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Global Production Networks

by Henryk Kierzkowski

Globalization, a term that has entered everyday usage, means more than the intensification of trade relations. Improvements in transportation, communications and technology have resulted in a new organization of the production process. Previously concentrated productive activities can now be segmented and geographically dispersed over an international network. This may involve multinational enterprises or, instead, be contracted out as arms-lengths outsourcing transactions, when the costs of coordination are low enough to facilitate increased geographical dispersion of productive activities.

The driving force behind the intensification of international trade is fragmentation of the production process. Integrated technology, requiring production of a good to occur in one place and in “one go”, is replaced by fragmented technology that breaks down the manufacturing process into separate blocks. These blocks need not be produced by one firm or in one place at the same time. They need not even be produced in the same country! The main idea of fragmentation of production was articulated by Ron Jones from the University of Rochester and myself over a decade ago.

Increased fragmentation of production leads to a finer and finer division of labour. Services, ranging from transportation and insurance to telecommunications and banking, play a crucial role in the fragmentation process, because they form the links between various production blocks.

A key feature of globalization in the eyes of many is offshore production of parts and components for an increasing variety of goods and services. This is not new, as companies in a variety of industries have long used outside suppliers for parts and components. The auto industry comes immediately to mind. But outsourcing in the past tended to revolve more around domestic suppliers than foreign.

The New Division of Labour

What is new, is the increasing importance of the off-shore element in outsourcing and the growing role of low-wage countries in that development. What has made this growth possible has been the recent revolution in communications and related technologies and a sharp reduction in coordination costs that came with it. With the death of distance, to borrow the title of a recent book in this area, the scope for modularizing and reorganizing production processes has increased considerably. No wonder that the countries of East Asia have been exploiting, in a good sense of the word, new opportunities. The figure shows the dynamics of the traditional East Asian exports against exports of manufactured components. The later grew at a pace twice as fast as the former over 1984 -1996. This phenomenon is now spreading across Europe.

​Off-shore sourcing can occur in a variety of settings, but its common objective is to reduce the cost of the final product. Typically, companies in high-wage countries will utilize offshore sourcing to reduce labour costs. Not only parts and components, but final assembly and a variety of services may be subject to offshore procurement. Cheap labour need not be, however, the main reason why a large firm from a capital-rich country may wish to establish components production in a low-wage country (moving there its labour intensive stages of production). Professor Fukunari Kimura has presented a fascinating case of Fujitsu Ltd. moving from Japan to the Philippines not labour but the most capital-intensive stages of the production of hard disc drives. (The case is documented in the book by Cheng and Kierzkowski referred to at the end of this article.) The main reason for this astonishing result is that a new generation of disc drives is introduced about every two years and hence new and extremely expensive machines have to be amortized in such a short period of time. With three production shifts, capital equipment and facilities are fully utilized in The Philippines, an arrangement that Japanese trade unions are apparently not willing to accept.​​

Fragmentation of Production

New patterns of production and trade emerge in response to fragmentation of production. In a multi-commodity world it takes just one good to capture the benefits of trade. Similarly, it is enough to have comparative advantage at a single production stage to break into international markets without any need at all to be an efficient producer of the entire product.

Fragmented production is more complex than integrated production, because it requires that individual production blocks be connected by service links. These links can be thought of as consisting of bundles of activities—coordination, transportation, telecommunications, insurance, financial services, and so on. Efficient production requires, among other things, that the quality of intermediate goods produced at various stages remain within quality parameters and that production moves seamlessly from one stage to the next. The so-called “just-in-time technology” can be seen as a natural outcome of the fragmentation of production.

Fragmentation of production presents new opportunities for various countries but, alas, it is also associated with considerable risks and dangers. Malaysia can become a major sub-contractor for Nike and this is in general a positive development. After all, would many kids in North America, Europe and indeed in Asia buy fancy basketball shoes without an extensive (and hugely expensive) distribution network set up in those market and without top super-stars advertising the product continuously on television world-wide? But what if Nike decides to move its overseas production from Malaysia to another country? This could easily happen for a variety of reasons: service links, such as the Internet, could become less dependable or more costly, financial or currency crises could reduce or even eliminate the local cost advantage, or political instability could put in question the security and dependability of the supply.

International production networks are like social clubs: you sometimes need to meet very stringent conditions. However, the continuity of membership is not at all assured and a country may be forced to leave the club. Ultimately, every country has to face Groucho Marx’s dilemma and decide for itself whether it is worth joining such a club.
 

Henryk Kierzkowski is Professor of Economics at the Graduate Institute of International Studies in Geneva. This article is based upon Professor Kierzkowski’s public lecture at WIDER on 1 May 2001. For more on global production networks see Leonard Cheng and Henryk Kierzkowski (eds) “Global Production and Trade in East Asia”, Kluwer, Boston, 2001; and Sven Arndt and Henryk Kierzkowski (eds) “Fragmentation: New Production and Trade Patterns in the World Economy”, Oxford University Press, New York 2001. Further information about both books is available at: http://www.springer.com/economics/international+economics/book/978-0-7923-7330-8 and http://ukcatalogue.oup.com/product/9780199243310.do