board of Trade) summarises important trends that challenge conventional wisdom with respect to international trade. The report is based on previous analysis by the National Board of Trade and it describes

1. how production increasingly takes place in international networks

2. the increased service content of trade - so called “servicification”

3. the digitalisation of international trade

Digitalisation is probably the most important of these three trends. On the one hand, it gives rise to completely new types of trade. On the other hand, it paves the way for servicification and further spe-cialisation within international production net-works.

3

2.1 ”The great unbundling”In recent years, the geographic division of produc-tion has been discussed frequently both by interna-tional institutions and in the academic literature. Rather than goods and services being produced from start to finish within one country, tasks within the production process are spread out across many countries. Some economists draw far-reaching conclusions from this trend. The development has been described both as an economic paradigm shift and as the next industrial revolution.

What is clear is that the nature of global trade is changing and that the traditional image of trade is out-of-date. Prior to the Industrial Revolution, self-sufficiency meant that nearly all consumption was directly linked to production. According to trade economist Richard Baldwin, ”the first unbun-dling” occurred when the Industrial Revolution facilitated the separation of production from con-sumption. As a result, factories emerged and within these factories tasks making up the the production process were performed.

2. International Production Networks

”The second unbundling”, according to Baldwin, began in the mid 1980s and was caused by falling transportation costs, the IT revolution and the lib-eralisation of trade and investment. This meant that the production process was divided into various tasks that were performed at different geographic locations. Initially this applied primarily to the production of goods, but more recently the trend has also spread to encompass services.

”In short, the first unbundling was the spatial separation of factories and consumers. The second unbundling separated factories and offices.”(Baldwin, 2006)

A number of other terms have been used to describe the development towards increasingly internationalised production, of which ”global value chains” has been particularly frequent. In order to reinforce the network-related nature of the phenomenon, we choose to use the term ”interna-tional production networks” in this report.

4

0

5

10

15

20

25

30

35

40

RussiaUSAUKJapanIndiaFranceGermanyChinaSweden

Share of total exports per country (%)

Source: OECD1995 2008

Figure 1. The import content of exports

0

5

10

15

20

25

30

20092008200520001995

Export-weighted average, share of total exports (%)

Source: OECD/National Board of Trade's calculations]

Figure 2. The import content of world exports

5

2.2 The trend towards international production networksThe most common way of describing the develop-ment towards international production networks is to measure the proportion of a country’s exports that consists of imports. Figure 1 illustrates the import content of exports for a number of selected countries between 1995 and 2008.1

As is evident from the graph, the dependency on imports has increased in many countries, in certain cases by over 100 per cent. This applies, for instance, to Asian countries such as Japan, China and India. However, in countries such as Russia, where trade is largely based on raw materials, the dependency on imports has fallen.

In order to provide an overall picture of how the import dependency of exports has developed over time, Figure 2 shows the export-weighted average for 56 economies which together account for more than 90 per cent of world trade.2 The graph illustrates how import dependency increased rapidly up until the financial crisis in 2009.

1. The statistics are taken from the OECD’s database Trade in Value Added (TiVA) which is based on data for the years 1995, 2000, 2005, 2008 and 2009. Here, we use figures for 2008 since the figures for 2009 were affected by the financial crisis. Gross trade figures had already started to recover to pre-crisis levels in 2011. It can therefore be assumed that the data for 2008 is more representative for the years following the financial crisis than the data for 2009.

2. An export-weighted average means that a large country such as the US affects the average more than a small country such as Luxembourg. For weighting purposes, the exports of each country as a percentage of world exports are used. The weights are calculated for each year.

Facts

Measuring international tradeTrade is traditionally measured in gross terms, i.e. the total value of goods and services crossing a country’s borders. However, this measure implies a certain amount of double counting since the imported value is included in the goods that are exported.

A supplementary measure is therefore trade in value added. This measures the value created in the domestic production of the goods or services that are exported. In this way, the domestic value added of a country’s exports is isolated.

Trade statistics in the form of value added highlight both the share of exports that is made up of imported value and where that imported value was added. Bilateral trade balances meas-ured this way can therefore differ from corre-sponding trade balances expressed in gross terms. A good example of this is China’s trade surplus vis-à-vis the US, which decreases by nearly a third when calculated in value added terms. The reduction is due to high US value added in Chinese exports to the US.

6

Made in China?Apple’s iPhone is an excellent example of how traditional trade statistics can be misleading, as far as the identification of a product’s geographic origin is concerned. In traditional trade statistics the iPhone is recorded as a Chinese export, since the last stage of the production chain, the assembly of the iPhone’s various components, occurs in China. Despite it nominally being a case of Chinese exports, more than 60 per cent of the sales value of an iPhone benefits the US.

Facts

Made in the US?Most people consider the ”Boeing 787 Dream-liner” to be a typical American product, despite the fact that its production involves 43 different sup-pliers in 135 different locations all over the world. The wings are produced in Japan, the engines in the UK and the USA, flaps and ailerons in Canada and Australia, the undercarriage in France, the fuselage in Japan, Italy and the USA, and the doors in Sweden and France. Almost 70 per cent of the thousands of components required for the assembly of the aircraft are produced outside of the U.S.

Facts

The trend towards production in international networks is also closely linked to foreign direct investment. Since 1990, foreign direct investment as a percentage of global GNP has increased from less than 10 per cent to over 30 per cent. In 2012, for the first time, more than half of the world’s foreign direct investments went to developing countries.

At the same time, investments have tended to be-come more specialised in the core business of com-panies. This trend is consistent with the development towards international production networks which is based on firms purchasing more input goods and services in order to maintain and strengthen com-petitive advantages within their core business.

7

For a long time, it has been argued that we are entering a service society. At the same time, we consume more goods than ever before. The service society therefore does not seem to imply that goods are becoming less important, rather that the production and consumption of goods and ser-vices are being integrated.

The manufacturing industry is being ”servicified” which means that it

1. purchases and produces more services than previously, and 2. increasingly sells and exports services, often as part of a package deal together with a product.

3.1 Increased service content in productionManufacturing companies use an increasing num-ber of services in their production. Research and development is required in order to develop prod-ucts and stay competitive. The management of a business requires legal services, administration, financial management, accounting and communi-cation services. Sales require marketing, while logistics and transportation services are needed in order to get goods to the customer.

Firms can either produce the services themselves or purchase them from external suppliers. The use of both these forms has increased. For example, pur-

3. The Servicification of Production and Trade

chased services as a share of the total production value doubled between 1975 and 2005 within Swedish manufacturing. At the same time, the share of services in production has also increased. In 2006, almost half of all employees within Swedish manufacturing com-panies worked in service-related professions, an increase from just under 40 per cent in 2001.

A good example of a “servicified” business is Sandvik Tooling. As image 1 shows, the firm needs more than 40 different types of services for its pro-duction to work.

8

Legal servicesAccounting, book-keeping etc. Taxation servicesMedical servicesComputer servicesResearch and developmentRental/LeasingAdvertisingMarket researchServices incidental tomanufacturingPlacement of personnelMaintenance and repairConvention services

Security servicesPackagingPrinting, publishingDesignBuilding-cleaning servicesPhotographic servicesCourier servicesLogistic services Postal servicesTelecommunicationsAudio-Visual servicesEducational servicesEnvironmental servicesBanking services

InsurancesHealth related servicesHotels and restaurantsTravel agency servicesMaritime transport - freightInland waterways - freight Air transport - freight/passengerRoad transport - freight/passengerCargo-handling servicesStorage and warehouse servicesFreight transport agency serviceFeeder servicesEnergy services

Image 1. Sandvik Tooling Supply Chain

9

3.3 Increased service content in tradeServices currently account for more than half of Swedish exports when a value added measure is used (see the fact box on page 10 for an explanation of the different ways of measuring the service con-tent of exports). For Swedish exports where the US is the final destination, the corresponding figure is more than 60 per cent.

Figure 3 shows the share of services in total exports, expressed in value added. As shown, some countries, such as the UK and India, have witnessed an even greater increase in the service content of exports than Sweden. On average, the service con-tent of exports is 50 per cent within the OECD.

As a result of the increased service content in trade, the need for personnel to move across bor-

3.2 Increased service content in salesSwedish manufacturing companies also sell signifi-cantly more services today than they did two dec-ades ago. Between 1997 and 2006 alone, the share of services in the turnover of manufacturing com-panies increased by 25 per cent. Nowadays, cus-tomers often demand solutions where goods and services come together as a package offer. Services can constitute up to 80 per cent of the offer of a manufacturing company and it is becoming increasingly difficult to distinguish between goods and services. For example, many consumers buy their mobile telephone at the same time as they subscribe to various services that a telephone oper-ator offers.

Atlas CopcoAtlas Copco is a manufacturing company that sells mining and construction equipment as well as electric power tools. The company’s business model is becoming increasingly geared towards the sale of services, including maintenance and repair, the hiring/leasing of tools, product optimi-sation, surveillance, management, and the provi-sion of spare parts and diagnostic tools.

Some of these services accompany products, others are sold separately. In 2011, 40 per cent of Atlas Copco’s turnover came from the sale of ser-vices. Hiring and leasing is now a separate divi-sion within the company. Technicians who con-duct maintenance and service are then included as part of the package. By leasing tools to their customers, Atlas Copco offers them a service where they once sold goods.

Facts

10

3.4 Servicification, international production networks and digitalisationServicification is in many ways linked to the devel-opment of international production networks. To start with, the geographical division of production would not have been possible without the develop-ment of cheaper transport and logistics services, along with the growth of modern IT services. Fur-thermore, the production of both goods and ser-vices consists of a number of separate tasks. This means that, as factories are ”unbundled”, the more likely it is that a transaction between two parties (national or international) will be categorized as a service. As economic specialisation advances, the smaller the probability becomes that a ”bundle” of different tasks will be treated as a good in the eyes of trade statistics. The strict division into goods and services in traditional statistics will, from that per-spective, become almost an illusion.

Servicification and increased specialisation are also closely linked to digitalisation (see next sec-tion). Digitalisation implies, for instance, that ser-vices can be divided up in time and space and saved. Previously, the majority of services needed to be consumed when they were produced. Entirely new services have also emerged, such as electronic surveillance services in modern cars that signals if something is wrong or when it is time for mainte-nance.

ders has grown. A package that offers both goods and services can, for example, mean that an employee is dispatched to the customer in order to install the product or train the buyer in how to use it. When offices, factories and sales are spread out over many countries, the need for coordination, logistics, and the transfer of knowledge also increases. This is something that requires increased cross-border mobility and drives up the service content in the trade of goods.

The service content of Swedish exports According to traditional trade statistics, the export of services constitutes approximately 30 per cent of Swedish exports. This measure refers to the value of all exports categorized as “ser-vices” as a share of total Swedish exports (i.e. both goods and services). If the value of imported intermediate goods and services is subtracted from the value of total exports, the service content of Swedish exports increases. By this measure, services constituted 36 per cent of Swedish exports in 2005. The higher figure is explained by the fact that services typically have a lower share of imported inputs than goods. If the service content in the production of all exports (measured in value added terms) is taken into consideration, i.e. regardless of whether an export transaction is categorized as a good or service, the share of services in Swedish exports increases further. In 2008, it was 51 per cent.

Facts

11

1995 2008

0

10

20

30

40

50

60

ChinaRussiaJapanGermanyUSASwedenFranceIndiaUK

Source: OECD/National Board of Trade's calculations

Figure 3. The share of services in exportsPercentage of total exports, measured by value added

12

4. Digitalisation

We live in an online society and digital solutions are part of our everyday life. Digitalisation involves both the conversion of information into digital form and increased usage of computers and the Internet. More than two billion people are online, a figure that is expected to rise to three billion by 2016. In developing countries, the Internet-econ-omy is expected to grow by at least 20 per cent over the next five years - twice as fast as in developed nations.

Traditionally, the prospects for trade are thought to decrease with geographical distance. Digitalisa-tion reduces the significance of this barrier. Thanks to increased access to information and the trust created by online solutions, obstacles associated with distance are reduced by two thirds. The devel-opment of 3D printers further reduces the signifi-cance of geographical distances.

4.1 Digitalisation, the Internet and tradeDigitalisation has changed all aspect of society - not least international trade. It affects companies’ business models, our consumption patterns, who trades, what we trade and with whom we trade.

Today, it is difficult to imagine a transaction that does not involve digital processes in one or more stages of the transaction. With manufacturing industries integrating more services in their prod-ucts, the flow of data has become central to trading.

Approximately half of all trade in services would not take place in the absence of IT solutions. A ser-vice such as shipping can be conducted without digital support (even if information technology helps optimise it), but for financial services, the streaming of music, some architectural services etc., digitalisation is a precondition for trade in services. See image 2.

Image 2. Half of global trade in services is made possible by digitalisation.

13

4.2 The transformation of industries and business modelsIn the past, digitalisation was primarily driven by cost-saving through outsourcing and specialisation. Today, digital solutions are often at the core of pro-duction as well as sales of goods or services.

Modern business models are based on speciali-sation where functions that were previously per-formed within a business are divided into separate tasks and carried out by different operators. This development is driven still further by digitalisation and firms are becoming dependent on service pro-duction networks. One example of this is payment services. A purchase in a store with a credit card requires the purchase to be processed and a range of other financial services, supported by data trans-fer and ”hosting” services, are needed to complete the transaction.

4.3 Growing number of cross-border transactionsDigitalisation increases the number of transactions which together create trade flows between coun-tries. This can mean more traditional business transactions, due to the possibility to supply digital services, but it can also mean entirely new, more efficient solutions.

The majority of transactions are small, for exam-ple an agreement to link an image to a website. Other examples of how the number of transactions

increases are services incorporated into products (i.e. ”internet of things” where sensors in physical products monitor usage) and purchases of add-ons in apps. It is impossible to estimate how significant this transformation is, but there is without doubt a fundamental difference between a digital world economy with myriads of small transactions and the world economy of the early 1980s.

4.4 More and smaller firms tradeIt has been estimated that no more than four per cent of all businesses trade internationally, typi-cally large multinational firms. Digitalisation chal-lenges this figure as an increasing number of small and medium-sized enterprises can reach interna-tional markets through the Internet. One site can reach the whole world, apps reach everyone who downloads them, and digital marketplaces such as eBay and Amazon make it possible for companies to reach an international clientele. According to eBay, 95 per cent of the companies that use their platform are involved in exports, and 80 per cent export to five or more countries.

Furthermore, an increasing number of compa-nies now operate only digitally. For example, Mojang, the creator of the computer game Minecraft, manages its whole operation digitally and does not manufacture any physical product. In the UK, it is estimated that 15 per cent of all busi-nesses are completely digital.

14

4.5 The importance of data – transfer, collection and analysis

Digitalised trade implies that data, to an increasing degree, is transferred across national borders. Often the product itself consists of data, i.e. computer programmes or entertainment, but business trans-actions also require the transfer of data for contracts and payments.

The ability to transfer data internationally is crit-ical for the ability to trade and use goods and ser-vices. All commercial activity that uses the Internet

is dependent on data being transferred between countries. Storing a document in Google’s cloud service involves over 40 data transfers, whereby the document is split up into various parts and saved.

The opportunity to have access to the right information at the right time changes firms as well as international trade. Business models are often based on the centralisation of data, data that is then analysed, used and accessed from all corners of the earth. Businesses are consequently dependent on the ability to move, analyse and compile data in order to identify problems in processes or to offer individually tailored services to their customers.

15

5. Trade in the 21st Century

On a fundamental level, economic development involves two processes - progress with respect to knowledge and technology, and an increased spe-cialisation of production. Wealthy societies are characterised by a high degree of economic special-isation. Poverty is common where the economy is based on self-sufficiency.

In our lifetime, economic specialisation has pro-gressed even further. The IT revolution and other technological conquests drive and interplay with economic specialisation in the form of servicifica-tion and international production networks.

Increased specialisation means that the analysis of trade has been moved from sectors, firms, goods and services down to individual tasks. Whereas we previously talked about Sweden having comparative advantages in the automotive sector, that advantage has now transformed into a range of tasks that are part of international production networks that man-ufacture trucks or cars. These tasks carried out in Sweden are, in turn, dependent on other parts of the

production process that are conducted in other parts of the world.

How far can this development be expected to go? It is clear that the technical advances related to the IT revolution have not yet been exhausted. We can therefore expect that there will continue to be a transformative pressure on how production is organised, both within specific countries and inter-nationally. One uncertain factor concerns the extent to which national and international regulation will facilitate or obstruct adaptation to new production and consumption patterns. This concerns not least personal mobility and international data transfer.

Another process of change that we have not dis-cussed in this report is the rise of emerging econo-mies as important players in the global economy. All these factors - digitalisation, international pro-duction networks, servicification, economic regula-tion and geo-economic shifts - interplay in a com-plex process that continues to shape world trade in the 21st century.

16

Bibliography

The report is based on the following studies by the National Board of Trade. All reports can be found at www.kommers.se

Kommerskollegium (2013a). Global Value Chains and the Transatlantic Trade and Investment Partnership.

Kommerskollegium (2013b). Minecraft Brick by Brick.

Kommerskollegium (2013c). Making Trade Happen – Business Perspectives on Cross-Border Movement of Persons.

Kommerskollegium (2012a). Business Reality and Trade Policy – Closing the Gap.

Kommerskollegium (2012b). Everybody is in Services – The Impact of Servicification in Manufacturing on Trade and Trade Policy.

Kommerskollegium (2010a). Made in Sweden?

Kommerskollegium (2010b). Servicification of Swedish Manufacturing.

Kommerskollegium (2010c). At Your Service – The Importance of Services for Manufacturing Companies and Possible Trade Policy Implicaitons.

Other literature Please contact the National Board of Trade for details of source references.

Baldwin, Richard (2006), Globalisation: The Great Unbundling(s), paper for the Economic Council of Finland. Genève: The Graduate Institute.

Blinder, Alan (2006), Offshoring: The Next Industrial Revolution?, Foreign Affairs (85:2).

eBay (2012), Enabling Traders to Enter and Grow on the Global Stage. Bryssel: eBay.

Kraemer, Kenneth L., Greg Linden och Jason Dedrick (2011), Capturing Value in Global Networks: Apple’s iPad and iPhone. Kalifornien: UC Irvine, UC Berkeley och Syracuse University.

Lanz, Rainer, Sébastien Miroudot och Hildegunn Nordås (2011), Trade in Tasks. OECD Trade Policy Working Papers 117. Paris: OECD.

Lendle, Andreas, Marcelo Olarreaga, Simon Schropp och Pierre-Louis Vézina (2012), There Goes Gravity: How eBay Reduces Trade Costs. Policy Re search Working Paper 6253. Washington DC: The World Bank.

Miroudot, Sébastien, Reiner Lanz and Alexandros Ragoussis (2009), Trade in Intermediate Goods and Services. OECD Trade Policy Working Paper No. 93. Paris: OECD.

Newhouse, John och A. A, Knopf (2007), Boeing vs Airbus, The Inside Story of the Greatest International Competition in Business. New York: Vintage Books.

OECD (2013), Interconnected Economies – Benefitting from Global Value Chains. Paris: OECD.

xiv

Box 6803, S-113 86 Stockholm, SwedenPhone +46 8 690 48 00 Fax +46 8 30 67 59

E-mail registrator@kommers.se www.kommers.se

2014 03