Functional diversification and GVC exposure: Evidence and implications

Abstract

This work examines the links between the diversification of economies across value chain functions and their exposure to disruptions in global value chains (GVCs). We empirically model this relationship by combining new indicators of GVC exposure with an FDI-based measure of functional diversification for a wide range of countries and industries in 2003–2018. Our results show that greater functional diversification lowers GVC exposure on average, at both the country and industry levels. However, this negative relationship holds for Scale-intensive and Supplier-dominated industries, not for Science-based and Specialized supplier industries. This seems consistent with the greater need for the latter types of industries to rely on global sourcing of specific components and knowledge assets located abroad. Our findings are robust to the inclusion of several control factors and confirmed by System-GMM model estimates accounting for potential endogeneity concerns. Accordingly, industrial policies aimed at expanding the array of value chain functions should be complemented by a careful selection of global partners for the supply of key inputs and tailored to the specific needs of different industries.