Global Value Chains explained

“Nations may have borders, but businesses no longer do”, Anthony Mistri (Economics expert at the World Trade Organization – WTO)

The Global Value Chain (GVC) concept refers to that international production sharing method where the production process is broken into different stages, each (or part) of them being re-allocated in different countries of the world. 

GVCs are an evolution of the economic concept of “division of labour”, popularised by Adam Smith in its book “An Inquiry into the Nature and Causes of the Wealth of Nations” (1776), where the Scottish economist used the example of a pin factory to explain how this methodology works. 

Smith noted that the efficiency of production of pins can vastly increase if the production process is divided into a number of small and distinct operations, each of them to be performed by a dedicated worker. 

The idea is simple: the traditional production process of a pin is normally articulated in a series of operations. Let’s suppose these operations are 6, as: 1) iron ore must be firstly extracted from the soil through mining, 2) refined, 3) forged, 4) converted into metal filaments, 5) cut, and 6) mounted onto a pin-head. 

If all these activities are carried out by a single worker, he would be able to produce only a few pins in a certain period (we assumed a 6-months period), because of the need to perform such activities in a sequential order. Conversely, if the different stages of the production are assigned to specific workers each of them concentrating on a single stage of this process, this will increase overall efficiency because such activities can be carried out in parallel, with the effect of producing in only one month the same quantities that a single worker would be able to produce in 6 months. 

The example below will better illustrate the point:

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The difference between the Adam Smith’s division of labour and GVCs is that the operations (or some of the operations) in which the production process is split are distributed internationally (between different companies located in more countries), instead of internally (between different workers within the same factory), which in most cases allows companies also to benefit from significant reduction of costs, because of the relocation of such phases in countries that specialise in performing such phases more efficiently, and/or where the manpower costs less. 

The example below shows the typical international division of labor in a Global Value Chain, where the different stages of the production process are fragmented across different factories located in different areas of the globe. 

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