New dimensions of labour division in economically integrated Europe. The role of global value chains

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1 New dimensions of labour division in economically integrated Europe. The role of global value chains Maciej Grodzicki, MA, Jagiellonian University Tomasz Geodecki, PhD, Cracow University of Economics 1 Abstract In this paper we aim to investigate the core-periphery relations within the enlarged European Union. Firstly, we identify the groups of core and periphery countries in Europe on the basis of cluster analysis, and then proceed to describe them in the three dimensions of peripherality: position in labour division, connectedness, and development level. Secondly, we assess the involvement of European Union s core and peripheral countries in the global value chains of manufacturing production in the period We analyse how the position of European countries in the value chains has evolved throughout the period under study. On that basis conclusions are drawn regarding the competitiveness model of the two regions: Southern and Eastern Europe, in comparison to the Core European countries. We also try to appraise the consequences of the EU enlargement to the East, relative to the economic situation in the South. We hypothesize that Southern European countries have lost a significant part of their competitive position in the role of suppliers and assemblers for the European-core economies, due to the EU enlargement in the easterly direction. We also try to assess whether the theory of dependent development with the division of economies into economic centre and peripheral countries effectively accounts for the trajectories and patterns of economic growth of Eastern and Southern European Member States. Contrary to the traditional dependency theory, those countries boast a relatively good position in terms of GDP per capita, as compared to the rest of the world, while their economic function extends well beyond that of the raw-material suppliers. However, de-industrialisation processes in the EU-15 and stagnation in the South prompts us to raise a question on the division of the benefits from growing interdependence of the European economy. Our research is grounded well within the theoretical framework of global value chains and production fragmentation (Gereffi 2006; Baldwin 2009). We also draw inspiration from the debate on the varieties of capitalism in Europe (Bruszt, Greskovits 2009; Nölke, Vliegenthart 2009), and on the consequences of economic integration (Marques 2008). Our research methods involve predominantly statistical and econometric techniques. We conduct a quantitative description of the involvement of EU economies in the global value chains (GVCs), making use of World Input-Output Database. We calculate several measures (based on value 1 Work on this paper has partly been financed out of the Project: Consolidation of public governance theory in the research on public policy: a critical perspective, conducted by the Cracow University of Economics, Faculty of Economics and International Relations, and co-financed by the National Centre for Science, in pursuance of the contract No. DEC-2012/07/B/HS4/

2 added flows) regarding: extent of involvement in GVC; relative comparative advantages; labour productivity; GVC position; and dependence on major economic partners. Key words: international labour division, global value chain, input-output analyses, Central and Eastern Europe, Southern Europe, core and periphery JEL Classification: F60 Economic Impacts of Globalization: General; O47 Measurement of Economic Growth; Aggregate Productivity; Cross-Country Output Convergence; O57 Comparative Studies of Countries. I. Introduction We have grown accustomed to calling in public discourse the Southern and Central and Eastern Europe the peripheries, whilst regarding the North of Europe as the core. In the colloquial usage, those terms refer mainly to the differences in the actual level of economic development between respective regions (Barry 2004). However, in economics they boast much deeper connotations, since they have been widely used in the dependency theories, as well as in contemporary New Economic Geography. In this respect peripherality refers to a position in global labour division, and to its connectedness with global economy. Therefore, primary aim of our research consists in investigating core-periphery relations within the enlarged European Union. We identify the true groups of core and periphery countries in Europe in the three dimensions: position in labour division, connectedness, and development level. However, we also point out that the nature of peripherality has changed over recent decades due to dynamic integration of low- and middle-income economies in global production networks. Hence, the secondary objective is to assess the position of European economies in global value chains. The theoretical foundations of this part are anchored in the approach proposed by global value chains and fragmentation of production (Gereffi 2006; Jones & Kierzkowski 2005; Baldwin 2006; Milberg & Winkler 2013), which tries to account for contemporary phenomena within international economics, and has developed specifically for this purpose the new theoretical categories and research techniques. Finally, we would like to compare the evolving situation of the two purportedly peripheral regions: the South and the Central-East of Europe. Some authors argued that Eastern Enlargement of the EU posed a threat to competitiveness of Southern Europe (Marques 2002; Barry 2004). We are going to establish, whilst making use of the available data for the period up to 2011, whether those assertions have any grounds. In the first empirical part, we refer to the theory of core-periphery international relations and undertake a cluster analysis in order to verify whether the core of the European Union and its - 2 -

3 peripheries if there can actually be identified. We make use of trade and FDI variables to describe the level of openness of the European economies, as well as the select data on technological advancement and labour costs to verify, whether there is a visible labour division between them, and the patterns of specialization based on technological advancement. In the second part of the empirical analysis we offer a detailed description of the involvement of both Southern and Central and Eastern Europe, as well as Western core, in global value chains of manufacturing the finished goods. It is based on the observation of international value added flows, and on making use of specific techniques, based on the input-output tables. It facilitates investigating a new dimension of core-periphery relations, stemming from participation in the manufacturing networks, as well as allows to draw innovative conclusions on the emerging economic landscape in Europe. II. Theoretical and empirical insights into the core periphery international relations The core-periphery relations are the traditional subject of interest of industrial geography. In the simple theoretical model of P. Krugman (1991) the manufacturers are concentrated in some regions, because the transportation costs happen to be low enough there to let the reasons of location prevail in particular localities. Besides, there is the economy of scale to consider, immobility of agricultural workers, and mobility of the industrial ones. The rest of regions remain agricultural in character. Hence, the core periphery relations emerge. When the transportation costs run high, a symmetric regional pattern of production tends to appear instead. Application of this model to the international relations is based on the different theoretical approaches. Smith and White (1992) distinguish three different approaches, so as to indicate diverse mechanisms and a variety of conclusions on the outcome of relations between the countries: neoclassical economic perspectives based on comparative advantage, international relations theories focused on geopolitics, and world-system approaches emphasising inequality of international exchange (Smith, White 1992). Also Barry (2004) demonstrates that there are actually three meanings of peripherality presently encountered in economic discourse: (1) the one related to historical division of labour and the economic structure of countries, (2) the geographical one, related to the distance from the key markets, and (3) the colloquial one, closely related to what is termed economic backwardness. In line with Bradshaw s view (1993), a theoretical perspective of dependent development has emerged since the 1960s, as a response to the core-periphery relations. The term was coined to illustrate the Singer-Prebisch thesis that underdeveloped countries experience the imposition of unequal exchanges by stronger, or more economically advanced countries, and become dependent on them in due course. Gereffi (1989) identifies four transnational economic linkages (TNELs) as the key elements of dependent development: foreign aid, foreign trade, foreign direct investments (FDI) and foreign loans. These different types of dependency prompted Gereffi to identify the state as the key - 3 -

4 player in the conversion of external linkages into national advantage. Economic success of the nation is thus based on historical timing, and an institutional ability to pursue the economic policy oriented towards national interests. Distinguishing the core and peripheries is often based upon the trade patterns: their structure and volume. For example, Smith and White (1992) use SITC classification of traded commodities at a two-digit level in order to identify the groups of countries specializing in trade in the goods that can be classified as the processed finished goods, and as the raw materials. One of the conclusions put forward in Smith s and White s analysis is that mobility between the respective blocks is attributable to the effect of new international division of labour, as manifested by e.g. massive relocation of the factories from the core countries to the peripheral ones in view of the low wage structure in the latter. This results in the transfer (relocation) of the industrial jobs, de-industrialisation process and higher unemployment in the core countries. One important finding of this work consists in that certain types of dependency may not in fact pose a barrier to being a member of the core, which is the case of Canada and its dependency on economic relations with the United States. Along with the trade liberalization under GATT agreements, the Washington Consensus promoted FDI liberalization in the 1990s. There have steadily been more and more FDI liberalizing and promoting changes in the respective national policies undertaken around the world having reached their maximum around There are two key reasons for the companies to get transformed into the multinationals that are indicated throughout the literature on the subject, resulting either in the adoption of a vertical, or a horizontal model of foreign investments. The first one, as described by Helpman (1984), is based upon the differences in factors endowment, due to which the prices of factors differ significantly. It leads to fragmentation of production, especially when transportation costs are negligible, since some of the stages of the production process can be undertaken abroad more economically. The consumers of finished goods are located predominantly in the home country, whereas the host country acts as an assembler. Onedirectional activities of MNCs are therefore encountered: corporate entities from a country richly endowed with capital tend to invest in a labour-abundant country, although investment in the opposite direction is scarce. The second one, a proximity-concentration model of a multinational company appears when the trade costs are appreciable and the factor endowments of home and host countries with regard to FDI are similar. Hence, this particular investment pattern seems to be a dominant one throughout the developed countries. This prompts a company to open a new plant manufacturing similar or identical products and using similar production methods, intended for the end-users in a host country. The key motive for acting in line with this strategy consists in accessing the host market and taking the advantage of the economy of scale. Consequently, internationalization in terms of similarities between the home and the host country takes place

5 A brief and clear summary of these models is offered by Buch et al. (2005), who analysed German FDIs. Empirical part of their work may be interesting as a point of departure for the analysis in the European context of FDI and their role as a development factor. They investigate the FDI relations between Germany and other countries: while the horizontal motives dominate in German FDI decisions, there are some regions where the cost factor is most significant, and where the most common type of investment prompted the emergence of the vertically integrated multinational companies. Especially the transition economies, e.g. The Czech Republic, Hungary, Poland and Slovakia were of key significance in this regard. As much as 13% of German foreign affiliates have invested in this region. Although in 2001 these transition economies had 4.2% share of total outward German investment, they accounted for 15.9% of the employment abroad. Apart from the question about labour productivity, it may indicate relative cheapness of their assets that are acquired, as well as that their economies are labour-abundant. Munich et al. (2014) research conducted within a group of German mother companies and their Czech daughters effectively corroborated rather vertical motives of investments in the CEECs. It would appear that the new Member States follow the trail blazed by the Southern European countries. In the 1980s Greece, Portugal and Spain boasted both similar economic characteristics and a potential to be a convenient location of FDI (Vazquez 2009), however in terms of GDP per head their income gap was lower than in the Eastern Europe. It follows, there is a higher likelihood that Southern Europe s investment relations with the core countries will be characterized by more balanced volumes of inflows and outflows. The lack of relocation of investment from the Southern countries, as observed by Vazquez (2009), seems to suggest that indeed access to their market could be a dominant motive for MNCs to invest their capital there. Recently, an important shift in strategies of multinational corporations has been observed (Milberg, Winkler 2013). MNCs began to focus their efforts on the core competencies. In practical terms this means that inside a company only the high added value generating parts of the value chain are being implemented. Activities bringing low economic rents, superfluous in terms of corporate profits, are contracted out (outsourced) to other entities (be that by market or quasi-hierarchical relations). This trend in business strategies manifests itself through a decreasing role of vertical FDI, and an emergence of global value chains - international networks of suppliers and subcontractors, coordinated by the leading companies. Theoretical developments and empirical studies (Munich et al. 2014, Buch et al. 2005) point out that particularly the manufacturing industry had an ulterior motive to have the production processes sliced in order to take advantage of the lower labour costs in the transition countries. Since it was not necessarily accompanied with geographical spread of MNC s subsidiaries, FDI flows and positions may no longer be deemed as adequately reflecting the international linkages and coreperiphery relations. Similar remarks should be stated about the analysis of international trade flows. In global value chains each country contributes only a minor share to total production of a particular final - 5 -

6 good, while dependence on imported intermediate inputs is high. In that way, observation of gross trade flows might lead to inadequate conclusions about country s contribution to international labour division, especially since differences between gross trade and value added flows are heterogeneous across countries and sectors (Johnson 2014). Above presented properties of global value chains incline to move beyond standard research techniques (based on trade and FDI data) and to look for new ones, which enable to observe specificity of economic activities performed in particular countries and their value-added contribution to global production. In addition to methodological challenges, the economic consequences of value chains fragmentation for the development of middle-income or semi-peripheral economies remain unclear. On the one hand, it provides such economies with many opportunities for entering the global production networks, and at the same time effectively gain access to foreign markets, know-how and capital (Baldwin 2006; 2009). Bruszt and Greskovits (2009) notice that globalization of value chains changes the nature of economic dependency and the way foreign-led development looks like. Firstly, they argue, dependence on foreign capital or technology is no longer a barrier for industrial upgrading and development at least to a certain level. Multinational corporations are willing to move even very complex tasks to middle-income countries, whereas the countries themselves are well capable of enhancing their human and physical capital. Secondly, peripheral countries do not have to sacrifice social inclusion in order to maintain their relationships with the economic core. On the contrary, part of their development model consists in increasing the living standards of domestic population. Thirdly, the above referenced positive aspects are being supported by governments of the core economies which undertake specific actions aimed at the integration of their semi-periphery. The third aspect of the new dependency mode is, according to the authors, the most relevant for the European Union. Accession to the EU is highly conditional, as it requires the candidate countries to appreciably adapt their institutions, as well as improve the level of economic development. Any such adaptation drive is supported by the affluent European core countries. Nonetheless, these actions remain very much in line with the vital interests of the core. However, since global competition has become much more intense nowadays, sustaining the pace of development requires constant industrial upgrading and moving up in the value chains (Gereffi 2005). Furthermore, direction and pace of upgrading within the value chains to a large extent is subject to the discretionary decisions made by multinational corporations. Relations in the GVCs are often asymmetrical, while MNCs are often in a position to extract most of the economic rents and to squeeze out their subcontractors. Due to strategic reasons they also might not be willing to let their peripheral partners expand (Milberg, Winkler 2013). This observation is in line with the tradition of perceiving motives for outsourcing and offshoring in terms of the transaction costs theory which identifies the causes of this process as the rise in competition. As Grossman and Helpman (2002) claim, it boosts the number of potential suppliers - 6 -

7 and thus reduces the costs of searching for potential business partners. Market relationships between the parties are quite feasible, however, in the conditions of low asset specificity (Milberg, Winkler, 2013, 138). The higher the specificity, the higher the probability of hierarchical relations between the leading company and its subcontractors. According to Gereffi et al. (2005), this specificity depends on the three factors: complexity of information, overall capacity of the leading company to codify information and the know-how applied in transactions, and the capability of respective suppliers to meet the specific transaction requirements. In search of a better market position, the strategies in certain GVC companies and governments focus on enhancing these key factors. From the point of view of the developing countries, the benefits of specialization in the sectors of high value added and specific assets (as advanced technologies) would be ensured by the pursuit of efficient public policies towards the investors, as well as the pressure on developing specific competences and know-how (see also Gereffi et al. 2005, OECD 2013). Emergence of GVCs changes the traditional view of core-periphery divisions, due to several reasons. Firstly, nowadays even low-developed countries might be highly integrated and sustain intense economic relations with core countries. Flows of capital and of advanced manufacturing goods are often bi-directional. Secondly, integration within value chains might constitute a chance for peripheral countries to attain higher level of development. Nonetheless, such model of dependent development is believed to bring benefits only to a certain extent and at some point might be a barrier to catching-up core economies. Thirdly, thanks to value chain fragmentation, peripheral countries can be involved in production of even very complex and high-technology goods. However, their position in value chains is usually reduced to simple tasks, which do not generate economic rents. It means that specialization patterns (based on classification of goods or industries) are not necessarily a good indicator of country s position in international labour division. From this particular standpoint investigating the processes of value chain fragmentation as the drivers of vertical specialization at the country level and of transformation of core-periphery divisions may appear of particular interest. European context One of the world regions that has been subject to a dynamic integration with global production networks is Central and Eastern Europe. Several studies of both quantitative (Timmer et al. 2012; Grodzicki 2014; Lejour et al. 2014) and qualitative type (Kaminski, Ng 2005) demonstrate that the new EU Member States have steadily been increasing their participation in value chains of foreign enterprises. Predominant factor underpinning these processes is the expansion of multinational corporations, which found Eastern Europe very attractive for locating their plants or building the networks of suppliers (Radosevic, Sadowski 2004). Initially, CEE plants or enterprises played mainly minor functions in the value chains, concentrated on the assembly tasks or on supplying simple parts and components. Over time, their responsibilities have become much more complex, however, mostly - 7 -

8 thanks to high human capital assets (Baldone et al. 2001; Kaminsky, Ng 2005; Berend 2011; Fortwengel 2011). Those processes were certainly stimulated to a great extent by political integration of CEE countries with the EU and by the EU accession itself. It was also in line with most of the econometric ex ante assessments which projected mutual benefits for both the new and the old member countries (Baldwin et al. 1997; Marques 2008). However, long-term consequences of Eastern Enlargement are not unambiguous and they have been subject to an on-going economic debate. One of the questions is whether the new Member States will manage to pull themselves out of the position of dependency. Reinert and Kattel (2007) argue that asymmetrical model of integration is incompatible with full economic convergence. Although the old EU does support institutional change in the East, at the same time it benefits from free access to its markets and blocks structural economic change in CEE countries. They contend that successful moving from periphery to the core is possible only in the conditions of a gradual integration, with strong support offered by the state, as is the case in East Asia. Other authors (Radosevic 2003; Fortwengel 2011; Jacoby 2010) identify major barriers for industrial upgrading in CEEs elsewhere, i.e. in the fact that strategic decisions in production networks are still being made abroad in MNC s headquarters. Another issue which emerges, when assessing the consequences of EU enlargement, is the situation of Southern European economies. It is argued that most of the benefits will be shared between the two groups of countries: European North and East, whereas the South will ultimately lose out on the process due to appreciably lower competitiveness (Barry 2004; Marques 2002; 2008). Analyses from the early 2000 s demonstrated that Southern Europe would have to compete with the new Member States in several areas. Firstly, both groups of countries found their comparative advantages in the manufacturing and exports of similar, labour-intensive goods. Complete removal of trade barriers could benefit CEE which was more competitive in terms of costs in such industries as food processing or textiles. In the CEE, however, there were also early signs of switching comparative advantage to the manufacture of medium- and high-tech goods (Marques 2002). Secondly, one could expect FDI displacement to the East, also due to lower labour costs in this region. Thirdly, enlargement of the EU changed the rules of granting structural aid in the way certainly most disadvantageous for Greece, Portugal or Spain (Barry 2004). Finally, the Great Recession, which hit the South in the hardest way, might be another factor contributing to changing the core-peripheries relations in Europe, to the disadvantage of this particular region. In the meantime, one could expect the de-industrialisation of the Core-European countries as the globalisation processes. The peripheral countries should benefit from it as the production phases of value chains are being moved to low-wage economies and cause convergence of the real income (e.g. Smith and White 1992, Baldwin 2006). However the trend of de-industrialization hit not only the most advanced countries but also the middle-income ones which are running out of industrialization - 8 -

9 opportunities sooner and at lower levels of income compared to the experience of early industrializers (Rodrik 2015). As this is the source of both economic and social concerns because it affecs low-skilled employment and cause the democratic failure, the re-industrialisation is being put on political agenda of the European Commission (e.g. European Commission 2011). Research questions The research questions emerging after the theoretical and empirical review are as follows: 1. What are the actual economic divisions in Europe? Does economic data in the three dimensions of peripherality, as identified by Barry (2004), reflect the dominant view in public discourse on the lower position of Southern Europe and Central and Eastern Europe? 2. What has been the dynamics of core-periphery differences since economic transition in CEE in early 1990 s and how was it influenced by accession to the EU? 3. Have peripheral regions of Europe remained separated from global economy and do they, as typical periphery, specialize in the manufacture of resource-based goods? 4. What is the vis-à-vis position of the two so-called peripheral regions of Europe Southern and Central and Eastern? Do they compete against each other? And what might be the impact of Eastern Enlargement of the EU on the comparative advantages of the South? 5. Does the analysis in terms of GVC participation support the view generated through the application of traditional measures of international trade? 6. Do we witness the de-industrialization processes in Western Europe due to offshoring of the manufacturing production to the developing countries, as anticipated by some authors (Smith& White 1992, Baldwin 2012, OECD 2013)? III. Research methods 1. Cluster analysis In order to assess the core-periphery relations in the context of the EU enlargements after 2000 and the complex economic situation of the Southern Europe we have undertaken a cluster analysis. Our purpose was as follows: - to verify whether the South may be perceived as a single group of similar countries and whether it is actually peripheral - to identify the core European countries with which the Southern and Eastern European countries trade in order to verify whether such a relationship might have all the hallmarks of an unequal exchange - to establish the key characteristics of trade and investment relations in both European regions in terms of what they had looked like prior to and following the accession of the new Member States - 9 -

10 We have divided the variables used for identifying the clusters into the three groups, as shown in Table 1: Table 1. Description of indexes and variables used in cluster analysis Dimension of peripherality (Index in cluster analysis) Position (technological competitiveness versus labour cost competitiveness extent of FDI penetration of the economy) Extent (level) of integration with global economy Variables considered 1. Unit labour costs (labour income share in GDP) 2. Exports of high technology products (as % of total exports) 3. Logarithm of patent applications to the EPO per million of population 4. Net FDI in % of GDP 1. Sum of inward and outward FDI stocks as % of GDP 2. Openness of the economy (imports plus Data sources 1. ILO 2. The World Bank 3. Eurostat 4. UNCTAD 1. UNCTAD 2. Penn World Tables exports to GDP) Level of development 1. GDP per capita PPP 1. Eurostat Source: Authors own resources. We have converted the values of the variables in three time-points (1995, 2003, 2011) into the normalized data in order to obtain the indexes based upon the arithmetic mean of variables in each group. Due to the lack of comprehensive data for 1995, out of 27 EU countries in 2011 we have excluded Cyprus, Luxembourg and Malta. Euclidean distance (value ca. 2) and the Ward agglomeration method have been used in clustering. 2. Analysis of international value added flows The second stage of the empirical analysis has been based on the assessment of international value added flows with the aid of the world input-output tables, in conjunction with specific techniques, as described further below. Their main objective consisted in incorporating in our assessment the new dimension of economic relations between respective regions, stemming from the participation in international production networks. In particular, we: - compared the scale of involvement of CEE, SE and European Core in the global value chains - verified whether the services or industry had been the basis of GVC incomes and how it had changed over time - identified whether the goods had been manufactured for the domestic end- users, or in order to meet a foreign demand - verified whether CEECs, SE and EC had displayed similar specialization in traditional industries over time, or whether it had changed in favour of more modern industries which would imply more similar types of activities, and facilitate an emergence of more horizontal relations

11 Description of the research methods applied in the present paper focuses on the most vitally important issues. A detailed discussion of some of the key concepts may be found in the works of Koopman et al. (2010) and Timmer et al. (2012). All calculations are based on the World Input-Output Database (Timmer 2012) which presents the direct flows of gross output between countries and sectors for It comprises 40 countries (and Rest of the World as a separate unit), and 35 economic sectors. A following notation is used (Timmer et al. 2012): y i (s) gross output of sector i in country s; f i (s, t) final demand for goods of sector i in country s from the users from country t; m ij (s, t)- intermediate inputs from sector i in country s used in production in sector j in country t; S number of sectors, N number of countries. In the first step, on the basis of input-output tables a (SNxSN) matrix A is calculated, which contains the coefficients of direct intermediate inputs between country-sectors: a ij (s, t) = m ij (s, t) y j (t). (1) Product of each sector is distributed between the final demand of N countries and intermediate inputs of SN country-sectors: S j y i (s) = N m ij (s, t) t + N t f i (s, t). (2) On the basis of (1) and (2), we can put forward a following matrix equation: y = Ay + f, (3) where: y a (SNx1) vector of gross output of country-sectors; f a (SNx1) vector of final demand of country-sectors. After simple transformations of (3), we obtain the so-called Leontief-inverse matrix: y = (I A) 1 f = Lf, (4) where: L (I A) 1 is the Leontief-inverse matrix and I is an (SNxSN) identity matrix. The values of Leontief-inverse, l ij (s, t), tell us how many units of gross output of sector i in country s were needed, both directly and indirectly, to produce a unit of gross output of sector j in country t. Now, thanks to the pre- and post-multiplications of Leontief-inverse by proper matrices of inputs and outputs, we can obtain the information on the absolute value added flows between countrysectors. For this purpose, let us make two additional matrices: P an (SNxSN) diagonal matrix in which each diagonal element p i (s) is a ratio of value added to gross output in sector i in country s; D - an (SNxSN) diagonal matrix in which each diagonal element d i (s) is the value of final demand for products of sector i in country s. To investigate the role of foreign final demand, a separate matrix D(s) for each country is required which comprises the final demand from all countries, apart from the country s

12 After the calculation: V = PLD we receive an (SNxSN) matrix V, where v ij (s,t) tells us about the total value added of sector i in country s embodied in gross output of sector j in country t. Proper summations of columns or vectors of this matrix provide the required information on the global value flows. Analogous matrices can be calculated for GVC employment: E = P E LD, where: P E is an (SNxSN) diagonal matrix in which each diagonal element p Ei (s) is a ratio of employment (measured in number of persons engaged) to gross output in sector i in country s. The values of E, e ij (s,t) tell us about total employment in sector i in country s involved in producing the value for sector j in country t. The empirical part of the present paper consisted in calculating for the European countries and regions, for the period spanning , the following measures: 1. In order to obtain GVC Income of sector i in country s we multiplied matrices: v = Vu, where u is a (SNx1) vector with 1 in places related to manufacturing industries and 0 elsewhere. v i(s) tells us about the total value added of sector i in country s embodied in global manufacturing value chains. 2. GVC income of country s is a summation of GVC income of its all sectors and its interpretation is analogous: GVC(s) v (s) = S i v i(s). 3. The three measures were calculated that provided us with the information on the position of the country-sectors in the manufacturing of global value chains. They refer to the three important relations within the value chains backward linkages, forward linkages and the final demand linkages (as illustrated in Diagram 1): Diagram 1. Linkages in global value chains Source: Authors own resources

13 3.1. Ratio of imported value added embodied in gross export ICE. ICE i (s) = [ N t s S j v ij (s, t) ] y i (s). This measure indicates the extent of dependence of a country-sectors on the foreign suppliers Foreign final goods ratio FFG is a share of GVC income of a country-sector, due to final demand for goods of foreign origin: S i FFG j (s) = [ N t s v ij (s, t) ] GVC j (s). The higher the FFG, the higher the dependence of a country-sector on the foreign manufacturers recipients Dependence on the foreign demand FOR which is a proportion between the GVC income due to foreign final demand and total GVC income of a country. 4. On the basis of the information on the value added contribution of each country-sector in the manufacture of finished goods of every other country-sector, a detailed analysis of evolving patterns of specialization might be undertaken. It is based on the revealed comparative advantages (RCAs). To obtain RCAs, firstly, we calculated the absolute values of contribution of particular countries in other GVC in sectoral dimension: GVC j (s) = i t v ij (s, t) (Contribution of country s to global production of industry j); Secondly, we used those values to obtain the revealed comparative advantages: RCA_GVC(s, t) = GVC(s,t) GVC(,t) GVC(s) GVC. Apart from a simple comparison and interpretation of respective values for distinguished regions, an analysis of the structural similarities of both regions was conducted. It was based on the calculations of coefficients of structural similarity, as follows: ρ(i, j) = PearsonCorrelationCoefficient(RCA i ; RCA j ) Its values told us whether the two regions had been involved in similar or dissimilar global value chains and, hence, to what extent they had been competitive to each other. A coefficient value close to 1.0 would indicate a high similarity of specialization patterns, while the negative values would suggest that the regions had been dissimilar in terms of their revealed comparative advantages. S N IV. Empirical analysis 1. Results of cluster analysis a. Five clusters of European economies Five clusters of countries were allocated to the respective years. The outcomes of cluster analysis are shown in Table

14 Table 2. Clusters of countries and the values of the indexes of variables applied in the analysis country POSI- TION CON GDP GROUP POSI- TION CON GDP GROUP POSI- TION CON GDP GROUP POL ROM BGR LTU LVA EST SVK HUN CZE SVN ESP GRC PRT ITA AUT DEU DNK FIN FRA GBR SWE IRL NLD BEL Source: Authors own calculations When we make a reference to the year 2011 as indicative of the most current economic situation, we distinguish the five clusters of countries. Among the least developed countries in 2011 the two basic groups may be isolated: a group of the more developed ones boasting GDP at the level between 0 and -1 std. deviation from the mean, and the second group with its value below -1. Since the Eastern enlargement, the countries from the better-off group have improved their standing in terms of the technological variables, labour share in GDP and net FDI, whereas in the second group the respective indicators have deteriorated. In terms of the variables under study Italy s position has deteriorated (lower technological standing, smaller extent of connectedness and lower GDP level) becoming closely similar to the other Southern European Economies, i.e. Greece, Portugal and Spain in 2003 and That is what has prompted us to take Italy out of the core economies. As opposed to the Western and Eastern European

15 Countries, Southern Europe has remained much less integrated, to the point of celebrating, as it were, its relative separateness. A commonly shared feature within this group was the deteriorating connectedness in terms of the trade to GDP ratio. It should be noted at this juncture that it is a relative measure. Hence, an even closer integration of the Southern Europe s economies with the core ones was outdone by the intensity of trade and investment linkages, and hence much deeper integration, of Eastern European ones. Interestingly, Greece and Spain have become capital exporters, after 2000, boasting an outward FDI rather than an inward one. Portugal has remained an importer of capital (but much closer to the balance) and Italy has stayed as investor. Two groups of affluent countries have been identified: smaller open ones (Belgium, Ireland and the Netherlands) and the rest of Western and Northern Europe. The main difference between them was the actual level of their openness: the former group was strongly bound by the trade relations pursued with the other world economies (more than 1 or even 2 std deviations over the average. Western and Northern European economies boasted much more appealing position values and GDP indexes. Their companies pursued investments in the other countries rather than being themselves the subjects of foreign purchases, as well as remained more frequent patent applicants and high tech exporters. This tangibly aided retaining better jobs in the core economies, and in paying steadily bigger share of value added to their workers (except Germany and Austria). Interestingly, in terms of trade and foreign investment activities (openness) until 2011, the Eastern European economies had become more open and closer connected than back in 1995, although the exact opposite (relatively weaker connections) was the case of the EU 15, except Germany, Austria and Belgium. This may lead us to believe that the main trade and investment partners of CEECs actually originated from these countries. The lack of detailed data of the main industries in which the MNCs remain active effectively precludes assessing the share of GVCs attributable to FDI flows. We do have, nevertheless, a sufficient body of data to make inferences on this issue in an indirect way by taking into account the data on FDI stocks, and by having GNI compared with the GDP index. Table 2a. Foreign direct investment and remuneration of national versus domestic factors of production in select European countries Country/ Region Inward FDI stock as percentage of GDP Outwards / inwards FDI stock GNI - GDP CEE-10 BGR 3% 31% 88% 0,23 0,01 0,03-1% 2% -3% CZE 13% 48% 56% 0,05 0,05 0,11 0% -3% -7% EST 15% 71% 75% 0,10 0,15 0,28 0% -5% -5% HUN 25% 58% 62% 0,02 0,07 0,28-3% -5% -5% LTU 5% 27% 33% 0,00 0,02 0,15 0% -2% -4% LVA 12% 29% 42% 0,38 0,03 0,07 1% 0% 1%

16 POL 6% 27% 39% 0,07 0,04 0,26-1% -1% -4% ROM 2% 21% 39% 0,15 0,02 0,02-1% -2% -1% SVK 7% 65% 54% 0,11 0,05 0,08 0% -5% -2% SVN 9% 22% 30% 0,28 0,37 0,52 1% -1% -1% SE-4 ESP 18% 38% 43% 0,33 0,65 1,04-1% -1% -2% GRC 8% 12% 10% 0,27 0,55 1,65 3% 0% -3% ITA 6% 12% 16% 1,63 1,07 1,46-2% -1% -1% PRT 16% 37% 47% 0,19 0,57 0,65 0% -1% -4% CORE-10 AUT 8% 23% 37% 0,60 0,97 1,24-1,6-1,0-0,7 BEL 40% 113% 183% 0,71 0,87 1,06 1,6 1,5 1,1 DEU 7% 16% 20% 1,62 2,11 2,03-0,9-0,8 2,3 DNK 13% 47% 43% 1,04 1,02 1,55-1,1-0,6 2,4 FIN 6% 31% 34% 1,77 1,51 1,50-3,3-0,8 0,3 FRA 15% 36% 35% 1,60 1,45 1,54-0,1 1,0 2,1 GBR 17% 34% 48% 1,53 1,94 1,43-0,9 1,3 1,3 IRL 65% 140% 129% 0,38 0,33 1,14-9,6-14,3-21,1 NLD 26% 85% 73% 1,49 1,21 1,61 1,5 1,1 0,3 SWE 26% 85% 73% 2,36 1,17 1,08-2,3 1,2 2,6 Source: Authors own calculations, based on Eurostat, OECD and UN data. When taking into account the indexes presented in Table 2a, especially the direction of investment flows, we might have sufficient grounds to believe that the interrelationships between the core and peripheral European economies might be to a greater extent elucidated by the factor proportion model where the main reason for pursuing investment consists in taking the advantage of the lower manufacturing costs rather than a proximity concentration model, whereby the main reason for investing consists is gaining access to a host country s market. The latter model is based on the similarity of production factors endowments, being corroborated by the two-directional flows of FDI. In turn, what may be observed in case of Eastern Europe is visible one-directional investment relations. 2. Results of GVC Analysis The second part of our empirical analyses consisted in a comprehensive description of involvement in the manufacturing global value chains of the three clusters of European countries: North-Western Core, Southern Europe and Central and Eastern Europe 2. Its main objective was to verify and supplement the results of cluster analysis. Whereas the previous studies focused predominantly upon the traditional dimensions of centre-periphery relations between the countries, we have decided to shift the focus of the investigation onto their modern characteristics stemming 2 The respective regions are defined as follows: Southern Europe: Italy, Greece, Spain, Portugal; Central and Eastern Europe: 10 new EU Member States; European Core: Austria, Belgium, Denmark, Finland, France, Germany, Ireland, Netherlands, Sweden, UK. Other European countries: Cyprus, Luxembourg, Malta

17 from the participation in GVCs. The respective regions are going to be compared in terms of their positions in GVCs, their patterns of specialization and main economic partners. a. GVC income and employment In Figure 1, GVC income per capita within respective regions in the period spanning is presented. It measures the total value added in the regions contributing to global manufacturing production, divided by their population, and may well serve as the indicator of absolute involvement in the GVCs. Figure 1. GVC income per capita in the clusters of European countries, USD CORE-10 SE-4 CEE Source: Authors own calculations, based on WIOD data. It prompts several observations. Firstly, participation of the European Core and Southern Europe in GVCs is much larger than the one of CEE. GVC income of the former groups in 2011 was ca. two-three times higher than in the CEE. Secondly, GVC income per capita in the regions was subject to different tendencies in time. In Southern Europe and in European Core it strongly fluctuated (around the ca and 5500 mark, respectively), with neither an upward, nor a downward trend. In result, the GVC income per capita in 2011 in these regions was at a very similar level to one reported in In CEE, however, a dynamic growth of GVC income was observed, but only after The income more than doubled until 2008, than it dropped by nearly 20% during the Economic Crisis, and started to recover in No such recovery following the Economic Crisis was manifest in Southern Europe, not until 2011, at least

18 Thirdly, GVC income per capita in the regions fluctuated in a similar manner. The periods of growth and decline/stability were almost the same, which may be indicative of the income from participation in global value chains being heavily impacted by global business cycles. More detailed information on absolute GVC income is comprised in Table A1 in the Appendix. European countries are very diverse in terms of their size and, in turn, their absolute participation in GVCs. Germany, France, United Kingdom in the Core, Poland in CEE, and Italy and Spain in SE are the manifestly outstanding economies in this respect. Countries varied also in terms of the growth rate in their GVC income. CEE as a whole grew at an average rate of 5.66% per year, whereas the growth rate in SE was very low 0.6%, and in the Core even lower slightly over 0%. Lithuania and Slovakia were the most dynamic economies in terms of their GVC income growth, while Slovenia and Bulgaria achieved the lowest growth rate within the CEE sample. Different dynamics of the two regions resulted in the changes of their shares in total European GVC income. Southern Europe managed to hold on to its share throughout, whereas Central and Eastern Europe increased its share by more than twice, effectively reaching almost the 10% mark. The European Core provides over two thirds of the GVC value added, yet its share has diminished since In the second step, the corresponding analyses are to be conducted for the employment related to the participation of respective countries and regions in the global value chains. In Figure 2, total employment attributable to the participation in GVCs in the three clusters of countries is shown. Figure 2. GVC employment, 1000 s of persons employed CEE-10 SE-4 CORE Note: the values for the European Core are indicated on the right-hand axis. Source: Authors own calculations, based on WIOD data

19 Its interpretation leads to the conclusions different from the ones based on GVC income. Although the cluster of core countries is again much larger than the two others (values on the right axis), out of the two peripheral regions it was the Central and Eastern Europe which boasted the higher values of GVC employment. Figures for all regions declined slightly throughout the period under study. This referred primarily to CEE in when the number of GVC workers in this region decreased by nearly 2 million. Combining those figures with the values of GVC income, some interesting conclusions on the economies of CEE and SE may be drawn. Much higher GVC income in SE in conjunction with the similar level of employment may suggest that the countries of Southern Europe are characterized by the much higher labour productivity than the Central and Eastern Europe countries. In the CEE impressive GVC income growth after 2002 took place without any significant changes to the employment structure, i.e. it was driven purely by the productivity enhancements. This said, the region still has some room for catching-up in productivity in the forthcoming years. Another inference is that prior to this date productivity growth was owed to a large extent to reductions in employment. Let us then move on to address the data on GVC employment in some more detail (Table A2 in the Appendix). In GVC employment declined in the entire European Union, by some 6.8% on average (altogether 3.5 million jobs were lost). This decline was relatively small in the Southern Europe and in the Core, but much higher in Central and Eastern Europe. There is a substantial diversity within GVC employment changes across the countries of all regions. Some small economies (the Baltics, Slovenia, Greece, Portugal, Denmark, Ireland), but also the United Kingdom, experienced the most significant drops in employment. Countries that managed to keep their GVC employment at a less stable level, or even to have it boosted were: Czech Republic, Hungary, Poland, Slovakia, Spain and Italy, Austria, Germany, and The Netherlands. The CEE region plays a very significant role within the GVC employment in Europe, still accounting for about a quarter of all GVC workers. Finally, one might inquire about the role of GVCs in the actual shaping of total production and employment within the respective economies. In Table 3, the respective shares in the income and employment that might be attributed to participation in GVCs are shown (expressed in total figures). It is remarkable that GVCs play a more important role in the CEE economies than in the SE and in European Core (approx. ¼ of the total vs. 1/5). Generally speaking, within all regions and within the EU as a whole, the GVC share in the income and employment is decreasing, which might be the result of an on-going tertiarization of economies. There are some countries in both regions (Latvia, Lithuania, Greece, United Kingdom), in which the GVC do not generate all that much income, nor indeed create so many new employment opportunities. On the other hand, the Czech Republic and Hungary, Italy are Germany are the cases where the role of GVC in the domestic economy is pretty high