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For decades, developing countries have seen global value chains (GVCs) as a path to greater prosperity. GVCs have made it possible to climb the income ladder faster by focusing on specific stages of production rather than turning out more complex finished goods. Thanks to GVCs, Bangladesh can supply fabric for European fashion brands, and Vietnam can assemble smartphones for customers in South Korea and North America.
Over half of world trade is now conducted indirectly, through GVCs. This growth has been especially pronounced in lower-middle income countries (Figure 1). Participation in value chains has myriad benefits. It accelerates productivity growth and job creation. Firms that take part in GVCs tend to pay higher wages and offer better working conditions as they strive to comply with global standards.
But now, the prospect of global trade-policy fragmentation threatens that progress. The reason: Striking trade deals on a country-by-country basis risks weakening the principle known as Most Favored Nation (MFN), the bedrock of the world trading system since the adoption of the Global Agreement on Tariffs and Trade in 1947. With MFN, the 163 countries in the World Trade Organization offer equal access to their market to all other members. MFN created the predictability and stability that nourished the rise of GVCs: Every country that orders textiles from Bangladesh knows it can do so on equal terms with its competitors.
To be sure, preferential trade agreements can reduce trade barriers. Examples include the US-Mexico-Canada Agreement, Comprehensive and Progressive Agreement for Trans-Pacific Partnership, and Regional Comprehensive Economic Partnership. Moving forward, however, new trade deals that increase tariffs and have cumbersome and costly trade compliance rules could fragment markets and hinder developing countries' participation in global value chains.
How does a fragmented trade policy landscape interfere with global value chains? In a fragmented regime, countries grant preferential terms to some trade partners but not to others If your country isn’t on the list of favored nations, it doesn’t get special treatment. But it might try to game the system by routing its exports through a third country. To avoid that happening, preferential trade agreements include rules of origin, which require importers to demonstrate where goods were made.
Documenting the origin of a ton of steel may not be difficult. But the task becomes much harder with goods like smartphones, which are composed of goods and services from several countries along the value chain. Trade regimes that discriminate between countries impose administrative costs on firms that include adjustments to internal processes, staff training, and engaging external trade professionals. Customs administrators are confronted with increased operational demands, including investigations, international cooperation and information exchange, and audits of valuation, classification, and origin.
Compliance is also costly for businesses. Costs related to rules of origin represent approximately 4.5 percent of the customs value of goods traded via preferential agreements, according to World Bank calculations. Small and medium-sized enterprises have more trouble complying with rules of origin because of their limited scale of operations and ability to absorb additional costs. Exclusion of such firms from GVCs could potentially lead to greater market concentration and reduced global competitiveness.
High compliance costs increase the incentives to cheat – defeating the purpose of rules of origin. The bigger the difference between the preferential rate and the one that applies to everyone else – what we call the preference margin – the more likely countries are to claim the preferential rate. Using data by Gonciarz and Verbeet (2025), we estimate that a 1 percent increase in the preference margin leads to a 0.39 percent increase in the utilization of the preferential rate.
Almost 80 years of trade based on non-discrimination have served the world well. Adoption of discriminatory trade rules, higher tariffs, and more rules of origin could unravel decades of progress for developing countries, jeopardizing the poverty-reducing effect of global value chains.
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