Oral statement to Parliament

The UK in a global world: how to focus on steps in the value chain that really add value

This speech was published under the 2010 to 2015 Conservative and Liberal Democrat coalition government

Vince Cable looks at how we should respond to the challenge of massive structural changes in the global market and why it is essential to understand what drives these changes.

Introduction

Thank you Martin [Donnelly] for your introduction

I’m delighted at the level of interest from the businesses, policy and academic community our joint conference with CEPR and the ESRC has generated, which comes at a very challenging time in our economic history.

Setting the Context

Let me explain, first, my own personal interest in this issue. I have been trying to understand and explain globalisation throughout my business, academic and government career. My first book, published three decades ago, dealt with the issues at the heart of this conference: how a free trading country should deal with industrial - relative - decline. A decade ago I wrote a book about globalisation and global governance: the dangerous deficit between rapidly integrating global markets for goods, services and finance, and the stolid systems of governance based on the old model of nation states. At Shell, one of the underlying questions on our scenario planning was whether globalisation and the rapid rise of emerging economies within that framework, should be taken as a given or treated as an historical aberration.

These questions reverberate today and help to define my job in government. When we step back from the daily fire fighting and budgetary management issues, the central issue for UK business is how to respond to the longer term challenge of massive structural changes in the global economy. Globalisation, the rise of the BRICs, including their move up the value chain and the growth in international value chains means that British based business - and wider society - are having to adapt and change, rapidly.

The Government has an important role in understanding and supporting this process. This is at the heart of our industrial strategy and Lord Heseltine’s review of competitiveness. As our spending resources are limited, the Government needs a sharp focus, intervening where it can add most value. But, to do this effectively it is crucial to understand the real drivers of change.

Trade and Growth

Commitment to an open trading system is an important element of the Government’s long term economic strategy. There is no contradiction between openness and seeking to strengthen our own goods and services sectors.

There is a risk that the post-2008 financial crisis, and its damaging impact on production, living standards and jobs, could provoke a nationalist and protectionist backlash within the EU and more widely. Although global trade liberalisation has ground to a halt there is little sign of a reversion to the trade warfare which aggravated the crisis of the 1930s.

There is, moreover, strong evidence that trade liberalisation is firmly linked to growth. Economic analysis suggests that an increase of 10% in trade openness translates into an increase of around 4% in income per person. And, contrary to the myth of McJobs, an OECD review found virtually no evidence that trade has played a major or systematic role in increasing household income inequality in either high or low income countries. Where inequalities have risen, the business cycle, technical change, fiscal policy and educational policy are more important influences than trade.

At a time when other sources of growth are weak, trade has helped, adding one percentage point to the EU’s GDP in 2011. Trade remains one of the few means we have to bolster growth without drawing on constrained public finances.

To maximise the benefits from trade we need to be open in all directions. In a world where companies increasingly operate on a global scale with complex investment and sourcing policies across continents, openness to others trade and investment is vital. The evidence suggests that a 1% increase in openness to imports results in a 0.6% increase in labour productivity amongst European firms.

Analysis of Competitiveness

Traditional analysis of competitiveness - such as estimates of revealed comparative advantage (RCA) - indicated that the UK has tended to specialise in various high skill or high value added sectors. These include the creative industries, financial and professional services as well as services that support industry such as architecture, technical services, advertising and R&D services. On the goods side, at a broad product level the UK has an apparent comparative advantage in equipment for ports and airports and pharmaceutical goods / medicines, and a fairly high RCA in educational, power and healthcare goods, as well as other chemicals. At a more detailed level there are a wide range of goods where the UK specialises from consumer products such as spirits through industrial products such as turbojets, hovercraft and excavators to a wide range of intermediate inputs.

Of course, we know the limitations of such analysis: it is backward looking and its results are sensitive to the level of disaggregation used. Furthermore the emergence of intra-industry trade and global value chains has made interpreting the patterns of trade specialisation more complex. The re-emergence of the UK as a significant net exporter of cars begs a lot of questions about where the value of production is located in complex supply chains. RCAs still provide a useful starting point for thinking about the UK’s relative competitiveness, but are a poor basis for normative conclusions.

New Approaches - Differentiating by Product Quality and Technology

So to better understand the UKs trade performance we need to consider other ways of analysing trade data. For example differentiating products by their market positioning - high quality / up market compared to low quality / market based on measures such as marketing and branding. Or differentiating products by their technological level.

The need for such measures is highlighted by the fact that many countries now export nearly all products. Out of just over 5,000 products traded in 2004 China exported 4,898 compared to Germany’s 4,932. But, a different picture emerges when unit prices are examined. For instance, on average, Japanese unit values are 1.4 times higher than for Brazil, 1.9 times higher than for India, and 2.9 times higher than for China, for the same products, shipped to the same markets, within the same year. So although countries might appear to be exporting the same products, the price data indicates they are not shipping the same varieties of these products.

Examining quality and technology throws up some interesting results.

Around 35% of UK exports are ‘up-market’ - goods sold at a premium price thanks to a design, quality premium and other features like after sales service. This is above France’s (32%) and close to Germany’s (36%) performance.

The UK’s share of global exports has held up better for up-market products than it has for all goods. Between 1995 and 2009 the UK’s share of global exports of goods fell by 1.8 percentage points. But, whilst the UK lost 2.4 percentage points of its share of low market products, the decline in its share of up markets products was only half this rate - 1.2 percentage points. This was less than the decline in the share of global exports in up market products experienced by Germany (-1.8 percentage points) and France (-1.5 percentage points).

There is a slightly different picture when it comes to technology. The UK has specialised in medium and high technology products. Around two thirds of the UK’s exports in 2009 were medium / high tech, with the remainder a mixture of low tech, resource-based or primary products. Although the share of UK exports accounted for by high technology products has grown, the big increase has been in exports of medium technology products. Between 1995 and 2009 the share of UK product exports accounted for by medium technology products grew by 2.5 percentage points, whilst that of high technology products increased by 0.5 percentage points. This differentiates the UK from Germany and France, both of which have seen a greater shift to high technology exports, with their shares of high technology exports growing by 4 percentage points and 6.4 percentage points respectively.

New Approaches - Value Added

This discussion has been based on traditional trade data. But, over the last 10-20 years as the world economy has become ever more complex this has become a less reliable guide to underlying economic relationships. Changing trade patterns - the BRICs share of global merchandise exports more than doubled between 2000 and 2010 (from 7% to 16%) - combined with a dramatic transformation in how businesses organise their production and the use of global value chains (GVCs) requires us to reassess how we approach our policies today. As stages and activities of the production process are located across different countries; competitiveness and comparative advantage will increasingly have to be interpreted in terms of tasks instead of industries. This isn’t just a marginal change. Two thirds of the EU’s imports of goods are of intermediate products; intra industry trade.

It is therefore crucial that we strengthen our knowledge of these changes and what they mean. The rise in global value chains makes interpreting traditional trade statistics increasingly difficult as they suffer from double counting. This can be explained via a simple example, a car engines and its wheels are produced in two separate countries, assembled in a third country and then shipped for sale in a fourth country. According to trade statistics, this produces a car with 2 engines and 8 wheels. This is a really simplified example on how one car is produced, but the same principle applies to many goods exports.

In addition, global value chains make analysing bi-lateral trade flows more challenging as ‘assembly countries’ exports flows are over estimated, while countries that specialise in ‘intangibles’ are underestimated. We are all aware of the Smartphone examples. Very briefly, according to trade statistics, the Nokia N95 is made in China; however around 55% of its value is actually added by European workers, mainly in Finland.

Sometimes the UK benefits from such revision. Officially, France exports the Airbus but Britain exports the wings - or most of them. Controversial procurement contracts are often clouded by doubts as to whether “British” suppliers add more value than overseas suppliers; and sometimes prestigious British export “wins” are nothing of the kind.

To solve these problems caused by supply chains fragmentation, the European Commission recently launched the World Input Output Database. This database allows users to identify the value added of trade and already some interesting statistics are emerging:

  • Almost 90% of the value of EU’s “traditional” gross exports is indeed EU domestic value added, emphasising the great importance of the Single Market as our exports tend to be “made in Europe”.
  • 13% of EU exports come directly from non-EU imports, which emphasis the importance of free trade, as our sales are dependant on accessing competitively priced intermediaries.
  • Less than 1% of EU exported value added comes back to the EU

However, we should not fall into the trap of blindly pursuing “high value added”. What matters is how participation in global value chains compares with alternative use of those resources in other activities. And the analysis may come up with different conclusions in conditions like the present where normally scarce resources are underemployed. We need to be more sophisticated in our policy making, recognising we may specialise in a range of tasks of varying skills and added value.

The evidence presented here today by the distinguished speakers and the debate they stimulate will help ensure that we have the right analysis necessary to formulate future trade and industrial policies.

Conclusion: Questions to be answered

Using this opportunity, I think some of the key questions which we as government need answers to in order to have better polices are:

  • Is the concept of comparative advantage still relevant today? And if so what should we measure and what data should we use?
  • To what extent can and should governments influence comparative advantage?
  • How can we strengthen the capacity of firms to compete in the global market?

I look forward to your suggestions.

Thank you for your attention, I’m happy to take questions for the next ten minutes.