Author: Susan Lund, James Manyika, Jonathan Woetzel, Jacques Bughin, Mekala Krishnan, Jeongmin Seong, and Mac Muir
Even with trade tensions and tariffs dominating the headlines, important structural changes in the nature of globalization have gone largely unnoticed. In Globalization in transition: The future of trade and value chains(PDF–3.7MB), the McKinsey Global Institute analyzes the dynamics of global value chains and finds structural shifts that have been hiding in plain sight.
Although output and trade continue to increase in absolute terms, trade intensity (that is, the share of output that is traded) is declining within almost every goods-producing value chain. Flows of services and data now play a much bigger role in tying the global economy together. Not only is trade in services growing faster than trade in goods, but services are creating value far beyond what national accounts measure. Using alternative measures, we find that services already constitute more value in global trade than goods. In addition, all global value chains are becoming more knowledge-intensive. Low-skill labor is becoming less important as factor of production. Contrary to popular perception, only about 18 percent of global goods trade is now driven by labor-cost arbitrage.
Three factors explain these changes: growing demand in China and the rest of the developing world, which enables these countries to consume more of what they produce; the growth of more comprehensive domestic supply chains in those countries, which has reduced their reliance on imports of intermediate goods; and the impact of new technologies.
Globalization is in the midst of a transformation. Yet the public debate about trade is often about recapturing the past rather than looking toward the future. The mix of countries, companies, and workers that stand to gain in the next era is changing. Understanding how the landscape is shifting will help policy makers and business leaders prepare for globalization’s next chapter and the opportunities and challenges it will present.
- Global value chains are undergoing five structural shifts
- One of the forces reshaping global value chains is a change in the geography of global demand
- The rise of domestic supply chains in China and other emerging economies has also decreased global trade intensity
- New technologies are changing costs across global value chains
- Given the shifts in value chains, companies need to reevaluate their strategies for operating globally
Global value chains are undergoing five structural shifts
The 1990s and 2000s saw the expansion of complex value chains spanning the globe. But production networks are not immutable; they continue to evolve. We observe five major shifts in global value chains over the past decade.1
1. Goods-producing value chains have grown less trade-intensive
Trade rose rapidly within nearly all global value chains from 1995 to 2007. More recently, trade intensity (that is, the ratio of gross exports to gross output) in almost all goods-producing value chains has fallen. Trade is still growing in absolute terms, but the share of output moving across the world’s borders has fallen from 28.1 percent in 2007 to 22.5 percent in 2017. Trade volume growth has also slowed. Between 1990 and 2007, global trade volumes grew 2.1 times faster than real GDP on average, but they have grown only 1.1 times faster than GDP since 2011.2
The decline in trade intensity is especially pronounced in the most complex and highly traded value chains (Exhibit 1). However, this trend does not signal that globalization is over. Rather, it reflects the development of China and other emerging economies, which are now consuming more of what they produce.
2. Services play a growing and undervalued role in global value chains
In 2017, gross trade in services totaled $5.1 trillion, a figure dwarfed by the $17.3 trillion global goods trade. But trade in services has grown more than 60 percent faster than goods trade over the past decade (Exhibit 2). Some subsectors, including telecom and IT services, business services, and intellectual property charges, are growing two to three times faster.
Yet the full role of services is obscured in traditional trade statistics. First, services create roughly one-third of the value that goes into traded manufactured goods. R&D, engineering, sales and marketing, finance, and human resources all enable goods to go to market. In addition, we find that imported services are substituting for domestic services in nearly all value chains. In the future, the distinction between goods and services will continue to blur as manufacturers increasingly introduce new types of leasing, subscription, and other “as a service” business models.
Second, the intangible assets that multinational companies send to their affiliates around the world—including software, branding, design, operational processes, and other intellectual property developed at headquarters—represent tremendous value, but they often go unpriced and untracked unless captured as intellectual property charges.3 Years of R&D go into developing pharmaceuticals and smartphones, for example, while design and branding enable companies such as Nike and Adidas to charge a premium for their products.
Finally, trade statistics do not track soaring cross-border flows of free digital services, including email, real-time mapping, video conferencing, and social media. Wikipedia, for instance, encompasses 40 million free articles in roughly 300 languages. Every day, users worldwide watch more than a billion hours of YouTube’s video content for free, and billions of people use Facebook and WeChat every month. These services undoubtedly create value for users, even without a monetary price.
We estimate that these three channels collectively produce up to $8.3 trillion in value annually—a figure that would increase overall trade flows by $4.0 trillion (or 20 percent) and reallocate another $4.3 trillion currently counted as part of the flow of goods to services. If viewed this way, trade in services is already more valuable than trade in goods. This perspective would substantially shift the trade balance for some countries, most notably the United States. This exercise is not meant to argue for redefining national trade statistics. It simply underscores the underappreciated role of services, which will be increasingly important for how companies and countries participate in global value chains and trade in the future.
3. Trade based on labor-cost arbitrage is declining in some value chains
As global value chains expanded in the 1990s and early 2000s, many decisions about where to locate production were based on labor costs, particularly in industries producing labor-intensive goods and services. Yet counter to popular perceptions, today only 18 percent of goods trade is based on labor-cost arbitrage (defined as exports from countries whose GDP per capita is one-fifth or less than that of the importing country).4 In other words, over 80 percent of today’s global goods trade is not from a low-wage country to a high-wage country. Considerations other than low wages factor into company decisions about where to base production, such as access to skilled labor or natural resources, proximity to consumers, and the quality of infrastructure.
Moreover, the share of trade based on labor-cost arbitrage has been declining in some value chains, especially labor-intensive goods manufacturing (where it dropped from 55 percent in 2005 to 43 percent in 2017). This mainly reflects rising wages in developing countries. In the future, however, automation and AI may amplify this trend, transforming labor-intensive manufacturing into capital-intensive manufacturing. This shift will have important implications for how low-income countries participate in global value chains.
4. Global value chains are growing more knowledge-intensive
In all value chains, capitalized spending on R&D and intangible assets such as brands, software, and intellectual property (IP) is growing as a share of revenue. Overall, it rose from 5.4 percent of revenue in 2000 to 13.1 percent in 2016. This trend is most apparent in global innovations value chains. Companies in machinery and equipment spend 36 percent of revenue on R&D and intangibles, while those in pharmaceuticals and medical devices average 80 percent (Exhibit 3). The growing emphasis on knowledge and intangibles favors countries with highly skilled labor forces, strong innovation and R&D capabilities, and robust intellectual property protections.5
In many value chains, value creation is shifting to upstream activities, such as R&D and design, and to downstream activities, such as distribution, marketing, and after-sales services. The share of value generated by the actual production of goods is declining (in part because offshoring has lowered the price of many goods). This trend is pronounced in pharmaceuticals and consumer electronics, which have seen the rise of “virtual manufacturing” companies that focus on developing goods and outsource actual production to contract manufacturers.
5. Value chains are becoming more regional and less global
Until recently, long-haul trade crisscrossing oceans was becoming more prevalent as transportation and communication costs fell and as global value chains expanded into China and other developing countries. The share of trade in goods between countries within the same region (as opposed to trade between more far-flung buyers and sellers) declined from 51 percent in 2000 to 45 percent in 2012.
That trend has begun to reverse in recent years. The intraregional share of global goods trade has increased by 2.7 percentage points since 2013, partially reflecting the rise of emerging-market consumption. This development is most noticeable for Asia and the EU-28 countries. Regionalization is most apparent in global innovations value chains, given their need to closely integrate many suppliers for just-in-time sequencing. This trend could accelerate in other value chains as well, as automation reduces the importance of labor costs and increases the importance of speed to market in company decisions about where to produce goods.
One of the forces reshaping global value chains is a change in the geography of global demand
The map of global demand, once heavily tilted toward advanced economies, is being redrawn—and value chains are reconfiguring as companies decide how to compete in the many major consumer markets that are now dotted worldwide. McKinsey estimates that emerging markets will consume almost two-thirds of the world’s manufactured goods by 2025, with products such as cars, building products, and machinery leading the way. By 2030, developing countries are projected to account for more than half of all global consumption. These nations continue to deepen their participation in global flows of goods, services, finance, people, and data.
The biggest wave of growth has been happening in China. Previous MGI research highlighted China’s working-age population as one of the key global consumer segments; by 2030, they are projected to account for 12 cents of every $1 of worldwide urban consumption. As it reaches the tipping point of having more millionaires than any other country in the world, China now represents roughly a third of the global market for luxury goods. In 2016, 40 percent more cars were sold in China than in all of Europe, and China also accounts for 40 percent of global textiles and apparel consumption.
As consumption grows, more of what gets made in China is now sold in China. This trend is contributing to the decline in trade intensity. Within the industry value chains we studied, China exported 17 percent of what it produced in 2007. By 2017, the share of exports was down to 9 percent. This is on a par with the share in the United States but is far lower than the shares in Germany (34 percent), South Korea (28 percent), and Japan (14 percent). This shift has been largely obscured because the country’s output, imports, and exports have all been rising so dramatically in absolute terms. But overall, China is gradually rebalancing toward more domestic consumption.
The rising middle class in other developing countries is also flexing new spending power. By 2030, the developing world outside of China is projected to account for 35 percent of global consumption, with countries including India, Indonesia, Thailand, Malaysia, and the Philippines leading the way. In 2002, India, for example, exported 35 percent of its final output in apparel, but by 2017, that share had fallen by half, to 17 percent, as Indian consumers stepped up purchases.
Growing demand in developing countries also offers an opportunity for exporters in advanced countries. Only 3 percent of exports from advanced economies went to China in 1995, but that share was up to 12 percent by 2017. The corresponding share going to other developing countries grew from 20 to 29 percent. In total, advanced economies’ exports to developing countries grew from $1 trillion in 1995 to $4.2 trillion in 2017. In the automotive industry, Japan, Germany, and the United States send 42 percent of their car exports to China and the rest of the developing world. In knowledge-intensive services, 45 percent of all exports from advanced economies go to the developing world. The Asia–Pacific region is already a top strategic priority for many Western brands.
The rise of domestic supply chains in China and other emerging economies has also decreased global trade intensity
China’s rapid growth has made it a major part of virtually every goods-producing global value chain. Overall, it now accounts for 20 percent of global gross output, up from just 4 percent in 1995. In textiles and apparel, electrical machinery, and glass, cement, and ceramics, it now produces nearly half of global output.
But as its economy has matured, China has moved beyond assembling imported inputs into final products. It now produces many intermediate goods and conducts more R&D in its own domestic supply chains. This is the second factor dampening global trade intensity in goods. In computers and electronics, for instance, Chinese companies are developing the kind of sophisticated smartphone chips that China once imported from advanced economies. Building more vertically integrated domestic industries enables China to capture more value added—and simultaneously bring jobs and economic development to its poorer inland provinces.
Other developing countries are beginning to exhibit the same structural shifts seen in China, although they are at earlier stages. In textiles and apparel, for instance, production networks spanning multiple stages are consolidating within individual countries such as Vietnam, Bangladesh, Malaysia, India, and Indonesia.
As a group, emerging Asia has become less reliant on imported intermediate inputs for the production of goods than the rest of the developing world (8.3 percent versus 15.1 percent in 2017). By contrast, in developing Europe, where economic growth has been slower, companies have continued to integrate into the supply chains of companies in Western Europe. The decline in trade intensity reflects growing industrial maturity in emerging economies. Over time, their production capabilities and consumption are gradually converging with those of advanced economies. Declining trade intensity in goods does not mean globalization is over; rather, digital technologies and data flows are becoming the connective tissue of the global economy.
New technologies are changing costs across global value chains
The explosive growth of cross-border data flows, highlighted in MGI’s previous research on digital globalization, is ongoing. From 2005 to 2017, the amount of cross-border bandwidth in use grew 148 times larger. A torrent of communications and content travels along these digital pathways—and some of this traffic reflects companies interacting with foreign operations, suppliers, and customers.
Instant and low-cost digital communication has had one clear effect: lowering transaction costs and enabling more trade flows. But the impact of next-generation technologies on global flows of goods and services will not be as simple. The net impact is uncertain, but in some plausible scenarios, the next wave of technology could dampen global goods trade while continuing to fuel service flows.
Digital platforms, logistics technologies, and data-processing advances will continue to reduce cross-border transaction costs and enable all types of flows
In goods-producing value chains, logistics costs can be substantial. Companies often lose time and money to customs processing or delays in international payments. Three sets of technologies will continue to reduce these frictions in the years ahead.
Digital platforms can bring together far-flung participants, making cross-border search and coordination more efficient. E-commerce marketplaces have already enabled significant cross-border flows by aggregating huge selections and making pricing and comparisons more transparent. Alibaba’s AliResearch projects that cross-border B2C e-commerce sales will reach approximately $1 trillion by 2020. B2B e-commerce could be five or six times as large. While many of those transactions may substitute for traditional offline trade flows, e-commerce could still spur some $1.3 trillion to $2.1 trillion in incremental trade by 2030, boosting trade in manufactured goods by 6 to 10 percent. Continued rapid growth in small-parcel trade would present a challenge for customs processing, however.
Logistics technologies also continue to improve. The IoT can make delivery services more efficient by tracking shipments in real time, and AI can route trucks based on current road conditions. Automated document processing can speed goods through customs. At ports, autonomous vehicles can unload, stack, and reload containers faster and with fewer errors. Blockchain shipping solutions can reduce transit times and speed payments. We calculate that new logistics technologies could reduce shipping and customs processing times by 16 to 28 percent. By removing some of the frictions that slow the movement of goods today, these technologies together could potentially boost overall trade by 6 to 11 percent by 2030.6
Automation and additive manufacturing change production processes and the relative importance of inputs
Previous MGI research has found that roughly half of the tasks that workers are paid to do could technically be automated, suggesting a profound shift in the importance of capital versus labor across industries. The growing adoption of automation and advanced robotics in manufacturing makes proximity to consumer markets, access to resources, workforce skills, and infrastructure quality assume more importance as companies decide where to produce goods.
Service processes can also be automated by artificial intelligence (AI) and virtual agents. The addition of machine learning to these virtual assistants means they can perform a growing range of tasks. Companies in advanced economies are already automating some customer support services rather than offshoring them. This could reduce the $160 billion global market for business process outsourcing (BPO), now one of the most heavily traded service sectors.
Additive manufacturing (3-D printing) could also influence future trade flows. Most experts believe it will not replace mass production over the next decade; its cost, speed, and quality are still limitations. But it is gaining traction for prototypes, replacement parts, toys, shoes, and medical devices. While 3-D printing could reduce trade in some specific products substantially, the drop is unlikely to amount to more than a few percentage points across overall trade in manufactured goods by 2030. In some cases, additive manufacturing could even spur trade by enabling customization.
Overall, we estimate that automation, AI, and additive manufacturing could reduce global goods trade by up to 10 percent by 2030, as compared to the baseline. However, this reflects only the direct impact of these technologies on enabling production closer to end consumers in advanced economies. It is also possible that these technologies could lead to nearshoring and regionalization of trade instead of reshoring in advanced economies. Moreover, developing countries could adopt these technologies to improve productivity and retain production, thereby sustaining trade.
New goods and services enabled by technology will impact trade flows
Technology can transform some products and services, altering the content and volume of trade flows in the process. For example, McKinsey’s automotive practice estimates that electric vehicles will make up some 17 percent of total car sales globally by 2030, up from 1 percent in 2017. This could reduce trade in vehicle parts by up to 10 percent (since EVs have many fewer moving parts than traditional models) while also dampening oil imports.
The shift from physical to digital flows that started years ago with individual movies, albums, and games is now evolving once again with streaming and subscription models. Streaming now accounts for nearly 40 percent of global recorded music revenues. Cloud computinguses a similar pay-as-you-go or subscription model for storage and software, freeing users from making heavy capital investments in their own IT infrastructure.
The advent of ultra-fast 5G wireless networks opens new possibilities for delivering services. Remote surgery, for example, may become more viable as networks transmit sharp images without any delays and robots respond more precisely to remote manipulation. In industrial plants, 5G can support augmented and virtual reality–based maintenance from remote locations, creating new service and data flows.
Given the shifts in value chains, companies need to reevaluate their strategies for operating globally
Both the costs and the risks of global operations are shifting. Several imperatives stand out for global companies in this landscape:
- Reassess where to compete along the value chain. Business leaders need to continuously monitor where value is moving in their industry and adapt accordingly. Some have narrowed their focus to R&D and distribution while outsourcing production. By contrast, many makers of consumer goods take a hyperlocal approach, with customized product portfolios for individual markets. Providers of “global-local” services, such as Airbnb and Uber, have recognized global brands but also extensive local operations that deliver in-person services. Network companies, most of which are knowledge-intensive service providers, create value through a geographically dispersed operating model and global reach. Regardless of the strategy, a key point is to maintain control, trust, and collaboration in all parts of the value chain. For some companies, this might mean bringing more operations in-house. Those that outsource need close supplier relationships and greater visibility into lower tiers of the supply chain.
- Consider how to capture value from services. Across multiple value chains (including manufacturing), more value is coming from services. Shifting to services can offer advantages: smoothing cyclicality in sales, providing higher-margin revenue streams, and enabling new sales or design ideas due to closer interaction with customers. At its extreme, entire business models shift from producing goods to delivering services. To make this shift successfully, companies need to gain insight into customer needs, invest in data and analytics, and develop the right subscription, per-use, or performance-based service contracts.
- Reconsider your operational footprint to reflect new risks. New automation technologies, changing factor costs, an expanding set of risks, and the increasing importance of speed to market in some industries are all driving localization in many goods-producing value chains. As a result, it may make sense to place production in or near key consumer markets around the world. Before investing, companies should consider the full risk-adjusted, end-to-end landed costs of location decisions—and today many do not account for all of the variables.
- Be flexible and resilient. Today companies face a more complex set of unknowns as the postwar world order that held for decades seems to be giving way. There is a real chance that tariffs and nontariff barriers will continue to rise, reversing decades of trade liberalization. Tax codes are being reconsidered for the digital and intangible era. Building agile operations can help firms prepare for these types of uncertainties. This can take many forms, such as using versatile common platforms to share components across product lines and multiple plants. In purchasing, companies have achieved flexibility through price hedging, long-term contracting, shaping customer demand to enable using substitutes, and building redundancies into supply chains.
- Prioritize speed to market and proximity to customers. Companies in all industries now have real-time, granular sales and consumer behavior data at their disposal, but it takes manufacturing and distribution excellence to capitalize on these insights. Speed to market enables faster responses to what customers want and less product waste from forecasting errors. This does not necessarily require large-scale reshoring or full vertical integration in every major market. Companies can opt for postponement—that is, creating a largely standardized product at a distance and then finishing it with custom touches at a facility near the end market.
- Build closer supplier relationships. Arm’s-length relationships with suppliers across the globe involve hidden risks and costs. It makes sense to identify which suppliers are core to the business, then solicit their ideas and deepen relationships with them. Firms that genuinely collaborate can secure preferred customer status and benefit from new product ideas or process efficiencies bubbling up from suppliers. Large firms can also bring about systemic changes along the value chain, improving labor and environmental standards. Logistics and production technologies can transform supply chains, but optimizing what they can do requires end-to-end integration. Larger companies may need to help their small and medium-size suppliers upgrade and add digital capabilities to realize the full value.