Trade Wars in the Global Value Chain Era

By Emily Blanchard, Associate Professor, Tuck School of Business, Dartmouth College. Originally published at VoxEU

The nature of global commerce has changed dramatically over the past 40 years, with the meteoric rise of global value chain trade. This column, taken from a recent Vox eBook, builds on insights from recent research to identify three critical dimensions of global value chain trade that promise to make today’s trade wars more economically costly and more politically complex than previous trade wars.

Editor’s note: This column first appeared as a chapter in the Vox eBook “Trade War: The Clash of Economic Systems Endangering Global Prosperity”, available to download free here.

The nature of global commerce has changed dramatically over the past 40 years, with the meteoric rise of global value chain (GVC) trade.1Simply put, countries and companies make goods differently today than in the past.  In the 21st century, products are ‘made in the world’, as firms combine raw materials, inputs, labour, and ideas – the many slivers of value that ultimately make up a final product – each sourced from around the world according to specific cost-benefit tradeoffs for every component part of the value chain.  This phenomenon has been made possible by innovations in communications and transportation technologies, together with institutional and market reforms that have allowed scores of countries to join (or rejoin) the global economic landscape.  GVC trade – measured as a dramatic rise in the trade in value-added sub-components relative to gross trade – is the quantifiable manifestation of this ‘made in the world’ global production revolution.

In turn, the rise of GVC trade has reshaped the economic consequences and political contours of trade protection. While trade wars have always been disruptive, they are particularly expensive and divisive in the GVC era.

This chapter builds on insights from recent research to identify three critical dimensions of GVC trade that promise to make today’s trade wars more economically costly and more politically complex than previous trade wars.  Along the way, the discussion highlights distinctive aspects of the current, 2018-2019 trade actions that could carry additional, unintentional costs for the US economy.

The first point is obvious but important: GVCs amplify the effects of tariffs. Because tariffs are (typically) applied to the gross value of a good when it crosses the border, rather than just the ‘new’ value added, every border crossing increases the total tariff bill associated with production.

For example, suppose that a pair of blue jeans is made in three stages:  first, raw cotton is grown in country A and exported to country B; then country B processes the cotton into denim fabric, which is exported to country C; finally, country C cuts, sews, and finishes the jeans to be sold, ultimately, in country A.  If each country imposes a uniform 10% tariff on all imports, a tariff will be paid three times during the production process, with escalating costs as the gross value of trade increases from raw cotton, to the cotton fabric, to the finished product.  Had the jeans been produced start to finish in country C, the tariff would be paid just once (when the final product is shipped to the consumer in country A), and the total cost of production, inclusive of tariffs, would be lower.

The implication is immediate: the costs of higher tariffs in a trade war will be greater (potentially many times greater) in a trading system with GVC trade than in an otherwise equivalent world without it.  The corollary (discussed further below) is that higher tariffs in general, and trade wars in particular, may induce firms to shorten or otherwise reshape their global supply chains.2

The second point concerns not the total cost of a trade war, but the distribution of that cost across different stakeholders.  Fundamentally, GVC linkages mean that the burden of tariffs falls differently among consumers, workers, and firms involved throughout the value chain.  As explained below, some of the costs of trade protection may ultimately be borne by upstream producers in the country imposing the tariff,3 while some of the producer-side benefits from trade protection enjoyed by local import-competing firms may be passed along to foreign interests.

The same example of blue jean production serves to illustrate.  Suppose now that country A increases its tariff on all products (including blue jeans) to 25%.  If country A’s consumers constitute a sufficient share of global demand for blue jeans, then an increase in country A’s tariff may drive down the export price received by the producers of jeans in country C. (That is, the incidence of the tariff will be shared by consumers in country A, who pay higher prices, and producers in country C, who receive lower prices, with the government of country A collecting the difference as tariff revenue.)  By the same logic, if country C’s jeans producers are an important source of global demand for denim fabric, producers of jeans in country C may be able to pass on some of the fall in their revenue to producers of fabric in country B, who would then receive a lower export price.  In turn, if country B is a sufficiently important market for country A’s raw cotton, the price of cotton in country A may also fall.  Thus, ultimately, the costs of country A’s tariffs on imported blue jeans will be shared between country A’s consumers and all of the producers of value added embedded in the imported blue jeans, including, potentially, the producers of raw cotton in country A.

Meanwhile, if country A had a local producer of blue jeans competing head-to-head with imports from country C, that producer would gain from the additional protection afforded by the 25% tariff.  But if that local producer was owned by a foreign interest, or sourced its inputs from abroad, part of the benefit of that trade protection would be passed up the value chain, outside of country A. Thus, GVC linkages mean that country A may see its tariff protection eroded, even as it must internalise more of the costs of its tariff hike (Blanchard et al. 2016).

The extent to which producers in each country bear the costs of the tariff depend on a host of factors, including market power, bargaining relationships, input customisation, and trade volumes.  Whatever the details, the broad implication is the same:  GVC trade means that the costs and benefits of higher tariffs – and by extension, trade wars – may extend well beyond the immediate ‘intentional’ targets to include countries and companies around the world, including the very country that imposed the new protection at the outset.

The third point recognises that GVCs are themselves determined by market forces.  Because GVC structure is the result of strategic sourcing and foreign investment decisions of globally engaged firms, tariffs may have large, long-lasting, and unanticipated consequences for the pattern of global production.  If rising tariffs (or even just the threat of a trade war) causes firms to change how and where products are made in the world, this additional production dislocation will carry additional efficiency, job, profit, and welfare losses. Moreover, given the complex calculus faced by firms responding to changes in the global economic landscape, there is good reason to believe that global firms may not respond the way the importing country wants or expects.

Production dislocation is particularly likely under a tit-for-tat tariff escalation, in which multiple countries raise tariffs at the same time.  All else equal, higher tariffs give firms an incentive to consolidate their global supply networks into fewer countries, border crossings, and (thus) vulnerabilities.  But where firms choose to consolidate that production depends on a host of factors, including proximity not only to expected consumers but also to raw material, critical input suppliers, local economic regulations, policy certainty, access to skilled and low-cost labour, and more.  To the extent that some of the 2018-2019 tariffs are intended to induce producers to ‘re-shore’ production in the US, they may have unintended consequences if firms instead balkanise their production networks somewhere else. “America first” could backfire.

A noteworthy irony, given President Trump’s stated goal to bring jobs back to US shores, is that the administration has imposed new tariffs disproportionately on imported intermediate goods (Bown and Zhang 2019)— the very inputs that are necessary for US manufacturers to produce and sell their products competitively in the US and global markets.  If the intent is to induce US manufacturers to ‘re-shore’ production to the US (or to dissuade US firms from moving final assembly/downstream production overseas), lower tariffs on imported intermediate goods would be in order.  Higher tariffs on intermediate goods – together with increased uncertainty over the future of US tariff policy more generally4 – run the risk of inducing firms to shift their current production patterns away from the US and into ‘factory Asia’ or ‘factory Europe’.

Global firms seem to appreciate the importance of these GVC linkages and what they mean for the potential escalating and unanticipated costs of trade wars.  The US Chamber of Commerce has been a relentless advocate for a quick and amicable resolution of the 2018-2019 trade frictions.  At the same time, the United Steelworkers union, which represents nearly one million US worker-members in manufacturing, metals, forestry and beyond – industries that employ workers up and down the value chain across myriad traded products – has been an outspoken critic of renegotiating NAFTA in general, and the US steel and aluminium tariffs against Canada in particular.  Perhaps most notably, until recently, many governments had been implementing policies consistent with a sophisticated understanding of the relationship between GVCs and trade policy.  According to several studies, the contours of GVC linkages and firms’ global sourcing operations were reflected in trade policy before the 2018-2019 trade war, not least in the US.5

Early evidence suggests that even in the very short run, the current trade war is taking a toll on US firms and consumers.6 The key question in the months and years to come is how, if these tariffs continue, they will begin to feed back through global value chains at the expense of firms and workers in the US, China, and around the world.  How, ultimately, will firms shift, consolidate, and potentially balkanise their production to mitigate the costs of tit-for-tat tariffs and the uncertainty of future trade wars?  The consequences of this trade war may be slow to unfold and long lasting once they do.

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  1. RBHoughton

    Bill Brown at TRNN has been suggesting that the really big companies, the TBTF companies, are persuading a coterie of economists to repudiate competition amongst themselves and instead promote bigness as the perfection of commerce and industry, an East India Company result.

    With guaranteed government support such companies can take what they want and dictate policy to the world.

    1. Amfortas the hippie

      yes. the evolutionary argument.
      “it’s just natural…”
      corporations as god’s creatures, evolving according to divine plan into supranational egregores.
      and they’ve even built a sort of supranational pseudogovernment to fill up the void, so any democratic superstructures can’t get erected.
      i think it’s telling that the loudest voices for hypercompetition are themselves terrified of having to compete…not least in the realm of ideas.

      as far as the article, what stuck with me is “policy uncertainty”: perhaps these creatures are coming around to the same apparent place as many(most?) nations…that the usa cannot be trusted to stick to a promise or a plan for very long.
      if so, that’s an interesting phenomenon.

    2. Jeremy Grimm

      During the Reagan Years fears of Japan’s Cartels were used to fashion arguments for fighting fire-with-fire in global trade. US Cartels would meet Japan’s Cartels in the world marketplace. Smaller businesses were strangled in both countries.

  2. a different chris

    Wow from the clueless stupidity of the opening paragraph to… the complete misunderstanding of how the world works.

    The Ivy League strikes again. Do they ever go outside?

  3. John Wright

    I found this statement interesting:

    “If rising tariffs (or even just the threat of a trade war) causes firms to change how and where products are made in the world, this additional production dislocation will carry additional efficiency, job, profit, and welfare losses. ”

    Note that only losses are noted, while the possible beneficiaries, such as workers or manufacturers in other countries who may see new jobs or demand created in response to tariffs are not mentioned.

    It is as if we are in the best of all possible worlds, for everyone in the world, and any economic cost caused by a tariff is only negative.

    Assuming that CO2 production is roughly proportional to economic output, the tariffs, if tariffs do drop world wide economic output, or create local USA manufacturing, it might be a “good thing” environmentally.

    The tariffs might also let Americans know how tied to a fragile global supply chain the USA now is.

    Maybe we will see the new Donald Trump recast as an unintentional environmentalist.

    1. JEHR

      If ALL the costs were included in GVC, then they would be much higher, costs such as CO2 emissions, environmental degradation, air pollution, poverty caused by inadequate salaries for workers, etc.

  4. Susan the other`

    Interesting. Mostly because it is another example of the convoluted extent we are willing to go to maintain a neoliberal trading world, assuring an economy that operates, at least in part, on profits created by a wide variety of externalizations. Tariffs aren’t earmarked for specific domestic expenses, like cleaning up the pollution where it occurred – because if the blue jeans wholesaler here paid an import tariff, collected here, that money would get spent in the wrong country and pollution would expand exponentially in the country of the cheapest, dirtiest manufacture. For tariffs to actually smooth out all the problems with globalism they would have to be globalized too. The reason they are not is probably because that money gets used for grift and graft. It would be more interesting to see the Global Tariff Chain, the GTC, and learn where the money goes and how it is spent. It needs to be properly recycled back to mitigate the harm neoliberal trade has caused. Or we could just chuck all the nonsense and get serious about labor and the environment.

    1. drumlin woodchuckles

      Many years ago I read an article in Acres USA by Charles Walters Jr. suggesting a way to achieve the very same thing with tariffs which you would like to see achieved by a system of Global Tariffs with the money targeted to mitigate the problems by the Black Hat Perpetraders to begin with.

      Walters discussed having read it work by a “Catholic-Worker” based economic-justice Catholic economic analyst named Colin Clark . . . as I remember It was in a paper Clark had written for the “economic thinking” little part of the conferencing going on all around the Vatican Two conferencing.

      And the Colin Clark idea was called . . . equity of trade. Any perpetrader wishing to bring something into America from a country with lower costs reflected in lower prices to make the something . . . would have to pay the entire difference between this foreign cost and the American cost as a tariff to the American government. Every potential foreign source-country would have its own American-government-held-account into which each country would have its own charged-tariffs deposited into that country’s “buy-from-America” account. That money could then be tapped and used by any buyer from withIN that country to buy any American item that country wished to buy.

      Actually, I think Colin Clark described this method to be used every time something was sold between any two countries based on different costs as reflected in prices. The tariff would destroy the cost and price advantage sought by the differential costs arbitrage-working-racketeering perpetrader who wanted to ship a thing from country A to country B . . . and would use the tariff charged to destroy the cost and price advantage being arbitraged . . . to help the lower-cost source country buy something from the higher-cost sink country. So it was called Equity of Trade because it sought to destroy Forcey-Free-Trade and move the world to a balanced trade system involving value for value.

      I doubt this is on line anywhere. If one wanted to read the relevant Acres USA article, one would have to find someone with an old copy of the paper or one would have to go to the Acres USA offices and read it in their archives.

      1. Susan the other`

        This is interesting. And it also sounds like the thing Yanis Varoufakis wanted Germany/the EU to do which was share the wealth of EU exporters evenly across all the members. Because Germany was getting a free ride on the rest of the EU having lower GDPs, hence a lower euro.

      2. Scylla

        This system (or something similar) has actually been practiced in the past. I know that you could not remove currency from the Soviet Union for instance. I read about this when Pepsi started importing it’s products into the USSR- they could not take cash out of the country, so they exported vodka and sold it in the US. Always seemed quite fair to me.

  5. Sound of the Suburbs

    Richard Koo has discovered the assumption economists used when they said free trade would be a nett positive for any nation.

    Trade must be balanced, but the US runs a large trade deficit. The negative effects over a long period of time have brought Trump to power.

    Richard Koo wants to ensure the current system is maintained and hopes the successful developed Eastern nations will band together to help the US that has been shooting itself in the foot for four decades.

    The developed Eastern nations ran trade surpluses against the US and it was very good for them.

    1. Susan the other`

      According to Robert Rubin, we saved money by accruing such a huge trade deficit. Because we did not expend any of our resources, we merely took a free ride on the appreciating dollar. And for those 4 decades the dollar was so strong it couldn’t be stopped. The logic of the one percent. There could be some truth to it except for the devastation it caused by a race-to-the-bottom in 3rd world exporting countries, and to a lesser extent here. Even China, the most successful of them all, has a serious environmental deficit. It’s gonna be difficult going forward in this modern, technological age for any country to have a natural advantage and therefore benefit from the simple act of exporting their lucky “surplus”. Those days are long gone. And no amount of tweaking GVC stats will make any difference. It’s all 6s now. And arbitrage.

  6. Sound of the Suburbs

    Don’t tell Trump.
    US firms importing back into the US is where most of the trade deficit comes from.
    If only the US was more competitive.

    How did things go so wrong for the US?
    China was the big winner from an open, globalised world, it went from almost nothing to become a global superpower.

    Maximising profit is all about reducing costs.
    China had coal fired power stations to provide cheap energy.
    China had a low cost of living so employers could pay low wages.
    China had low taxes and a minimal welfare state.
    China also had lax regulations reducing environmental and health and safety costs.
    China had all the advantages in an open, globalised world.

    The US just couldn’t compete and it’s firms off-shored to China where they could make a decent profit.
    Mexico wasn’t bad either.

    Things look different at the national level.
    The US was immersed in the cult of individualism and didn’t think about the big picture.

    “There’s class warfare, all right, but it’s my class, the rich class, that’s making war, and we’re winning.” Warren Buffet, 25 May 2005
    That’s all very well Warren, but how is the US doing against China?
    Who cares, I’m making loads of money.
    Oh dear.

  7. Jeremy Grimm

    In a world of Global Value Chains — tariffs alone are blunt weapons that do damage in occult directions. Unaccompanied by some kind of industrial and commercial policies they wreck random harm and confer unintended advantages. But the flaws in wanton tariff policy make no argument favorable to maintaining Global Value Chains. They are crabbing-growth tumors which kill off smaller local industries and threaten global collapse as the “innovations in communications and transportation technologies” they depend upon wither in this age of Peak Oil. Global Value Chains are one of many frailties built-in to our global civilization — built from multiple thin lines riddled along their long reaches with single points of failure — radial spider webs without cross-webbing — held together by the brittle Neoliberal policies of Corporate Persons.

  8. Temporarily Sane

    So now “free trade” of the TPP variety, that even H.R. Clinton pretended to oppose because these deals blatantly undermine national sovereignty and put the rights of multinational corporations ahead of citizens’ right to fairly compensated employment, is an unquestionable good that must be supported by all right thinking people?

    Hmm…somewhere along the line a bait and switch took place. After Trump’s election victory there was still recognition by “progressive” media opponents of tariffs that the TPP and similar deals were bad for working people and prevented national governments from representing the interests of their citizens. But between then and now the idea that TPP-style “free trade” is a Good Thing, that right thinking people who don’t want the economy destroyed accept as a given, started being promoted by pretty much every left-leaning publication with any influence.

    The constantly stoked panic over Trump seems to be causing amnesia among left-wing “progressives” and making them susceptible to manipulation by neoliberal “progressives”, who bundle their poison together with leftish sounding rhetoric in a package deal that is sold to the left as a no brainer that only a misguided idiot or a Trump loving loser would challenge and refuse to accept.

  9. eg

    The only thing that matters is maintaining the infrastructure and productive capacity necessary for strategic defence purposes.

    Everything else is rounding error.

  10. drumlin woodchuckles

    I suspect this article was posted here as a pinyata-in-June gift for us to have fun hitting with sticks and clubs.

    The article itself gives an example of how GVC Free Trade causes global warming. Here is the quote . . .

    ” For example, suppose that a pair of blue jeans is made in three stages: first, raw cotton is grown in country A and exported to country B; then country B processes the cotton into denim fabric, which is exported to country C; finally, country C cuts, sews, and finishes the jeans to be sold, ultimately, in country A.”

    So . . . a big ship burns bunker oil to get cotton from country A to country B. Then a big ship burns bunker oil to get denim from country B to country C. Then a big ship burns bunker oil to get the jeans from country C to country A. That’s a lot of carbon skydumping to prevent workers from country A from being able to help capture the value of country A’s cotton for the wage-measured benefit of country A’s denim-makers and jeans makers. Who were all made jobless and homeless by the Forcey-Free-Trade Conspirators and told to go sleep under Bill Clinton’s Bridge to the Twenty First Century.

  11. JBird4049

    Levi’s Jeans shipped off most of manufacturing capabilities overseas along with the tools, knowledge, and technicians about thirty years ago. They also decreased the quality of the jeans making serious work clothes into overpriced casual wear and helped destroy the planet, but I am sure that the senior management made a lot of money.

    My question is how fast the economy will crash as America lost its manufacturing autarky decades ago and China has its economy dependent on exports after destroying much of its environment. My Dad never could understand my explanations of what was happening. I guess he wondered about who would buy all those products now that the workers no longer had money. It is an obvious problem, but it does take time to suck all the wealth of the former workers, so maybe that’s what the management of all those companies thought? We’ll make bank now and retire once the system crashes?

    The more I think on the Neoliberals destruction of the Bretton Woods System, the more I want to scream. Completely free trade, movement of money and open borders for workers is just lethal in the long run as we are about to see.

    1. drumlin woodchuckles

      The OverClasses are hoping it is all lethal to the rest of us but not lethal to themselves.

      Full-metal Jackpot design-engineering.

      ” Do it slow. And make it look like an accident.”

    1. cnchal

      Globalization is a disaster, no matter where one cares to look.

      “Made in China” fish is a good example. The fish after being caught and killed off of North America’s coasts travel many multiples of the distances they swam while living.

      How bad and tortured is the “system” now? I went to Wallys and instead of just grabbing a tube of toothpaste, I wanted to see where the stuff was made, and could find no toothpaste that was clearly marked as “Made In USA”. I found “Made in Vietnam” and “Made in Mexico” though. This for a product that is made using automated production techniques and minimal labor input. Truly demented.

      Now that toothpaste production appears to no longer be done anywhere close to local, will we loose the “toothpaste making” skill like the “toolmaking skill” is being lost, as per crApple’s Cook? As we keep this up, will America be held hostage to foreign producers and their toothpaste? All they need to do to bring America to it’s knees is to stop sending toothpaste and the resultant bad breath from everybody will drive us insane.

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