UIBE Global Value Chain Indexes System – Concept Note

Research Center for Global Value Chains

July, 2017

This note documents the underlying concept of UIBE Global Value Chain index system,
describes the decomposition of value-added and final goods production at country-sector
level as well as gross trade accounting at bilateral-sector level. These decompositions are
the economics and statistics foundation of the UIBE GVC index system storing in various
data files that are listed in a separate technical note.

There are 4 sections in this conceptual note. We outline the decomposition of GDP by
industry, final product production at country-sector level and gross bilateral trade at sector
level in each section and list major components of these decomposition and GVC indicators
generated from these decompositions.

The first and second sections follow Wang, Wei, Yu and Zhu (2017a) closely to identify
which parts of GDP generation and production of final goods and services are GVC
activities, which parts are domestic activities only, then define GVC indexes based on such
decomposition. The third section builds up trade in value-added related indicators from
gross bilateral trade accounting framework proposed by Koopman, Wang and Wei (2014)
and Wang, Wei and Zhu (2013). The fourth section define length of production and its
major segments according to Wang, Wei, Yu and Zhu (2017b).

I. Identifying which types of production are GVC activities and which are
not
The rise of GVCs has dramatically changed the world economy. But given the increasing
complexity and sophistication of cross-border production-sharing activities, the use of only
official trade and GDP statistics have not been able to reveal the significance and nature of
changes in the global business cycle over the past decades. An important reason is that
indicators based on official statistics cannot identify and distinguish which types of trade
and production are GVC activities and which types are not, thus resulting in the difficulty
of evaluating the relation between change in global trade and GDP growth.
GVCs depend on products and services that are used as inputs in production
1
processes that cross national borders, so the first major issue to be solved in GVC
measurement is dividing final and intermediate use in customs trade statistics. But
hundreds and thousands of products are classified by customs product codes (such as the
U.S. 10-digit Harmonized Tariff Schedule), and even within the 10-digit product groups,
the heterogeneity is tremendous. So properly identifying their final use is not easy.
Furthermore, supply chain trade or cross-border production-sharing measures in the
literature—such as “vertical specialization” (VS) proposed by Hummels, Ishii, and Yi
(2001) or “import to produce” (I2P) and “import to export” (I2E) proposed by Baldwin and
Lopez (2013)—are recursive concepts with pervasive double counting.
To overcome these difficulties in GVC measurement, “factor content” or “value-
added” trade is emerging as the mainstream measure of cross-border production-sharing
activities. Since production factors such as land, labor, and capital are relatively easy to
classify, production activities based on factor content embodied in various products can be
classified according to a uniform standard, which makes analytical work tractable. In an
era when traditional trade dominated international commerce, factors were less mobile
across countries, and factor content embodied in final products crossed national boarders
for consumption only. In today's world economy dominated by regional and global value
chains, factors such as FDI directly cross a national border, but a large portion of
production factors still do not cross national border directly, embedded instead in both final
and intermediate trade flows across national borders.
The production activities decomposition based on System of National Accounts
(SNA) standard underpinning UIBE GVC Index 1 and 2 is adopted from Wang, Wei, Yu
and Zhu (2017a). It classifies embedded factor content as GVC or non-GVC activities
based on whether they cross national borders for production or not. Value-added creation
is classified as GVC activities only when embedded factor content crosses national border
for production purposes. Domestic input-output coefficient matrix and import input-output
coefficient matrixes in an inter-country input–output (ICIO) table, including their local and
global Leontief inverse matrixes, are used to distinguish between domestic and foreign
factor content in various production activities.

2
 Without loss generality, let us consider a world economy with G countries and N
sectors. Its economic structure is represented by the following Inter-Country Input-Output
(ICIO) model in Table 1:

Table 1 General Inter-Country Input-Output table

Outputs Intermediate Use Final Demand

Total
1 2 ⋯ G 1 2 ⋯ G Output
Inputs
1 𝑍11 𝑍12 ⋯ 𝑍1𝑔 𝑌11 𝑌12 ⋯ 𝑌1𝑔 𝑋1

Intermediate 2 𝑍 21 𝑍 22 ⋯ 𝑍 2𝑔 𝑌 21 𝑌 22 ⋯ 𝑌 2𝑔 𝑋2
Inputs ⋮ ⋮ ⋮ ⋱ ⋮ ⋮ ⋮ ⋱ ⋮ ⋮
G 𝑍𝑔1 𝑍𝑔2 ⋯ 𝑍𝑔𝑔 𝑌𝑔1 𝑌𝑔2 ⋯ 𝑌𝑔𝑔 𝑋𝑔
Value-added 𝑉𝑎1 𝑉𝑎2 ⋯ 𝑉𝑎 𝑔
Total input (𝑋1 )′ (𝑋 2 )′ ⋯ (𝑋𝑔 )′

where Zsr is a N×N matrix of intermediate input flows that are produced in country s and
used in country r; Ysr is an N×1 vector giving final products produced in country s and
consumed in country r; Xs is also an N×1 vector giving gross outputs in country s; and VAs
denotes a 1×N vector of direct value added in country s. In this ICIO model, the input
coefficient matrix can be defined as 𝐴 = 𝑍𝑋̂ −1 , where 𝑋̂ denotes a diagonal matrix with
the output vector X in its diagonal. The value added coefficient vector can be defined as
𝑉 = 𝑉𝑎𝑋̂ −1 . Gross outputs X can be split into intermediate and final products, 𝐴𝑋 + 𝑌 =
𝑋. Rearranging terms, we can reach the classical Leontief (1936) equation, 𝑋 = 𝐵𝑌, where
𝐵 = (𝐼 − 𝐴)−1 is the well-known (global) Leontief inverse matrix.

The gross output production and use balance, or the row balance condition of the ICIO
table in Table 1 can be written as:

𝑋 = 𝐴𝑋 + 𝑌 = 𝐴𝐷 𝑋 + 𝑌 𝐷 + 𝐴𝐹 𝑋 + 𝑌 𝐹 = 𝐴𝐷 𝑋 + 𝑌 𝐷 + 𝐸 (1)

3
 𝐴11 0 ⋯ 0
Where 𝐴𝐷 = [ 0 𝐴22 ⋯ 0 ] is a GN×GN diagonal block matrix of domestic
⋮ ⋮ ⋱ ⋮
𝑔𝑔
0 0 ⋯ 𝐴
input coefficient, 𝐴𝐹 is a GN×GN off-diagonal block matrix of imported input coefficient,
𝐴𝐹 = 𝐴 − 𝐴𝐷 , 𝑌 = [∑𝐺𝑟 𝑌1𝑟 ∑𝐺𝑟 𝑌 2𝑟 ⋯ ∑𝐺𝑟 𝑌𝑔𝑟 ]′ is a GN×1 vector of final goods and
services production, 𝑌 𝐷 = [𝑌11 𝑌 22 ′
⋯ 𝑌𝑔𝑔 ] is a GN×1 vector of final goods and
service production for domestic consumption, 𝑌 𝐹 = 𝑌 − 𝑌 𝐷 is a GN×1 vector of final
products exports, 𝐸 = [∑𝐺𝑟≠1 𝐸1𝑟 ∑𝐺𝑟≠2 𝐸 2𝑟 ⋯ ∑𝐺𝑟≠𝑔 𝐸 𝑔𝑟 ]′ is a GN×1 vector of gross
exports, ′denotes transpose operation.

Rearranging equation (1) yields

𝑋 = (𝐼 − 𝐴𝐷 )−1 𝑌 𝐷 + (𝐼 − 𝐴𝐷 )−1 𝐸 = 𝐿𝑌 𝐷 + 𝐿𝐸

= 𝐿𝑌 𝐷 + 𝐿𝑌 𝐹 + 𝐿𝐴𝐹 𝑋 (2)

where L = (𝐼 − 𝐴D )−1is defined as local Leontief inverse, a GN by GN diagonal block

matrix. Pre-multiplying with the GN by GN diagonal matrix 𝑉̂ of direct value-added
coefficients, replacing X as BY, and further converting the 3 final goods and service
production vectors 𝑌 𝐷 , 𝑌 𝐹 and 𝑌 into GN by GN diagonal matrix 𝑌̂ , 𝑌̂ 𝐷 and 𝑌̂ 𝐹 , we can
obtain the decomposition of value added and final products production simultaneously as
follows:

𝑉̂ 𝐵𝑌̂ = 𝑉̂ 𝐿𝑌̂ 𝐷 + 𝑉̂ 𝐿𝑌̂ 𝐹 + 𝑉̂ 𝐿𝐴𝐹 𝐵𝑌̂

= 𝑉̂ 𝐿𝑌̂ 𝐷 + 𝑉̂ 𝐿𝑌̂ 𝐹 + 𝑉̂ 𝐿𝐴𝐹 𝐿𝑌̂ 𝐷 + 𝑉̂ 𝐿𝐴𝐹 (𝐵𝑌̂ − 𝐿𝑌̂ 𝐷 ) (3)

Each element in the 𝑉̂ 𝐵𝑌̂matrix represents the value added from a source country-
sector directly or indirectly used in the production of final goods and services in a particular
country/sector. The element of row (s, i) and column (r, j) in the matrix, 𝑣𝑖𝑠 𝑏𝑖𝑗
𝑠𝑟 𝑟
𝑦𝑗 , is the
total value added (direct and indirect) of sector i in country s embodied in the final products
produced by sector j of country r. Looking at the matrix along a row yields the distribution
of value added created from one country-sector that is absorbed by final goods production
in all country-sectors. Looking at the matrix along a column yields the contribution of value

4
added from all source country-sectors pairs that is embodied in final goods and services
produced by a particular country/sector.

The 𝑉̂ 𝐵𝑌̂matrix can be decomposed into four GN by GN matrixes, each representing

domestic value-added generated or foreign value-added used by the industry in its
production of final products to satisfy different segments of the global market. Equation (3)
identifies, for each country-sector, three types of production activities:

(1) Value added that is domestically produced and consumed (𝑉̂ 𝐿𝑌̂ 𝐷 ). This value
added does not involve cross border trade. An example is haircut.

(2) Value-added that is embodied in final product exports (𝑉̂ 𝐿𝑌̂ 𝐹 ). This embodied
domestic factor content crosses national borders for consumption only. It is similar to
“traditional” trade such as “French wine in exchange for England cloth”, in the term
proposed by Borin and Mancini (2015) 1.

(3) Value-added that is embodied in exports/imports of intermediate goods and

services (𝑉̂ 𝐿𝐴𝐹 𝐵𝑌̂). Because it is used in production activities outside the source country,
it is part of the cross-country production sharing activities. Based on whether the value
added crosses borders once or more than once, this term can be further split into two
categories2:

3a. Simple cross country production sharing activities (𝑉̂ 𝐿𝐴𝐹 𝐿𝑌̂ 𝐷 ). Domestic or/and
foreign value-added cross national border for production only once. Value-added
embodied in intermediate exports/imports that is used by a direct importing country to
produce products that are absorbed in the country. There are no indirect exports via third
countries or re-exports/re-imports of the source countries’ factor contents. An example is

1
In Ricard’s time, exports were 100% domestically produced value added, whereas today, many final product
exports from a country, foreign value added is always embodied and domestically produced value added is
only a part of the exports. However, using decomposition method based on input-output statistics, we are still
able to compute the portion of “traditional trade analytically.
2
It is important to note that the inter-country input-output table does not separate country j’s domestic value
added produced by foreign owned firms located in country j from country j’s value added produced by locally
owned firms. This means that the decomposition is residence based rather than ownership based. In
particular, valued added generated by foreign owned firms in country j is not considered as part of GVC
activities if it does not involve cross border trade.
5
Chinese value-added embodied in its steel exports to the US which is then used in US house
construction.

3b. Complex cross country production sharing activities ( 𝑉̂ 𝐿𝐴𝐹 (𝐵𝑌̂ − 𝐿𝑌̂ 𝐷 )) .
Domestic or/and foreign value-added embodied in intermediate exports/imports that is
used by partner country to produce exports (intermediate or final) for other countries. In
this case, the factor contents cross border at least twice. One example is the salaries of
Apple’s US designers that are embodied in the iPhones that are exported from China to the
US that are ultimately bought by American consumers; Another example is Japanese value-
added embodied in electronic chips installed in China-made toys that are export to the
United States3.

To obtain some more intuition from Equation (3), especially what activities constitute
the complex GVCs, let us look at an example of a two-country (home country s and foreign
country r) world with N tradable sectors. In this case, Equation (3) can be rewritten in block
matrix notations as follows:

Vˆ s LssYˆ ss 0  Vˆ s LssYˆ sr 0   0 Vˆ s Lss A sr LrrYˆ rr 

VˆBYˆ         
 0 Vˆ r LrrYˆ rr   0 Vˆ r LrrYˆ rs  Vˆ r Lrr Ars LssYˆ ss 0  (4)
ˆ
 V L A (B Y  B Y )
s ss sr rs ˆ ss rr ˆ rs ˆ
V L A [( B  L )Y  B Y 
s ss sr rr rr ˆ rr rs ˆ sr
  r rr rs ss 
ˆ ss ˆ ss sr ˆ rs
Vˆ r Lrr Ars ( B srYˆ rr  B ssYˆ sr ) 
V L A [( B  L )Y  B Y ]

The economic meaning of the first three terms can be clearly observed from the
block matrixes in Equation (4): They all only involve local Leontief inverse L. The first
two terms involve only country s or country r’s own local inverse, implying that the
production activities measured by the two terms are all local activities. The third term
contains both countries local inverse as well as the direct import input coefficient matrix,
implying cross-country production sharing activities between the home and foreign
countries. Asr or Ars represent the direct link in one production stage.

The last term is more complex, as it includes a global Leontief inverse B,

representing infinite iterations of direct input coefficient matrix A. It can be further

3
Term 3b can be further divided into returned domestic value added and foreign value added based on
their final destinations of absorption. A detailed mathematical derivation and their relation with the
measures in the existing literature can be found in Wang, Wei, Yu and Zhu (2017a).
6
decomposed into two sub-terms: The diagonal elements are domestic value-added that are
exported first but eventually returned home; while the off-diagonal elements are re-
exported foreign value-added.

Factor content or value added in types 1 and 2 involves no cross-border production

activities and satisfies domestic (type 1) and foreign (type 2) demand. Factor content or
value added in type 2 crosses borders once but only for consumption activities since all
value-added embodied in the good’s intermediate inputs are derived from domestic sources;
therefore, it is traditional trade in value added terms (French wine for English cloth). Factor
content in type 3 is embodied in trade in intermediate goods and can be decomposed further
into two types. Type 3a is value added embedded in intermediate goods absorbed by the
direct importer and in which cross-border production activities are conducted, but only
within the direct importing country (without further border crossing)—thus, these are
simple GVCs. Type 3b is value added that crosses borders at least twice to satisfy domestic
and foreign final demand, respectively— thus, these are complex GVCs. These last two
types measure cross-country production-sharing activities. They exclude domestic value
added measured by the first two types because those production activities are accomplished
completely within national borders and so can be treated as pure domestic production
activities.

II. Define GVC participation based on decomposition value added and final
goods production
Summing up equation (3) along the row direction, we can decompose value-added
generated from each industry/country pair (GDP by industry) in terms of where it goes.

𝑉𝑎′ = 𝑉̂ 𝐵𝑌 = 𝑉
̂ 𝐿𝑌 𝐷 + ⏟
⏟ 𝑉̂ 𝐿𝑌 𝐹 + ⏟
𝑉̂ 𝐿𝐴𝐹 𝐿𝑌 𝐷 + 𝑉
̂ 𝐿𝐴𝐹 (𝐵𝑌 − 𝐿𝑌 𝐷 )
⏟ (5)
(1)−𝑉_𝐷 (2)−𝑉_𝑅𝑇 (3𝑎)−𝑉_𝐺𝑉𝐶_𝑆 (3𝑏)−𝑉_𝐺𝑉𝐶_𝐶

Summing up equation (3) along the column direction, we can decompose country-
sector final goods production in terms of where the value added comes from.

7
 𝑌 ′ = 𝑉𝐵𝑌̂ = ⏟
𝑉𝐿𝑌̂ 𝐷 + ⏟
𝑉𝐿𝑌̂ 𝐹 + ⏟
𝑉𝐿𝐴𝐹 𝐿𝑌̂ 𝐷 + ⏟
𝑉𝐿𝐴𝐹 (𝐵𝑌̂ − 𝐿𝑌̂ 𝐷 ) (6) 4
(1)−𝑌_𝐷 (2)−𝑌_𝑅𝑇 (3𝑎)−𝑌_𝐺𝑉𝐶_𝑆 (3𝑏)−𝑌_𝐺𝑉𝐶_𝐶

The first terms in both equations (5) and (6) represent value-added produced at
home and absorbed by domestic final demand without involving international trade; we
label them as V_D and Y_D respectively. The second terms in Equation (5) are domestic
value-added embodied in final product exports, and are labeled as V_RT and Y_RT,
respectively. Both of them are domestic production activities, but V_D and V_RT from
Equation (5) are the sum of value added from a country-sector used in all downstream
sectors; Y_D and Y_RT from equation (6) are the value added in a country sector that sums
up the value added from all upstream sectors. In general, VD and V_RT are different from
Y_D and Y_RT except at the country aggregate level.
The third terms (3a) in the two equations are measures of simple GVC activities.
V_GVC_S from equation (5) is domestic value-added embodied in a country-sector’s
intermediate exports that is used by the direct importing country to produce its domestic
products that is consumed in that country, while Y_GVC_S from equation (6) is foreign
value added in a country sector that is imported directly from partner countries and used
for domestically consumed products. Both cross borders for production only once and are
therefore referred to “simple GVC activities.”
The fourth terms (3b) in the two equations involve value added that cross borders
more than once and are referred as complex GVC activities. V_GVC_C from equation (5) is
domestic factor content from a country-sector that is embodied in its intermediate exports
and used by a direct importing country to produce exports (intermediate or final) for other
countries; Y_GVC_C from equation (6) is either returned domestic value-added or foreign
value added embodied in intermediate imports used by the home country to produce its
final products for either domestic use or exports. Because of indirect trade through third
countries, V_GVC_C and Y_GVC_C are not the same except at their global aggregates.
The sum of the last three terms in equation (5) equals domestic value-added in gross
exports via forward linkages (DVA_F) as proposed by Koopman, Wang and Wei (2014).
The sum of the last two terms in Equation (6) minus returned domestic value added equals

4
A detailed mathematical derivation of equation (5) and (6) and their relations are provided in Wang, Wei
Yu and Zhu 2017a, Appendix B.
8
foreign value added in the exporting country’s final goods production as defined by Los,
Timmer and Vries (2015).
The downstream decomposition of GDP by industry based on forward linkages can
be illustrated as the left panel of Figure 1; and the upstream decomposition of final goods
production based on backward linkages can be depicted as the right panel of Figure 1.
Figure 1 Decomposing GDP and final goods production by country and sectors
Forward linkage-based: Producer perspective Backward linkage-based: User perspective
Which types of GDP production activities belong Which types of final goods production belong to
GVCs?
to GVCs?

The forward linkage–based decomposition views a country’s or sector’s

engagement in GVC activities from a producer perspective. It classifies the portion of GDP
created in a country or sector by domestic production factor content that crosses border for
production at least once as GVC production activities, and the portion of GDP created by
domestic factor content stays within the national border in the whole production process as
domestic production activities. It decomposes values but not goods. In contrast, the
backward industrial linkage–based decomposition views a country-sector pairs’
participation in GVC activities from a user perspective. It traces all primary factor inputs
embodied in the final products produced by the country/sector to its original country/sector
sources, and consistently classifies embodied domestic and/or foreign factor content into
GVC and non-GVC production activities based on whether they have crossed a national
border for production or not.

9
 Based on Equations (5) and (6), we can fully identify the intensity of a country-
sector’s participation in the global production network and construct indexes that help us
to measure the extent to which production factors employed in a particular country-sector
are involved in the global production process. Accordingly, we define a pair of GVC
participation indices at a country-sector level.

The first one describes the domestic value added generated from a country-sector’s
GVC activities through downstream firms as share of that country-sector’s total value
added, and can be expressed as follows:

𝑉_𝐺𝑉𝐶 𝑉_𝐺𝑉𝐶_𝑆 𝑉_𝐺𝑉𝐶_𝐶

𝐺𝑉𝐶𝑃𝑡_𝑓 = = + (7)
𝑉𝑎′ 𝑉𝑎′ 𝑉𝑎′

The denominator on the right-hand-side of equation (7) is the total value-added

generated in production from that country-sector pair, and the numerator is the total
domestic value added of that country sector that is embodied in its intermediate exports to
the world. This measure differs from the conventional VS1 measure (as percent of gross
exports) in two ways: (a) it is based on value added rather than gross exports; (b) it is a
production concept rather than trade.

A second participation index measures the percentage of a country-sector’s total

production of final goods and services that represent the value added that is involved in
GVC activities through upstream firms, and can be written as follows:

𝑌_𝐺𝑉𝐶 𝑌_𝐺𝑉𝐶_𝑆 𝑌_𝐺𝑉𝐶_𝐶

𝐺𝑉𝐶𝑃𝑡_𝑏 = = + (8)
𝑌′ 𝑌′ 𝑌′

This measure differs from the conventional VS measure (as percent of gross exports)
in two ways: (a) it is based on a net concept while VS is based on a gross concept; (b) it is
a production concept instead of trade. It includes not only foreign value-added embodied
in intermediate imports, reflecting the degree of foreign production factors’ participation
in the home country-sector’s production of final products, but also domestic factor content
that has returned home through international trade to satisfy domestic final demand.

10
 For the world as a whole, the sums of its numerator over all countries and sectors in
(7) and (8) equal to each other.5

In summary, this pair of GVC participation indices provides a complete picture of a

country’s participation in GVCs based on whether the production factor content crosses
national borders for production. They take into account both forward and backward
industrial linkages. The former measures domestic value added generated from GVCs
production and trade activities as a share of total sector value added (GDP)., whereas the
latter measures the percentage of a country’s final goods production contributed by both
domestic and foreign factors that involve cross country production sharing activities. The
relative values of the two indices indicate a country-sector’s position in the global
production network. For instance, a higher degree of forward participation than backward
participation implies that the country/sector is more actively engaged in upstream
production activities in GVCs.

III. Decomposition of gross trade flows at bilateral-sector level

Estimating value added exports or domestic value added in a country’s gross

exports alone can be accomplished by directly applying the standard Leontief (1936)
decomposition similar to decomposition of GDP by country industry pair, which does not
require decomposing international intermediate trade flows. However, uncovering the
value added structure of gross trade at a disaggregated level requires finding a way to
decompose intermediate trade into value added and double counted components, which
cannot be achieved by simply multiplying the Leontief inverse and final demand because
gross bilateral intermediate trade flows need to be estimated first from an inter-country
input-output (ICIO) model for any given level of final demand before they can be properly
decomposed. To solve this endogeneity problem, Wang, Wei and Zhu(2013) propose a
method to decompose all bilateral intermediate trade flows into major final demand groups
according to their final destination of absorption and express gross output in all stages of
production as related countries’ final demand. This key technical step converts gross
outputs (and gross exports) – usually called “endogenous variables” in standard ICIO

5
The mathematical proof can be find in Wang, Wei, Yu and Zhu (2017a), Appendix C.
11
models – to “exogenous variables” in the gross trade accounting framework Koopman,
Wang and Wei(2014) has proposed. This transparent framework completely decomposes
gross exports into (1) exports of value-added, (2) domestic value-added that returns home,
(3) foreign value-added, and (4) double-counted intermediate trade. These conceptually
different components sum up to 100% of the gross trade flows at any level of
disaggregation. By identifying which parts of the official data are double counted and the
sources of the double counting, it bridges gross trade statistics and national accounts in
consistence with the System of National Accounts standard. More importantly, it goes
beyond simply extracting value-added trade from gross trade, and recovers additional
useful information about the structure of international production sharing at a
disaggregated level that is masked by gross trade data.
Country s’s gross exports to Country r can be decomposed as follows:

E sr  (V s B ss )T # Y sr  (V s Lss )T #( Asr B rrY rr )

(1)  DVA _ FIN (2)  DVA _ INT

 G G G G

 (V s Lss )T #  Asr  B rtY tt  Asr B rr  Y rt  Asr  B rt  Y tu 
 t  s ,r t  s ,r t  s ,r u  s ,t 
(3)  DVA _ INTrex

 G

 (V s Lss )T #  Asr B rrY rs  Asr  B rtY ts  Asr B rsY ss 
 t  s ,r 
(4)  RDV _ G

 G G

 (V s Lss )T #( Asr B rs  Y st )  (V s Lss  Ast B ts )T #( Asr X r ) 
 t s t s 
(5)  DDC

 G

 (V r B rs )T # Y sr  (  V t B ts )T # Y sr 
 t  s ,r 
(6 )  FVA _ FIN

 G

 (V r B rs )T #( Asr LrrY rr )  (  V t B ts )T #( Asr LrrY rr ) 
 t  s ,r 
(9)
(7)  FVA _ INT

 G

 (V r B rs )T #( Asr Lrr E r* )  (  V t B ts )T #( Asr Lrr E r* ) 
 t  s ,r 
(8)  FDC

12
 G
whereV s Lss  A st B ts  V s B ss  V s Lss . Equation (9) indicates that the gross exports from
t s

Country s to Country r at sector levels can be completely decomposed into the sum of 16
detailed terms in 8 major categories:

The 1st category, (V s B ss )T # Y sr , is domestic value added (DVA for short) embodied in
final goods exports. We label it as DVA_FIN for short.

The 2nd category, (V s Lss )T # ( Asr B rrY rr ) , is DVA in intermediate exports used by direct
importer (r) to produce local final goods consumed in r. We label it as DVA_INT for short.6

The 3rd category is DVA in intermediate exports used by the direct importer (r) to
produce exports ultimately consumed by other countries except s. We name them as
G
DVA_INTrex for short. It includes three detailed terms: (V s Lss )T # ( Asr  B rtY tt ) is DVA in
t  s ,r

intermediate exports that are used by Country r to produce intermediates that it re-exports
G
to third Country t for production of local final goods; (V s Lss )T # ( Asr B rr  Y rt ) , is DVA in
t  s ,r

intermediate exports used by Country r to produce final goods that it re-exports to third
G G
Country t; (V s Lss )T #( Asr  B rt  Y tu ) is DVA in intermediate exports used by Country r
t  s ,r u  s ,t

to produce intermediates that it re-exports to third Country t for production of final goods

6
Note that besides the difference between backward and forward linkage based decomposition,
conceptually, the first and second terms in equation (9) include both domestic value-added directly and
indirectly absorbed by the importing country. Domestic value added of the exporting country that is directly
absorbed by the partner country can be measured as(𝑉 𝑠 𝐿𝑠𝑠 )𝑇 #𝑌 𝑠𝑟 (𝑓𝑖𝑛𝑎𝑙 𝑔𝑜𝑜𝑑𝑠), which is a portion of the
1st term, and (𝑉 𝑠 𝐿𝑠𝑠 )𝑇 #(𝐴𝑠𝑟 𝐿𝑟𝑟 𝑌 𝑟𝑟 ) (𝑖𝑛𝑡𝑒𝑟𝑚𝑒𝑑𝑖𝑎𝑡𝑒 𝑔𝑜𝑜𝑑𝑠), which is a portion of the 2nd term. These two
portions are called “Ricardian Trade” by Borin and Mancini (2015), which do not involve any additional
production activity in third countries. The domestic value-added in exports indirectly absorbed by the partner
country is measured by [𝑉 𝑠 (𝐵 𝑠𝑠 − 𝐿𝑠𝑠 )]𝑇 #𝑌 𝑠𝑟 and (𝑉 𝑠 𝐿𝑠𝑠 )𝑇 #(𝐴𝑠𝑟 (𝐵𝑟𝑟 − 𝐿𝑟𝑟 )𝑌 𝑟𝑟 ) respectively, which
involve production activities in third countries before the value-added in exports is finally absorbed in the
partner country. In equation (3), we provide alternative decomposition measures that accounts for traditional
or direct and GVC trade separately. Equation (9) shows clearly which part in gross bilateral trade flow can
be decomposed by applying the standard Leontief insight directly (final goods trade), which part cannot
(intermediate goods trade), and provide structure information for both domestic value-added in exports and
double counting; while equation (3) shows clearly which part of domestic value-added of the exporting
country is absorbed by its partner country directly(part 2 and 3a), and which part of domestic value-added of
the exporting country is absorbed by its partner countries indirectly (off-diagonal portion of part 3b). Both
decomposition measures are useful depending on one’s particular analytical needs.
13
exports that are shipped to other countries (including the direct importer, Country r) except
Country s.

The first three categories are all DVA embodied in Country s’s gross exports to
Country r and ultimately absorbed abroad, which are value-added exports (labeled as VAX
by Johnson and Noguera (2012)) associated with gross export flows based on backward
industrial linkages. We name them collectively as VAX_G for short.

The 4th category is DVA in intermediate exports that are returned to Country s and
consumed at home. We name them as RDV_G for short. It also includes three detailed
terms: (V s Lss )T # ( Asr B rrY rs ) is DVA that returns home via its final imports from the direct
G
s ss T
importer (r); (V L ) # ( A sr
B
t  s ,r
rt
Y ts ) is DVA that returns home via final imports from

third countries; and (V s Lss )T # ( Asr B rsY ss ) is DVA that returns home via its intermediate
imports and used to produce domestic final products. Summing across all sectors and
trading partners, the first two terms equal the 4th term, and the last term equals the 5th term
in equation (36) of KWW.

The first four categories are DVA embodied in Country s’s sector level gross exports
to Country r, which include value added created from all sectors in Country s. We name
their sum as DVA_G for short. At the country aggregate, it reduces to equation (37) of
KWW. As shown by WWZ, these DVA terms represent different types of cross country
production sharing arrangements and can be used to gauge the role and position of a
country in various global value chains.

G
The 5th category has two terms. The first term, (V s Lss )T # ( Asr B rs  Y st ) , is DVA
ts

embodied in its intermediate exports to Country r but return home as its intermediate
imports, and used for production of its final exports, which are parts of DVA in Country
s’s final exports and are already counted once in the first category of equation (3). For this
reason, they are a portion of domestic double counted terms caused by the back and forth
intermediate goods trade in order to produce exports of final products in Country s. The

14
 G
second term, (V s Lss  A st B ts ) T # ( A sr X r ) , is DVA in intermediate exports to Country r
ts

that returns home as intermediate imports and used for production of its intermediate
exports. It is also a domestic double counted portion caused by the back and forth
intermediate trade to produce intermediate exports in Country s (repeat counting of
Country s’s intermediate goods exports).7 We name them as DDC for short. Summing these
two terms across all sectors and country pairs equals the 6th term in equation (36) of KWW.

The 6th category includes two terms: the first term (V r B rs )T # Y sr , is foreign value added
G
(FVA) from the importer (r) embodied in final exports; the second term, (  V t B ts )T # Y sr ,
t  s ,r

is FVA from other Countries (t) embodied in final exports. We label them as FVA_FIN for
short. Summing them across all sectors and country pairs equals the 7th term in equation
(36) of KWW.

Adding up the 1st (DVA from source Country s), and the 6th (FVA from Country r and
Country t) categories accounts for 100% of the value of the sector level final exports from
Country s to Country r.

The 7th category also includes two terms: the first term (V r B rs )T # ( Asr LrrY rr ) , is FVA
from the importer (r) embodied in intermediate exports, which are then used by r to produce
G
its domestic final goods. The second term, ( V t B ts )T # ( Asr LrrY rr ) , is FVA from third
t  s ,r

Country t embodied in intermediate exports, which are then used by Country r to produce
its local final goods. We name them as FVA_INT for short. Summing them across all
sectors and country pairs equals the 8th term in equation (36) of KWW.8

G
(V s B ss  V s Lss ) T # ( A sr X r )  (V s Lss  A st B ts )# ( A sr X r ) .
7

t s
8
The 6th and 7th categories can be grouped differently in decomposing bilateral gross trade flows. Summing
up the first terms of these two categories yields total value added from the direct importer (Country r) used
in the production of gross exports of Country s. We can label them as MVA for short. Summing up the second
terms of these two categories yields total value added from other countries (t) used in the production of gross
exports of Country s. We can label them as OVA for short.
15
 Summing the 6th and 7th categories yield the total foreign value added embodied in
Country s’s sector level gross exports to Country r. We name them as FVA for short.

The last category is double counted terms in Country s’s gross exports originating from
foreign countries. Similar to categories 6 and 7, it also includes two terms: the first term,
(V r B rs )T # ( Asr Lrr E r* ) , is FVA from the importer (r) embodied in intermediate exports to
produce its exports, which is a pure double counted term of r’s value added in s’s exports.
G
The second term, ( V t B ts )T # ( Asr Lrr E r* ) , is FVA from third Country t embodied in
t  s ,r

intermediate exports to produce its exports to the world. We label them as FDC for short.

The 5th and last categories are both pure double counted terms in Country s’s gross
exports but originating from home country and foreign countries respectively. We name
their sum as PDC for short.

The sum of the last four categories can be seen as an extension of the vertical
specialization (VS) measure proposed by Hummels, Ishii, and Yi (2001) in a multi-country
setting with more than one country engaging in intermediate goods trade9. As we will show
by examples in the next section, these different components within the total VS also
represent different types of cross-country production sharing arrangements and are useful
to study the upstream value-added structures of a country’s gross exports in various global
value chains.

The 16 detailed terms in the 8 categories discussed above completely decompose

bilateral gross exports from Country s to Country r into different value added and double
counted components, and their sum equals 100% of bilateral trade flows at the sector level.
The disaggregated accounting framework made by equation (9) is also diagrammed in
Figure 2.

9
KWW (2014) split the PDC terms into domestic and foreign content based on the origins of the double
counted terms, and allocate a portion of the PDC to the VS measure. WWZ(2013) allocates the entire PDC
term to the VS measure so as to keep the notion of “domestic value added embedded in gross exports” as a
“net” concept, and is then consistent with the one country model that the original Hummels, Ishii, and Yi
(2001) measure is based on. It avoids additional layer in the decomposition and intuitively appealing. Note
that the VS measure is not a “net” concept and always contains double counted terms no matter how the PDC
term is allocated.
16
 Figure 2 Decomposition of Gross trade flows

(0)
Gross exports (Goods and
services)
(E*)

(1)+(2)+(3) (4) (6)+(7) (5)+(8)

Domestic value-added Foreign value- Pure double
absorbed abroad Domestic value-added counted terms
added
(VAX_G) first exported then
returned home (FVA) (PDC)
(RDV_G)

(1) (2) (3) (5) (6) (7) (8)

Final goods Intermediate Intermediates sent Pure double Foreign value Foreign value Pure double
exports to first importer counting from added added contained counting from
and services
absorbed by and then re- domestic contained in in intermediates foreign
exports
direct importer exported to third sources final exports exports sources
(DVA_INT) country (DDC)
(DVA_FIN) (DVA_INTrex) (FVA_FIN) (FVA_INT) (FDC)

Domestic Value-added (DVA_G) Vertical Specialization (VS)

Note: E* can be at country-sector, country aggregate, bilateral-sector, or bilateral aggregate levels; both
VAX_G and RDV_G are based on backward industrial linkages.

IV. Length of production and its decomposition

Length of production as a basic measure of GVCs, is defined as the number of stages

in a value chain, reflecting the level of fragmentation and complexity of the production
process.
1. Total length of production-Concept and measurement

We define the total length of production as the average number of production stages
between the primary inputs in a country-sector to final products in another country-sector.
It measures the average number of times that value-added created by the primary factors

17
employed in the country-sector pair has been counted as gross output in the entire
production process until it is embodied in final products thus exit the production process.
Mathematically, it can be defined as
𝑣𝑖𝑠 ∑𝐺,𝑁 𝑠𝑡 𝑡𝑟 𝑟
𝑡,𝑘 𝑏𝑖𝑘 𝑏𝑘𝑗 𝑦𝑗 ̂𝐵𝐵𝑌̂
𝑉
𝑝𝑙𝑣𝑦𝑖𝑗𝑠𝑟 = or in matrix notation as 𝑃𝐿𝑣𝑦 = (10)
𝑣𝑖𝑠 𝑏𝑖𝑗
𝑠𝑟 𝑟
𝑦𝑗 ̂𝐵𝑌̂
𝑉

The denominator is the total value added from sector i of country s contributing to the
final product in sector j of country r, and the numerator is the total output accumulated
along the production chain induced by the value added. When value added is used as input
in a production stage, either as primary input or embodied in intermediate inputs, it will be
counted as output where it is used. Therefore, the length of a production chain is the number
of times of value added counted as output in the production chain, from the first time it is
used as the primary input until it absorbed by a final product.

Figure 3 Concept of length of production – Economic intuition

Other Other
industry industry

First count
Second count Third count

Primary input Gross Gross Gross

(capital, output of output of
labor, land)
output of Consumer
Cotton textile apparels

Other Other Other

intermediate intermediate intermediate
inputs inputs inputs

Figure 3 uses the cotton-textile-appeals production chain as example to illustrate the

economic intuition behind the definition of length of production. When farmers’ capital,
land and labor are used to produce cotton, the value-added generated from these primary
factors will be counted first time as part of gross output of cotton production; When cotton
is used as intermediate input for textile production, these value-added generated by primary
factor embodied in cotton will be counted second time as gross output of textile production;
finally, when textile is used as intermediate input for cloth production, which is the final
18
products will sell to consumers, these value-added generated by primary factor embodied
in cotton will be counted third time as gross output of apparels production and exit the
production process when it purchased by consumer. Therefore, the length of the cotton-
textile-appeals production chain is three since value-added generated by primary factor
embodied in cotton were counted three times before it exits the production process and
enter consumption.
Aggregating (10) over all products j, we obtain the total production length of value
added generated in sector i, i.e., the average production length measure based on forward
industrial linkage. Expressing in matrix notation gives:

̂𝐵𝐵𝑌̂𝜇 ′
𝑉 ̂𝐵𝐵𝑌
𝑉
𝑃𝐿𝑣 = ̂𝐵𝑌̂𝜇 ′
= ̂𝐵𝑌
= 𝑋̂ −1 𝐵𝑋 = 𝑋̂ −1 𝐵𝑋̂𝜇 ′ = 𝐺𝜇′ (11)
𝑉 𝑉

where 𝜇 is a 1×N unit vector with all its elements equal to 1, and 𝐺 is the Ghosh inverse
matrix. It is the sum along the rows of the Ghosh inverse matrix, which equals the total
value of gross outputs that are related to one unit of value added created by primary inputs
from a particular sector. Therefore, equation (11) measures total gross outputs induced by
one unit of value added at the sector level, which are the footprints of each sector’s value
added in the economy as a whole. The longer the production chain, the greater the number
of downstream production stages a sector’s value added is counted as gross output in the
economy.

Aggregating (10) over value-added from all sectors i that have contributed to the final
goods and services produced by sector j, we obtain the production length measure based
on backward industrial linkages. Expressing in matrix notation gives

𝜇𝑉̂𝐵𝐵𝑌̂ 𝑉𝐵𝐵𝑌̂
𝑃𝐿𝑦 = ̂𝐵𝑌̂
= = 𝜇𝐵 (12)
𝜇𝑉 𝑉𝐵𝑌̂

It is the sum along the column of the Leontief inverse matrix, which equals the total value
of inputs induced by a unit of final product produced in a particular sector. Therefore,
equation (12) measures total intermediate inputs induced by a unit value of a particular
final product throughout all upstream sectors in the economy. The longer the production
chain, the greater the number of upstream production stages a particular final product has
in the economy.

19
 Using the shares of sector value added in GDP as weights, aggregating (10) over
all i and j, we obtain average total production length of the world economy as a whole:

̂𝐵𝐵𝑌̂𝜇 ′
𝑢𝑉 𝑉𝐵𝐵𝑌 𝑢𝐵𝑌 𝑢𝑋
PL𝑤 = ̂ 𝐵𝑌̂𝜇 ′
= = = 𝐺𝐷𝑃 (13)
𝑢𝑉 𝑉𝐵𝑌 𝑢𝑌

It indicates that the average length of the production chain in whole economy equals
the ratio of total gross outputs to GDP, which is an index of complexity of the production
process in the economy, i.e., the higher this ratio, the more complex the production system
in the economy.

2. Decompose total length of production into major segments

According to the value-added and final goods production decomposition framework
we have outlined in section I of this concept note, production activities can be divided into
four parts based on whether there are cross border activities for production. In the same
logic, total length of production also can be decomposed into 4 segments: the first and
second segments measure length of pure domestic production and traditional trade; the
third and fourth segments measure production length of simple and complex GVC
activities, such a production length system can be illustrated by figure 4 as follows:

Figure 4 Index System for Production Length

Total Production
Length (TPL)
(TPL)

Pure Domestic Traditional GVC

Production Length Production Production
(PL_D) Length (PL_RT) Length (PL_GVC)
(PL_RT) (PL_GVC) )

DVA share
weighted Output and value Output and value added
added absorbed absorbed by production
directly by Importer of re-exports
(PL_GVC_S) (PL_GVC_C)
ad

Simple Segment before first Border crossing for Segment after first
Adding + +
border crossing (d) production (c) border crossing (f)

20
Detailed description of the 4 segments of length of production and their computation formula can
be found in Wang, Wei, Yu and Zhu (2017b).

Reference
Antràs P, Chor D, Fally T, Hillberry R. Measuring the Upstreamness of Production and Trade
Flows. The American Economic Review: Papers & Proceedings, 2012, 102(3): 412-416.

Antràs, P., Chor, D. Organizing the global value chain. Econometrica, 2013, 81(6), 2127-2204.

Borin, Alessandro, and Michele Mancini. “Follow the value added: Bilateral gross exports
accounting.” No. 1026 Working paper of Banca D’Italia, July 2015.
Dietzenbacher, E. and I. Romero “Production chains in an interregional framework: identification
by means of average propagation lengths”. International Regional Science Review, 2007, 30,
362-383.
Johnson R C, Noguera G. Accounting for Intermediates: Production Sharing and Trade in Value
Added. Journal of International Economics, 2012, 86(2): 224-236.

Koopman R B, Wang Z, Wei S J. Tracing Value-Added and Double Counting in Gross Exports.
The American Economic Review, 2014, 104(2): 459-494.

B. Los, M.P. Timmer and G.J. de Vries (2015) "How Global are Global Value Chains? A New
Approach to Measure International Fragmentation" Journal of Regional Science, 55(1), 66-92.

Wang Z., S. Wei, X. Yu, and K. Zhu. 2017a. "Measures of Participation in Global Value Chain
and Global Business Cycles." NBER Working Paper No. 23222, NBER, Cambridge, MA.
———. 2017b. "Characterizing Global Value Chains: Production Length and Upstreamness."
NBER Working Paper No. 23261, NBER, Cambridge, MA.
Wang Z., S. Wei, X. Yu, and K. Zhu. 2013. Quantifying International Production Sharing at the
Bilateral and Sector Level. NBER Working No. 19677, NBER, Cambridge, MA.

21