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May providers drive globalization within the post-COVID-19 world?

Political

May providers drive globalization within the post-COVID-19 world?

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A growing chorus of expert opinions predict that COVID-19 will curb the forces of globalization, and obituaries are being written of its impending death. The pandemic, many say, will be the last straw in a long chain of events that have undermined the momentum of global integration, including the trade war between China and the US, Brexit, and economic nationalism in many parts of the world. As businesses and policymakers shift the focus from economic efficiency to resilience and flexibility, the process of relocating production is expected to accelerate and accelerate the end of global economic integration.

Trade in industrial goods has been declining since the Great Recession in 2008. After recovering from the sharp downturn in 2009, world trade in manufacturing – and in the broader sense of value chain integration – has seen a secular decline since 2011 (Figure 1). According to the World Input-Output Database (WIOD), the share of foreign content in domestic production – a broad measure of the fragmentation of the value chain in manufacturing – has steadily declined from its peak of 25.4 percent in 2011. With rising wages in emerging economies and technological change facilitating domestic automation, multinational corporations in advanced economies have shown less appetite to move their production abroad. The emerging view is that COVID-19 will fuel this trend as it pushes economies to turn inward to avoid external economic and health shocks.

However, there is one important caveat to this view: the trend towards global integration is likely to diverge between services and production. In the period after 2000 and most recently since 2011, trade in services has increased faster than trade in industrial goods (Figure 1). In addition, trade in services declined much less than industrial goods trade during the Great Recession and continued to grow thereafter, although industrial goods trade declined. The foreign share of domestic service production showed a similar pattern. This upward trend in trade in services is likely to continue in the post-COVID-19 world, potentially offsetting some of the losses in the manufacturing value chain integration. Once the worst of the pandemic is behind us and lockdown restrictions are lifted, services are likely to recover quickly and remain resistant to political and economic forces that threaten to reverse global integration.

Although services account for 75 percent of GDP and 80 percent of employment in OECD countries, the current value of world trade in services is only a third of the value of industrial goods. This is despite the fact that the service sector includes many tradable activities, such as information and communication technology services, financial intermediation, insurance, and professional, scientific and technical services. Tradable business services have a higher share of employment than manufacturing in many advanced economies, although their contribution to cross-border trade and production networks is even less understood due to data and measurement problems. The size of the service sector and the relatively large wage differentials between countries will offer enormous potential for service-based global integration.

There is likely to be more service integration in the coming decades, even if manufacturing is concentrated for several reasons:

1. The same technological changes that reduce the cost advantage of relocating production to low-wage countries will also facilitate greater service integration. As teleworking, “telerobotics” and “telemedicine” technologies mature, they will enable higher levels of virtual service delivery so that workers can offer services remotely. In particular, COVID-19 can help bring teleworking into the mainstream by changing attitudes and enabling favorable regulations.

Today, many activities such as software development and scientific research are carried out by virtual teams that work remotely. The future could see the fragmentation of certain service functions and tasks into different roles, which would enable companies to outsource certain tasks to virtual service providers. The adoption of 5G networks and the wider adoption of cloud computing technologies will facilitate service globalization, where the tasks themselves, not the factories, will be fragmented. This process, which Richard Baldwin referred to as “the third unbundling,” is likely to accelerate as digitalization continues, the rise of large tech companies, and business-to-customer and business-to-business e-commerce.

2. Trade in services may be less accessible to direct political restrictions such as tariffs and quotas. More than a quarter of all trade in services takes place between companies and their subsidiaries, making it difficult for governments to monitor and control. Trade in services could, however, require complementary free movement of workers as well as certain standards and licenses. For example, companies that purchase computer services over the Internet may require a software engineer to visit their sites occasionally to solve technical problems or train employees. A significant restriction in the movement of people and goods will therefore also have an impact on the globalization of services to a certain extent.

3. As companies respond to political forces by redeploying production, they are likely to continue to depend on imported business services. Tradable services are an important input factor for high-tech in manufacturing, which is also heavily integrated into international production networks. New technologies will continue to make outsourcing services easier and cheaper, and allow companies to stay local but coordinate production globally. This will help curb the cost of a highly skilled workforce in advanced economies, which will increase with demographic change and rapid changes in the skills demanded.

Services therefore have great potential to drive globalization in a post-COVID-19 world that is reluctant to adopt more overt forms of global integration. Much of the early growth is likely to take place in middle- and upper-income countries that have a complementary, highly skilled workforce that should make service globalization politically accessible. Unless countries put artificial legal barriers in place to limit them, service integration is likely to increase significantly as technological change exponentially lowers the cost of coordinating activities across borders. Even as we say goodbye to the heyday of globalization in manufacturing, we could welcome services as the new driving force behind global integration.

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