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Global Value Chain Participation and Current AccountImbalances
Johannes BrummUniversity of Zurich
Georgios GeorgiadisEuropean Central Bank
Johannes GrabEuropean Central Bank
Fabian TrottnerPrinceton University
March 31, 2016
BGGT GVC Participation and Imbalances March 31, 2016 1 / 35
MotivationTwo major developments
Two salient developments in the world economy
1 Emergence of large and persistent external imbalances
BGGT GVC Participation and Imbalances March 31, 2016 2 / 35
MotivationTwo major developments
Two salient developments in the world economy1 Emergence of large and persistent external imbalances
BGGT GVC Participation and Imbalances March 31, 2016 2 / 35
MotivationTwo major developments
Two salient developments in the world economy1 Emergence of large and persistent external imbalances2 Increase in fragmentation and geographic dispersion of production
processes
This paper: Is there a connection between the two?
BGGT GVC Participation and Imbalances March 31, 2016 4 / 35
MotivationGlobal Imbalances - Patterns we have a convincing story for
Persistent CA deficit in the US, surplus in many newly industrializedeconomies (in particular China)
Heterogeneity in financial development affect asset demand andaccumulation of foreign liabilities (Mendoza et al, 2009)Interplay of increases in wealth and heterogeneity in asset supply(Caballero et al, 2015, 2008)
Such institutional differences explain North-South pattern in thebroadest sense
However, empirical evidence seems more complex...
BGGT GVC Participation and Imbalances March 31, 2016 5 / 35
MotivationGlobal Imbalances - Patterns we have a convincing story for
Persistent CA deficit in the US, surplus in many newly industrializedeconomies (in particular China)
Heterogeneity in financial development affect asset demand andaccumulation of foreign liabilities (Mendoza et al, 2009)Interplay of increases in wealth and heterogeneity in asset supply(Caballero et al, 2015, 2008)
Such institutional differences explain North-South pattern in thebroadest sense
However, empirical evidence seems more complex...
BGGT GVC Participation and Imbalances March 31, 2016 5 / 35
MotivationGlobal Imbalances - Patterns we have a convincing story for
Persistent CA deficit in the US, surplus in many newly industrializedeconomies (in particular China)
Heterogeneity in financial development affect asset demand andaccumulation of foreign liabilities (Mendoza et al, 2009)Interplay of increases in wealth and heterogeneity in asset supply(Caballero et al, 2015, 2008)
Such institutional differences explain North-South pattern in thebroadest sense
However, empirical evidence seems more complex...
BGGT GVC Participation and Imbalances March 31, 2016 5 / 35
MotivationGlobal Imbalances - The limits of our understanding
Figure: 2007 CA surplus countries and EBA residuals-.0
50
.05
.1
Austria China Finland GermanyNetherlands SwedenUnited States
CA to GDP Residuals
BGGT GVC Participation and Imbalances March 31, 2016 6 / 35
MotivationGVCP and Imbalances I
Figure: Backward Participation for high residual countries
.06
.065
.07
.075
.08
-.02
-.01
0.0
1.0
2
.015
.02.
025.
03.0
35.0
4
.09.
095
.1.1
05.1
1.11
5
.05
.055
.06
.065
.07
-.045
-.04
-.035
-.03
-.025
-.05
0.0
5
0.0
5.1
-.02
0.0
2.0
4.0
6
.02
.04
.06
.08
.04
.06
.08
.1
-.06
-.04
-.02
1995 2000 2005 2010 1995 2000 2005 2010 1995 2000 2005 2010
1995 2000 2005 2010 1995 2000 2005 2010 1995 2000 2005 2010
Austria China Germany
Netherlands Sweden United States
CA to GDP Backward Participation, relative to RoW
CA
to G
DP
year
BGGT GVC Participation and Imbalances March 31, 2016 7 / 35
MotivationGVCP and Imbalances II
Figure: Forward Participation for high residual countries
-.24
-.22
-.2-.1
8-.1
6
-.3-.2
-.10
.1
.3.3
5.4
.45
.5
-.2-.1
5-.1
-.05
-.24
-.22
-.2-.1
8-.1
6
.2.2
5.3
.35
-.05
0.0
5
0.0
5.1
-.02
0.0
2.0
4.0
6
.02
.04
.06
.08
.04
.06
.08
.1
-.06
-.04
-.02
1995 2000 2005 2010 1995 2000 2005 2010 1995 2000 2005 2010
1995 2000 2005 2010 1995 2000 2005 2010 1995 2000 2005 2010
Austria China Germany
Netherlands Sweden United States
CA to GDP Forward Participation, relative to RoW
CA
to G
DP
year
BGGT GVC Participation and Imbalances March 31, 2016 8 / 35
This paperGlobal Imbalances and Competitiveness through Integration
Starting point: An empirical relation between higher CA surpluses andhigher levels of GVCP
How can we start thinking about this in the context of a standardmacro model?
Integration in global value chains triggered by temporary (rel. to therest of the world)
increases in the efficiency of the usage of foreign inputsIceberg trade costsInterplay of sectoral technology shocks and differences in sectoralcomposition
ThenHigher levels of participation reflect (temporary) improvements incompetitivenessIn the presence of a precautionary savings motive, additional incomewill be partly saved
BGGT GVC Participation and Imbalances March 31, 2016 9 / 35
This paperGlobal Imbalances and Competitiveness through Integration
Starting point: An empirical relation between higher CA surpluses andhigher levels of GVCP
How can we start thinking about this in the context of a standardmacro model?
Integration in global value chains triggered by temporary (rel. to therest of the world)
increases in the efficiency of the usage of foreign inputsIceberg trade costsInterplay of sectoral technology shocks and differences in sectoralcomposition
ThenHigher levels of participation reflect (temporary) improvements incompetitivenessIn the presence of a precautionary savings motive, additional incomewill be partly saved
BGGT GVC Participation and Imbalances March 31, 2016 9 / 35
This paperGlobal Imbalances and Competitiveness through Integration
Starting point: An empirical relation between higher CA surpluses andhigher levels of GVCP
How can we start thinking about this in the context of a standardmacro model?
Integration in global value chains triggered by temporary (rel. to therest of the world)
increases in the efficiency of the usage of foreign inputsIceberg trade costsInterplay of sectoral technology shocks and differences in sectoralcomposition
ThenHigher levels of participation reflect (temporary) improvements incompetitivenessIn the presence of a precautionary savings motive, additional incomewill be partly saved
BGGT GVC Participation and Imbalances March 31, 2016 9 / 35
1 Empirical Evidence
2 Model
3 Quantitative Exercises
4 Conclusion
BGGT GVC Participation and Imbalances March 31, 2016 10 / 35
Empirical Evidence
Documenting Participation IData sources
World Input Output Database for participation measures
Global input output linkages on an annual basis from 1995 to 2011
Sufficient to calculate our measures of interest on a country level
BGGT GVC Participation and Imbalances March 31, 2016 11 / 35
Empirical Evidence
Documenting Participation IIMeasures
In the baseline, construct measure of both forward and backwardparticipation in Global Value Chains
Backward participation: Gross intermediate imports to gross output
BPi =IMi
Xi, (1)
Forward participation: Gross intermediate exports to gross output
FPi =IXi
Xi(2)
Crude measures of a country’s upstream and downstream position
Importantly, measure against the RoW:
avoid ”logical fallacy” of postulating linear relationship
BGGT GVC Participation and Imbalances March 31, 2016 12 / 35
Empirical Evidence
Documenting Participation IIMeasures
In the baseline, construct measure of both forward and backwardparticipation in Global Value Chains
Backward participation: Gross intermediate imports to gross output
BPi =IMi
Xi, (1)
Forward participation: Gross intermediate exports to gross output
FPi =IXi
Xi(2)
Crude measures of a country’s upstream and downstream position
Importantly, measure against the RoW:
avoid ”logical fallacy” of postulating linear relationship
BGGT GVC Participation and Imbalances March 31, 2016 12 / 35
Empirical Evidence
Documenting Participation IIIEvolution of the Cross-Country Average of Backward and Forward Participation from1995 to 2011
.12
.13
.14
.15
.16
For
war
d pa
rtic
ipat
ion
.08
.09
.1.1
1.1
2B
ackw
ard
part
icip
atio
n
1995 2000 2005 2010year
Backward participation Forward participation
Note: The figure presents the evolution of the cross-country average of the measure of backward and forward participation as
defined in (1) and (2) for all countries that enter our regression analysis.BGGT GVC Participation and Imbalances March 31, 2016 13 / 35
Empirical Evidence
Documenting Participation IVBackward vs Forward Participation 2005)
0.2
.4.6
.8Fo
rwar
d pa
rtici
patio
n
0 .1 .2 .3 .4Backward participation
BGGT GVC Participation and Imbalances March 31, 2016 14 / 35
Empirical Evidence
Documenting Participation VRelationship to other measures
Table: Correlation between Baseline Measure of Backward Participation andAlternative Measures of Backward Participation
count b
VAX 456 -0.970VAX (Johnson, 2014) 398 -0.916Foreign value added (OECD) 456 0.937
BGGT GVC Participation and Imbalances March 31, 2016 15 / 35
Empirical Evidence
Empirical FrameworkA large set of controls
Goal is to establish the empirical relevance of GVC participation forthe CA against a large set of controls
Embed measures in a reduced form specification using the IMF’s EBAframework:
cait = α + xitβ + δgvcit + uit (3)
Variables measured relative to the rest of the world
xit : Explanatory variables include amongst others:
oil balance, output per worker, demographics, capital controls, growth,terms of trade, output gap, dummies for financial centers, measures ofinstitutional strength
BGGT GVC Participation and Imbalances March 31, 2016 16 / 35
Empirical Evidence
Empirical FrameworkA large set of controls
Goal is to establish the empirical relevance of GVC participation forthe CA against a large set of controls
Embed measures in a reduced form specification using the IMF’s EBAframework:
cait = α + xitβ + δgvcit + uit (3)
Variables measured relative to the rest of the world
xit : Explanatory variables include amongst others:
oil balance, output per worker, demographics, capital controls, growth,terms of trade, output gap, dummies for financial centers, measures ofinstitutional strength
BGGT GVC Participation and Imbalances March 31, 2016 16 / 35
Empirical Evidence
Empirical ResultsGlobal Value Chains and the Current Account
Baseline VAX FVA/IVA WIOD sample Fixed Effects Pre-2008Backward Participation 0.17∗∗∗ 0.11∗ 0.25∗∗∗ 0.18∗∗∗
Forward Participation 0.04∗∗ 0.03∗∗ 0.05∗∗∗ 0.13∗∗∗ 0.04∗∗
VAX −0.12∗∗∗
Foreign value added 0.07∗∗
Indirect value added 0.08∗
Observations 456 456 456 553 553 340
R2 0.40 0.41 0.39 0.42 0.42 0.47Number of countries 29 29 29 38 29 29
Robust standard errors.+ p < 0.2, ∗ p < 0.1, ∗∗ p < 0.05, ∗∗∗ p < 0.01
BGGT GVC Participation and Imbalances March 31, 2016 17 / 35
Empirical Evidence
Empirical ResultsImprovement of fit - 2007
-.2-.1
0.1
.2.3
Perc
enta
ge R
educ
tion
in R
esid
ual
Austria
China
Finland
German
y
Netherl
ands
Sweden
United
States
BGGT GVC Participation and Imbalances March 31, 2016 18 / 35
Model
ModelMotivation
Hypothesis: Global value chain participation positively affects thecurrent account
Now: Take a first step towards understanding this joint pattern
Purpose: Flesh out key ingredients to rationalize observed patterns ina standard framework
BGGT GVC Participation and Imbalances March 31, 2016 19 / 35
Model
ModelOutline
Want to write a model where GVCP and current account imbalancescan potentially comove as in the data
Write down the simplest open economy model which
features trade in final and intermediate goodsallows a country’s current account balance and its position in the valuechain to endogenously respond to the same underlying shock
Key ingredients
Input-augmenting shocks for intermediatesIncomplete MarketsHome bias in consumption (and production)
BGGT GVC Participation and Imbalances March 31, 2016 20 / 35
Model
ModelOutline
Want to write a model where GVCP and current account imbalancescan potentially comove as in the data
Write down the simplest open economy model which
features trade in final and intermediate goodsallows a country’s current account balance and its position in the valuechain to endogenously respond to the same underlying shock
Key ingredients
Input-augmenting shocks for intermediatesIncomplete MarketsHome bias in consumption (and production)
BGGT GVC Participation and Imbalances March 31, 2016 20 / 35
Model
ModelOutline
Want to write a model where GVCP and current account imbalancescan potentially comove as in the data
Write down the simplest open economy model which
features trade in final and intermediate goodsallows a country’s current account balance and its position in the valuechain to endogenously respond to the same underlying shock
Key ingredients
Input-augmenting shocks for intermediatesIncomplete MarketsHome bias in consumption (and production)
BGGT GVC Participation and Imbalances March 31, 2016 20 / 35
Model
Setup and Technology
2 countries, H and F = RoW , one sector producing a tradable goodused as final good in consumption as well as intermediate input inproduction
Perfectly competitive markets with production technology in countryi ∈ {H,F} given by:
xi = Ai
[α1−η lηi + (1− α)1−ηMi (xii , xji , τi )
η]1/η , (4)
11−η : Elasticity of substitution between factors and inputs
Mi =(ω1−φi (xii )
φ + (1− ωi )1−φ (τixji )
φ)1/φ
(5)
BGGT GVC Participation and Imbalances March 31, 2016 21 / 35
Model
Setup and Technology
2 countries, H and F = RoW , one sector producing a tradable goodused as final good in consumption as well as intermediate input inproduction
Perfectly competitive markets with production technology in countryi ∈ {H,F} given by:
xi = Ai
[α1−η lηi + (1− α)1−ηMi (xii , xji , τi )
η]1/η , (4)
11−η : Elasticity of substitution between factors and inputs
Mi =(ω1−φi (xii )
φ + (1− ωi )1−φ (τixji )
φ)1/φ
(5)
BGGT GVC Participation and Imbalances March 31, 2016 21 / 35
Model
Setup and Technology
2 countries, H and F = RoW , one sector producing a tradable goodused as final good in consumption as well as intermediate input inproduction
Perfectly competitive markets with production technology in countryi ∈ {H,F} given by:
xi = Ai
[α1−η lηi + (1− α)1−ηMi (xii , xji , τi )
η]1/η , (4)
11−η : Elasticity of substitution between factors and inputs
Mi =(ω1−φi (xii )
φ + (1− ωi )1−φ (τixji )
φ)1/φ
(5)
BGGT GVC Participation and Imbalances March 31, 2016 21 / 35
Model
Input-Augmenting ShocksτH and τF
Mi =(ω1−φi (xii )
φ + (1− ωi )1−φ (τixji )
φ)1/φ
We explore two types of shocks:
τH : A shock affecting backward participationτF : A shock affecting forward participation
Note that these are not symmetric shocks
BGGT GVC Participation and Imbalances March 31, 2016 22 / 35
Model
Households
Denoting histories by st ∈ Σ, households in i choose asset holdingsand consumption to maximize expected life-time utility:
E0
[ ∞∑t=0
βtu (ci (t))
]=∞∑t=0
βt∑st
π(st)u(ci(st)), (6)
u(c) =1
1− σc1−σ
Consumption is over both domestic and foreign goods:
ci(st)
=(νi
1−ψcψii + 1− νi 1−ψcψji)1/ψ
, (7)
νi : Governs home-bias in consumption1
1−ψ : Elasticity of substitution between consumption goods
BGGT GVC Participation and Imbalances March 31, 2016 23 / 35
Model
Budget Constraint and Financial Markets
Households in i supply labor Li at wage wi
A one-period bond is traded at international financial markets at priceQ (st)
The budget constraint in country i then reads:
∑j∈N
p(s t)cji(s t)
+ Q(s t)bi (s t) = wi
(s t)Li + bi
(s t−1
)(∑j∈N
pj(s t) Lj
LW
)(8)
Denomination is for symmetry
BGGT GVC Participation and Imbalances March 31, 2016 24 / 35
Model
Current Account and GVC measures
bi coincides with a country’s net foreign asset (NFA) holdings andthus CA is given by:
cai(st)
= bi(st)− bi
(st−1
). (9)
Market clearing in asset markets requires that for all st :∑i∈{H,F}
bi(st)
= 0 (10)
All measures of GCV participation that we consider can bestraightforwardly calculated from the model
BGGT GVC Participation and Imbalances March 31, 2016 25 / 35
Model
Equilibrium
Definition
A competitive equilibrium, for the economy with initial bond holdings{bH0 , b
F0
}, is a collection of prices{
pH(st), pF
(st),wH
(st),wF
(st), r(st)}
st∈Σ
and allocations
{cii(st), cji(st), xji(st), xii(st), bi(st−1
)}i ,j∈{H,F},st∈Σ
such that households and firms, taking those prices as given, solve theirrespective maximization problems and markets clear.
BGGT GVC Participation and Imbalances March 31, 2016 26 / 35
Quantitative Exercises
Quantitative ExplorationTwo Exercises
We calibrate the model to the ”representative” country in our sample
We ask the following questions:1 How do macro variables of interest respond to shocks driving forward
and backward participation?2 Can the model replicate the relation between participation and current
account imbalances?
BGGT GVC Participation and Imbalances March 31, 2016 27 / 35
Quantitative Exercises
CalibrationShocks and parameter choices
Specify shocks as autoregressive processes:
log τH(st)
= ρτH log τH(st−1)
)+ ετH
(st)
(11)
log τF(st)
= ρτF log τF(st−1)
)+ ετF
(st)
(12)
logAi
(st)
= log ρAAi
(st−1)
)+ εA
(st)
(13)
Innovations are jointly normal with relative standard deviationscalibrated to match relative standard deviation of participationmeasures
Other parameters are calibrated to match WIOD moments in steadystate and/or are taken from the literature
BGGT GVC Participation and Imbalances March 31, 2016 28 / 35
Quantitative Exercises
CalibrationA representative economy in the WIOD sample
PreferencesDiscount Factor β 0.96EoS 1
1−ψ 1.5
Curvature σ 2Home Bias νH 0.86TechnologyEoS Intermediates 1
1−φ 1.5
Labor share α 0.5EoS Factors Inputs 1
1−η 1.2
Home Bias ωH 0.75Others
Relative Country Size Li/LW 1/67
Std. dev. of Backward Shock σετH 0.025
Std. dev. of Forward Shock σετF 0.055
Std. dev. of Aggregate Shock σεA 0.01Shock persistence ρ 0.9Correl. of Volatility Shocks 0
BGGT GVC Participation and Imbalances March 31, 2016 29 / 35
Quantitative Exercises
Computation
Decision rules are computed using third order approximation methods
Ensures that equilibrium bond holdings are stationaryStrengthens precautionary savings motive
BGGT GVC Participation and Imbalances March 31, 2016 30 / 35
Quantitative Exercises
Calibration ResultsImpulse Responses to a Domestic Shock τH
2 4 6 8 10
0
0.005
0.01Output
2 4 6 8 10
0
2
4
6×10
-3 Current Account
2 4 6 8 10
0
2
4
6×10
-3 Backward Part.
2 4 6 8 10
0
2
4
6×10
-3 Forward Part.
2 4 6 8 10
0
0.5
1×10
-4 Bond Price
2 4 6 8 10
-6
-4
-2
0×10
-3 Terms of Trade
2 4 6 8 10
0
0.01
0.02
Real Wage Home
2 4 6 8 10
0
0.01
0.02
Real Wage Foreign
BGGT GVC Participation and Imbalances March 31, 2016 31 / 35
Quantitative Exercises
Calibration ResultsImpulse Responses to a Foreign Shock τF
2 4 6 8 10
0
0.005
0.01Output
2 4 6 8 10
0
2
4
6×10
-3 Current Account
2 4 6 8 10
0
5
10×10
-3 Backward Part.
2 4 6 8 10
0
5
10×10
-3 Forward Part.
2 4 6 8 10
-1
-0.5
0×10
-4 Bond Price
2 4 6 8 10
0.5
1
1.5
2×10
-3 Terms of Trade
2 4 6 8 10
0
0.5
1
×10-3 Real Wage Home
2 4 6 8 10
0
0.5
1
×10-3 Real Wage Foreign
BGGT GVC Participation and Imbalances March 31, 2016 32 / 35
Quantitative Exercises
The importance of GVC shocksSimulating the WIOD sample
1 40 simulations of two country model for 16 years under baselinecalibration
2 Innovations hitting the RoW remain the same across 40 simulationsof the two country model
3 For each simulation, compute participation relative to the RoW
4 Drop RoW, leaving a time series for 40 artificial countries, each facingthe same partner
5 Use artificial dataset to regress the current account on baselineparticipation measures
BGGT GVC Participation and Imbalances March 31, 2016 33 / 35
Quantitative Exercises
Quantitative ExerciseResults
Data Model
Participation Statistics GVC shocks No GVC shocks
σ(fw)/σ(bw) 2.24 2.24 0.9σfw/σ(ca) 2.31 2.31 0.7Regression Coefficients
δFW 0.05∗ 0.15∗∗ 0.01
δBW 0.11∗∗∗ 0.41∗∗ −0.02
BGGT GVC Participation and Imbalances March 31, 2016 34 / 35
Conclusion
Conclusion
We connect two major developments in the world economy
Asked to which degree a standard IRBC framework can help shedlight on the data
More work needed to establish (i) existence and (ii) quantitativerelevance of proposed channels
BGGT GVC Participation and Imbalances March 31, 2016 35 / 35
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