In a world economy characterized by the fragmentation of production processes across different countries through global value chains (GVCs), misaligned or redundant regulations can become a key source of transaction costs. For supply chains to work efficiently, inputs need to be sourced expediently and reliably across multiple markets. Any delays or frictions from diverse domestic standards or inspection processes can generate disruptions that reverberate across an entire regional or global production network. This results in accumulated transactions costs. It adversely affects not only the parent company but a range of other businesses in upstream and downstream activities, particularly small and medium-sized enterprises (SMEs). Ultimately, the costs also affect consumers through higher prices for final goods, reducing real purchasing power and overall living standards.
In addition to and interlinked with trade, the operation of supply chains invariably entails foreign direct investment (FDI) by multinational enterprises (MNEs) across the various countries where the different segments of an integrated production process are located. Since investment is by definition a behind-the-border transaction, the quality and predictability of domestic regulations greatly affect investment decisions and overall market access. Given that MNEs establish manufacturing affiliates across multiple markets and regions, the convergence of regulatory processes across countries reduces search and transaction costs, increasing efficiency. Improving regulatory frameworks can therefore help countries become more competitive in attracting “foreign factories” linked to GVCs, bringing important employment opportunities and associated spillover effects.
Overall, the increased awareness of the interdependency between trade and FDI brought about by GVCs implies that transaction costs for divergent or opaque regulatory measures do not just affect trade flows but have important effects on investment as well, particularly FDI linked to GVCs. In this context, GVCs heighten the importance of reducing transaction costs from domestic regulations, without compromising the achievement of legitimate public policy goals. Generally, trade and FDI costs from domestic regulation stem from two factors: how restrictive regulations are and the extent to which they differ across the markets in question. This paper focuses on the latter, discussing the benefits of and avenues for promoting regulatory convergence from a GVC lens.
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