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This chapter presents background that will provide context for the rest of the report, including key concepts and frameworks, recent trends in the emergence of production sharing, and a discussion on the potential benefits and risks of joining global supply chains.

As mentioned in the previous chapter, the concept of international supply chain is typically understood as a group of firms in different countries that work together—from the design to the distribution of a product—under the coordination of a lead firm that seeks to minimize total system costs. Unfortunately, very few existing trade or foreign direct investment databases provide enough information to verify that the cross-border transactions that economists observe conform to this definition. Therefore, short of working with case studies, empirical research in this area has relied primarily on proxies to measure value-chain participation.

Building on the work of Jones and Kierzkowski (1990), economists have been writing models that describe how firms are increasingly fragmenting production processes into various stages or tasks and moving them to more advantageous locations (e.g., Deardorff, 2001a, 2001b; Findlay & Jones, 2001; Grossman & Rossi-Hansberg, 2008; Jones & Kierzkowski, 2000, 2001). Most of the models in this literature draw on findings from an earlier literature on FDI, namely that firms will fragment production or tasks across different countries to arbitrage international differences in factor prices (Helpman, 1984; Helpman & Krugman, 1985). The rationale behind most models of fragmentation can be stated in simple terms: in traditional production processes, inputs are organized and combined to generate final outputs in the same location. Where there are many inputs, coordination is normally necessary and proximity helps to lower the costs of coordination and transportation. But if firms could separate the production process into different production blocks and relocate them in places with lower factor prices, the total costs of production could be further reduced. Therefore firms will unbundle their production processes, as long as the resulting reduction in production costs would more than compensate for the additional costs of coordinating remotely located production blocks and moving these production blocks around.

The previous chapter examined factors affecting global value chain participation that are mostly external to the firm, such as the role of a country’s transport infrastructure or the quality of its contracting institutions. Now we turn to determinants of GVC accession that are specific to the firms themselves, such as skills and capabilities. The theme of this chapter is that participation in international production networks typically demands skills and capabilities that often exceed levels found in firms that only serve the domestic market. While firms are responsible for the development of their own capacities, they also face constraints in attaining these capacities that include lack of information and coordination. In this chapter we discuss policy options for reducing these constraints.

Terms such as global value chains, globalization of production, and slicing the value added chain have emerged in recent years to describe the co-participation of countries in the design, production, and distribution of a good or service. Some may argue that beyond the semantics and the sometimes catchy terminology, there is not much LAC can learn about policy issues on this topic; after all, the region has been providing raw inputs and natural resource intensive goods to other countries for decades.