Introduction

The relatively recent recognition of the importance of global value chains (GVCs) for the organization of production and international trade means that they are only now being integrated into the theory of international trade. Grossman and Rossi-Hansberg (2006a, 2006b, 2008) assert that the new wave of globalization requires a new theory of trade, because trade in intermediate goods and services – what the authors refer to as “trade in tasks” – is of a different nature than trade in final goods. Referring to Ricardo's famous example, Grossman and Rossi-Hansberg write that “it's not wine for cloth anymore.” In this chapter, we show that the structure and governance of GVCs call for quite a different account of international trade – with a change in the traditional thinking on the determinants of trade as well as a different connection between trade and growth and between trade and economic development – than that offered in the traditional theory.

The economics of GVCs has not been fully developed within the theory of international trade. Economists analyzing offshoring, with a few exceptions, have emphasized the traditional gains from trade, focusing on static efficiency effects of offshoring and assuming full employment and balanced trade in a trade model driven by relative factor endowments or different technologies. The welfare analysis based on Pareto optimality has presumed that adjustment costs for factors displaced by offshoring are insignificant and that potential compensation of losers by the winners is adequate to establish the economic case for offshoring. Regarding lead firm behavior in GVCs, transactions costs theory has placed great emphasis on the costs of contracting with suppliers as the determinant of the decision to “make” or “buy” inputs.