The World Investment Report has monitored FDI and the activities of MNEs for 30 years. During that time, international production saw two decades of rapid growth followed by one of stagnation.
The growth of international production in the first two decades was driven by policies (a wave of liberalization and export-led growth policies), economics (labour-cost arbitrage opportunities and declining costs of trade) and technology (advances allowing the fine-slicing of production processes and coordination in complex cross-border supply chains). These same factors started pushing in the opposite direction after the global financial crisis, with a return of protectionist tendencies, a gradual decline in the rate of return on FDI and increasing technology-enabled asset lightness in international operations.
As a result, after 2010, the growth momentum of international production stalled. This was first reflected in trade: worldwide exports of goods and services, which had grown at more than double the rate of GDP for decades, slowed down significantly relative to economic growth. Stagnation in cross-border investment in productive capacity was a key driver of the slowdown in overall trade, and GVC trade in particular (figure 8).
The 2010s were only the quiet before the storm. The crisis caused by COVID-19 at the dawn of this new decade arrives on top of existing challenges to the system of international production arising from the new industrial revolution (NIR), growing economic nationalism and the sustainability imperative (table 1). These challenges were already reaching an inflection point. Their impact was felt, but they had not yet begun to fundamentally reshape international production networks. The pandemic looks set to tip the scales. The decade to 2030 is likely to prove a decade of transformation for international production.
Trade and investment trends unfold in three key dimensions of international production: the degree of fragmentation and the length of value chains (short to long), the geographical spread of value added (concentrated to distributed), and the governance choices of MNEs that determine the prevalence of arm’s length trade vs FDI. This report identifies several archetypical configurations covering industries that, together, account for the lion’s share of global trade and investment. They include capital- and labour-intensive industries in the primary sector; high- and low-tech GVC-intensive industries; geographically dispersed regional processing and hub-and-spoke industries; and high and lower value added services industries.
Three key technology trends of the NIR will shape international production going forward: robotics-enabled automation, enhanced supply chain digitalization and additive manufacturing. Each of these technologies will have distinct effects on the length, geographical distribution and governance of GVCs.
For example, robotics-enabled automation reduces the labour cost component in production, increases economies of scale, and can lead to the rebundling and reshoring of fragmented processes. The application of digital technologies results in a reduction of governance and transaction costs in production networks, more effective coordination of complex supply chains and improved bottom-up access to GVCs for SME suppliers through platforms. Additive manufacturing leads to a higher geographic distribution of often out-sourced activities in the final stages of GVCs, location closer to markets and customers, and concentration of value added in the design phase of the value chain. Thus, each technology, depending on industry-specific deployment, will flatten, stretch or bend the “smile curve” of international production – the conceptual representation of value chains with higher value added activities at the beginning (e.g. research and development) and end (e.g. marketing) and lower value added activities in the middle (e.g. assembly).
The pace and extent of adoption of these technologies will depend to a significant extent on the policy environment for trade and investment, which is trending towards more interventionism, rising protectionism and a shift away from multilateral to regional and bilateral frameworks. New industrial policies tend to push for the clustering of know-how and technology and for the rebundling of fragmented activities to increase value capture. Protectionism will lead to rising trade costs and increase the risk of technological fragmentation. And regionalism will shift trade preferences from global to regional value chains. Sustainability concerns will also be an important driver of the transformation of international production. Differences in approach between countries and regions on emission targets and environmental, social and governance (ESG) standards will add to trade and investment policy pressures through the need for, for example, carbon border adjustments. Markets – including both risk averse financial markets and reputation-aware consumers – are pushing for changes in products and processes. And supply chain resilience measures were already in vogue in response to increasingly frequent extreme weather events; they will become even more important as a result of the pandemic.
The effects on international production of technology, policy and sustainability trends are multi-faceted. They are at times mutually reinforcing, they occasionally push in opposite directions, and they will play out differently across industries and geographies. Depending on the starting point of individual industries – their archetypical international production configurations – they will tend to favour one of four trajectories (figure 9).
(1) Reshoring will lead to shorter, less fragmented value chains and a higher geographical concentration of value added. It will primarily affect higher technology GVC-intensive industries. The implications of this trajectory include increased divestment and a shrinking pool of efficiency-seeking FDI. For some economies it implies the need to re-industrialize, for others to cope with premature de-industrialization. Access to and upgrading along the GVC development ladder becomes more difficult for developing countries.
(2) Diversification will lead to a wider distribution of economic activities. It will primarily affect services and GVC-intensive manufacturing industries. This trajectory will increase opportunities for new entrants (economies and firms) to participate in GVCs, but its reliance on supply chain digitalization will cause those GVCs to be more loosely governed, platform-based and asset-light, and value capture in host countries will become more difficult. GVC participation will require high quality hard and soft digital infrastructure.
(3) Regionalization will reduce the physical length, but not the fragmentation of supply chains. The geographical distribution of value added will increase. This trajectory will affect regional processing industries, some GVC-intensive industries, and even the primary sector. It will imply a shift from global efficiency seeking investment to regional market-seeking investment, and from investment in vertical GVC segments to broader industrial bases and clusters. Regional economic cooperation, industrial policy, and investment promotion will become indispensable to build regional value chains.
(3) Replication will lead to shorter value chains and a rebundling of production stages. It will lead to more geographically distributed activities, but more concentrated value added. It will be especially relevant for hub-and-spoke and regional processing industries. This trajectory implies a shift from investment in large-scale industrial activity to distributed manufacturing, which relies on lean physical and quality digital infrastructure. A local manufacturing base and producer services become a prerequisite to attract the final stages of GVCs, but value capture and technology dissemination will not be guaranteed.
The four trajectories all have different implications for investment-development policymakers (table 2). The push for reshoring will cause a shock for economies that depend on export-led growth and GVC participation. Diversification and digitalization will imply a challenge to value capture in GVCs but will also lead to new opportunities to participate in them. Regionalization will make cooperation with neighbours on industrial development, trade and investment of critical importance. And replication will change the model of investment promotion focused solely on large-scale industrial activities.
Although the different trajectories show that the expected transformation of international production is not unidirectional, on balance, the trends point towards shorter value chains, more concentrated value added, and reduced cross-border investment in physical productive assets. They show a system under pressure with heightened risks of a retreat and hollowing-out of GVCs. Given the importance of international production for post-pandemic recovery, for economic growth and job creation, and for the development prospects of lower-income countries, policymakers need to maintain a trade and investment policy environment that favours a gradual – rather than shock – adjustment of international production networks.
The transformation of international production will bring both challenges and opportunities for investment and development policymakers:
- Challenges include increased divestment, relocations, and investment diversion, and a shrinking pool of efficiency-seeking investment implying tougher competition for FDI. Value capture in GVCs and development based on vertical specialization will become more difficult. Infrastructure built for a world of GVCs will see diminishing returns. Changes in locational determinants of investment will often negatively affect the chances of developing countries to attract MNE operations.
- Opportunities arising from the transformation include attracting investors looking to diversify supply bases and building redundancy and resilience. The pool of regional market-seeking investment will increase. Shorter value chains will bring more investment in distributed manufacturing and final goods production with broader industrial capacity building and clustering. And digital infrastructure and platforms will enable new applications and services and improve bottom-up access to GVCs.
Confronting the challenges and capturing the opportunities requires a change in the investment-development paradigm. (i) From a focus on export-oriented efficiency-seeking investment in narrowly specialized GVC segments, to an “export-plus-plus” focus – plus investment in production for regional markets, plus investment in a broader industrial base. (ii) From cost-based competition for single-location investors to competition for diversified investments based on flexibility and resilience. And (iii) from prioritizing large-scale industrial investors with “Big infrastructure” to making room for small-scale manufacturing facilities and services with “Lean infrastructure”. The Report proposes a new framework for investment–development policies to reflect this change. Finally, a shift in investment promotion strategies towards infrastructure and services is necessary. For the past three decades international production and the promotion of export-oriented manufacturing investment has been the pillar of development and industrialization strategies of most developing countries. Investment geared towards exploiting factors of production, resources and low cost labour will remain important, but the pool of such investment is shrinking. A degree of rebalancing towards growth based on domestic and regional demand and on services is unavoidable.