Trading up

The rapid growth in network trade and what it means for developing and developed nations

Omer Majeed

Economics and finance, Trade and industry | Australia, Asia, East Asia, South Asia, Southeast Asia, The World

17 September 2015

Network trade is big business. But what should policymakers be doing about its downsides? Omer Majeed offers some pointers. 

Technological improvements are changing the very nature of trade. With innovations in the production process and communications systems over the last few decades, it has become increasingly easy to split up the production process. As a result, network trade – the process in which production gets fragmented and allocated to different countries based on the respective country’s comparative advantage – has proliferated.

According to the United Nations Comtrade database, network trade has grown at an annual average rate of around 7.3 per cent between 1992 and 2013. This is higher than total manufacturing trade, which increased by around 6.3 per cent over the same period. Moreover, network trade accounted for around 28.8 per cent of total manufacturing trade, or about US$2.6 trillion. While network trade permeates several categories of manufacturing items, it is especially prevalent in the manufacturing of electronic items like smart phones, tablets, computers and TVs.

Network trade playing such an important role in international trade has implications for both developing and developed economies.

For developing economies, it opens up opportunities for economic growth and increased trade. If a country can tap into the US$2.7 trillion market, then it offers the potential for increased exports and employment, and can help a country to specialize in areas where it has a comparative advantage – for instance labour-abundant countries can focus on labour-intensive sections of production, while capital-abundant countries can target capital-intensive sections of the production process. But most of all, being part of multinational network trade offers access to technology and best practices that these developing countries may have never had previously.

Several developing economies such as China, Malaysia, Mexico, South Korea and Thailand have benefited substantially from network trade. In two recent studies, variables like infrastructure and institutions were identified as important determinants for network trade.

Institutions are important because multinationals involved in the network trade want a safe and reliable environment for their investment. Good infrastructure is important to ensure delivery between production plants is fast and affordable.  This becomes particularly important when production plants are located across countries.

This offers new challenges to developing economies as it puts pressure on them to develop business-friendly infrastructure and institutions if they want to attract investment and be a part of global network trade.

For developed economies, network trade offers a different type of challenge – inequality.

Inequality has been increasing due to technological developments and the automation of jobs. Splitting of the production processes and shipping off labour-intensive jobs to labour-abundant countries means that unskilled workers in developed economies may be worse off.

Governments in wealthy countries cannot and should not intervene to stop network trade. Giving multinationals subsidies to hold off on moving production processes abroad will delay the process, but not stop it. It may even be counterproductive and make these companies less competitive.

What governments can do to make the adjustment less costly is to help retrain the unskilled workforce during the transition period.

They can also start investing in infrastructure development, which is labour-intensive by nature. This will not only boost productivity, but also create breathing space for the unskilled workers so that they can retrain while still holding a job.

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