The servitization of manufacturing flows within the triangle Germany-CEE-China

ABSTRACT

The study examines changes in the role of CEE, Germany and China in cross-sectoral connections. The paper aims to understand the flows in the servitization of manufacturing among three economies. It tried to answer the question of how strong links are in the servitization of manufacturing and whether there are any visible trends in value-added flows within this triangle.

KEYWORDS:

• Servitization of manufacturing
• China
• Germany
• CEE

1. Introduction

The importance of value-added services in global value chains (GVCs) is increasing, as companies shift their focus towards service-oriented business models and Industry 4.0 (I4.0) technologies (Feliciano-Cestero et al. 2023; Frank et al. 2019; Ibarra, Ganzarain, and Igartua 2018; Kohtamäki et al. 2019; Kraus et al. 2022; Müller and Buliga 2019). This transformation, known as the servitization of manufacturing (Kimita et al. 2022; Zhang et al. 2023; Zhou et al. 2023), is changing the traditional structure of GVCs (Naude, Surdej, and I Cameron 2019) and is expected to have a significant impact on manufacturing (Song and Yang 2023) and the interface between I4.0 and circular economy (Awan et al. 2022; Ul-Durar et al. 2023). As a result, economies that are positioned in the downstream market can improve their position.

Most of the studies focus on servitization of manufacturing in the national context (Chen et al. 2023; Du and Agbola 2022; Huang et al. 2022; Liu and Kim 2020), and often the research is conducted at the microeconomic level. Research on servitization of manufacturing in an international context is rare (Nie et al. 2023; Pomfret 2019). Therefore, it was justified to deal with this phenomenon in the context of strongly interconnected economies with different levels of economic development.

The study aimed to understand the flows in the servitization of manufacturing. It tried to answer the question of how strong links are in the servitization of manufacturing and whether there are any visible trends in value-added flows within the triangle Germany, China, and Central and Eastern Europe (CEE). In the study, input-output model using the Inter-Country Input-Output databases was employed. The analysis spans years 1995–2018.

This study contributes to enriching the existing literature about the servitization of manufacturing within the advanced services flows context, providing an in-depth characterisation of cross-sectoral value-added flows. Moreover, most of subject literature has not classified services according to their level of sophistication. To the best of the author’s knowledge, no previous studies have been conducted on the intersectoral flows between these three economies.

The CEE is experiencing the negative impacts of transitioning towards the I4.0. As advanced technologies increasingly replace labour-intensive production, the region’s position in GVCs is declining (Hnát and Sankot 2019; Kersan-Skabić 2017). Despite these challenges, access to digital technologies, including ICT services, is crucial for the CEE’s transition into the I4.0 phase. Germany, which has strong ties with the CEE, is a significant supplier of these technologies (Naude and Nagler 2017).

China’s global strategies, which include the introduction of advanced products and services, position it as a significant non-European technology supplier for CEE (OECD 2023). This has been amplified by China’s growing presence in the global market, making it a potential competitor for Germany (Le Corre 2023). The CEE serves as a critical destination for Chinese services, acting as a ‘launchpad’ for Chinese technological projects in Europe and a conduit for acquiring technology from Europe (Krpata 2023).

For Germany, China’s presence signifies a dichotomous strategy. Germany has been one of the European leader in the I4.0 (Greef and Schroeder 2021) and maintains strong cooperation with China (Shucun and Chuntai 2019). Germany also seeks to protect its technological industries from China’s technology (Reuters 2023).

German supply chains in CEE have allowed it to maintain a comparative advantage in key economic sectors, while also helping CEE countries join GVCs, positively impacting economic growth. However, some CEE economies have been stuck in downward segment of functional specialisation (Kordalska and Olczyk 2023). Eventually, Germany has strong cooperation and competition with China, and CEE economies are increasingly dependent on Chinese value added and are still being linked to German chain strongly. In turn, for China, the German economy is more important than CEE, as it is an important market for technological services.

2. Method

The input-output model for the decomposition of gross exports (Figure 1) and its limitation was presented in Appendix 1. The model was utilised to assess the cross-sectoral links between Germany, CEE, and China. This approach combines the methods developed by Koopman et al. (2014), Hummels et al. (2001), and Timmer et al. (2019).

Figure 1. Decomposition scheme. In parentheses are the number of equations presented in the appendix. Source: Based on Koopman et al. (2012).

3. Discussion

There is a much higher intensification of value-added flows between CEE and Germany than between Germany-China and CEE-China. Figure 2(a) presents these flows.

Figure 2. Value-added flows (share of destination country’s gross exports). An average for selected period. Source: based on data (OECD, 2023).

Figure 2. (Continued).

Over the years, the share of foreign value added in the triad has changed significantly. Still in the period 1995–1999, the highest shares were observed in flows from Germany to CEE (especially in telecommunications and computer programming, consultancy and information services activities embedded in manufacturing and ICT services in transport equipment). However, CEE’s shares in both German and Chinese manufacturing were insignificant. China’s role as a supplier of services in the triad was almost insignificant. The role of European economies in Chinese manufacturing was also negligible, e.g. Germany had the highest shares in ICT services to transport equipment (6.59%).

By the period 2015–2018, the situation had changed dramatically. The largest positive changes were recorded in CEE’s computer programming, consultancy and information services activities directed to German manufacturing (7.45% change between 1995–1999 and 2015–2018), and then in German and Chinese ICT services directed to CEE’s computer, electronic and electrical equipment (6.38% and 6.30% respectively). However, the uttermost decline was observed in German ICT directed to CEE’s manufacturing (−3.39%).

In 2015–2018 the largest share of servitization of manufacturing was observed in flows between Germany and CEE, especially in German ICT services embodied in transport equipment (26.67%). Generally, intensified value-added flows between economies are not surprising, as they were part of the trend of foreign trade and FDI flows between them. In the service flows from CEE to German manufacturing, an upward trend is observed in all cases. The highest fluctuations occurred in flows of computer programming, consultancy and information services activities between economies.

Analyzing flows between Germany and China, three trends are visible. Firstly, German-Chinese flows are lower than German-CEE flows. Secondly, the increases of German-Chinese flows were more sustainable. Thirdly, in service flows from China to Germany, there was an increasing trend, while in the opposite direction, such increases could not be observed everywhere (e.g. German ICT embodied in Chinese manufacturing declined). The greatest imbalance in German-Chinese relations occurred in ICT directed to transport equipment (Table B1, Appendix B).

The greatest value-added flow imbalances occurred in China-CEE relations (especially in in ICT services to manufacturing and computer, electronic and electrical equipment) (Table B1, Appendix B). However, Chinese-CEE relations were characterised by the lowest fluctuations. Generally, when examining these relations, the following phenomena are visible. Firstly, the share of Chinese services in the CEE’s manufacturing sectors is constantly growing and vice versa. Secondly, there are increasing gaps in almost every flow (Table B1, Appendix B). Thirdly, in none of the analysed industries, China’s share exceeded Germany’s share in CEE’s manufacturing, and a similar situation occurs in CEE’s shares in Chinese manufacturing – Germany’s shares are much higher.

There is no direct compensation between the increase in Chinese value-added flows to Germany and decrease in CEE flows (no compensation for the decrease in German-CEE flows by German-Chinese flows was observed). However, as relations between Germany and China strengthen, the value-added flows from advanced Chinese services are catching up to those from CEE directed to Germany.

Generally, the relationships between CEE and China are becoming more imbalanced but Germany and China as well as Germany and CEE (mostly) have built more sustainable relations comparing the periods 1995–1999 and 2015–2018 (Table B1, Appendix B). Moreover, differences in the intensity of flows result from the advancement of these economies. For example, in 1995–1999, the role of Chinese ICT services in cross-sectoral connections was limited due to the underdevelopment of these activities, but now this intensification is high.

4. Conclusions

This study found reduction in the imbalance in flows in most pairs of economies, except for almost all China-CEE relations and one China-Germany flow (Table B1, Appendix B). However, the intensification grew in most of analysed flows, except for two flows from Germany to CEE and the flow from Germany to China. The largest average increase in value-added flows was observed in ICT services in computer, electronic and electrical equipment (Table B2, Appendix B). There is no direct compensation among economies. CEE was the most dependent on German and Chinese value-added (in 2015–2018 on average 12.61%), while China was the least dependent on the two economies (4.11%). However, we should be aware of longer and stronger relations between Germany and CEE than between CEE and China. Still, China’s position as a value-added supplier is growing much faster than Germany or CEE.¹

If the presented value-added flow changes reflect the effectiveness of I4.0, it can be said that Germany is fulfilling its role the most efficiently (in 2015–2018 the dependence on German value added was on average in two economies at 13.55%), while China and CEE effectiveness is similar (4.61% and 5.17%, respectively).

Imbalances in flows between European economies and China and the growing role of the latter, cause countries to introduce changes in their policies towards China. Most often, these are balanced changes, because European economies agree that China cannot be eliminated from the world economy (there are too strong connections) and practically no global problem can be solved without China’s support (e.g. climate issues). However, the policy of balancing inequalities in relations with China (de-risk) is increasingly being emphasised. In the case of servitization research, balancing the relationship should not be about limiting the inflow of Chinese services, but about supporting the development (making them more competitive) of European advanced services directed to China. The problem of European countries is both, the lack of unanimity in their policy towards China, which is visible in the example of CEE (tough policy of the Baltic States vs. intensification of relations in Hungary or Romania), and different stages of I4.0 development. Moreover, this research raises a few challenges for the economic policy in the triad, among them are the properly diagnosis of the competitiveness and exports ability of advanced services.

Acknowledgments

The article is the result of the research project ‘Digital Silk Road as a network of technological connections between China and Europe within value chains: towards win-win or decoupling?’ financed by the National Science Center, Poland (UMO-2021/43/B/HS4/01079).

Disclosure statement

No potential conflict of interest was reported by the authors.

Data availability statement

The data that support the findings of this study are available in OECD Stats at https://stats.oecd.org/ and in OSF at https://doi.org/10.17605/OSF.IO/DZ27T.

Additional information

Notes on contributors

Ewa Cieślik

Ewa Cieślik (Ph.D. and Habilitation) is an associate professor in the Department of International Economics at the Poznan University of Economics and Business, Poland. Her research interests include international economics and emerging markets.

Notes

1. Some of conclusions were presented at the 3rd International Conference ‘Economic and Business Trends Shaping the Future’, 11.11.2022, Skopje, and published in an abstract proceedings (Cieślik 2022).

Appexdices

Appendix A Model and its limitations

The model was used to analyse flows between services and manufacturing in three economies: Germany, CEE, and China. The analysis was conducted over 20 years (1995–2018). The chosen research method was based on analysing Inter-Country Input-Output (ICIO) database from the OECD. The 2021 version of the ICIO features 45 distinct industries, classified according to the ISIC Revision 4. Trade flows are harmonised in basic prices. The database was selected due to the most up-to-date data for the studied economies (OECD 2023).

Although the model also analyzes flows of domestic value added embodied in partners’ gross exports, the study focuses on foreign value added embodied in the country’s gross exports. Five different flow configurations were tested (Figure 2a in the text).

First, the intensity of flows between manufacturing and the main group of the ICT service (ISIC Rev. 4 codes: 58–63) and its two subgroups (telecommunications and computer programming, consultancy and information services activities) were examined. The subgroup ‘publishing, audiovisual, and broadcasting activities’ was consciously omitted, considering it to be insignificant in bilateral value-added flows. Then, the study analyzes the value-added flows of ICT services to the two industries most strongly connected to GVCs: computer, electronic and electrical equipment (ISIC Rev. 4 codes: 26 and 27) and transport equipment (ISIC Rev. 4 codes: 29 and 30) (OECD 2023).

We have S and N economies. Each sector produces a single differentiated product: SN goods.

$\left[\begin{array}{ccc}{X}_{11}& \cdots & X_{1\mathit{N}}\\ ⋮& \ddots & ⋮\\ X_{\mathit{N}1}& \cdots & X_{\mathit{NN}}\end{array}\right]$ = $\left[\begin{array}{ccc}{B}_{11}& \cdots & B_{1\mathit{N}}\\ ⋮& \ddots & ⋮\\ B_{\mathit{N}1}& \cdots & B_{\mathit{NN}}\end{array}\right]\left[\begin{array}{ccc}{Y}_{11}& \cdots & Y_{1\mathit{N}}\\ ⋮& \ddots & ⋮\\ Y_{\mathit{N}1}& \cdots & Y_{\mathit{NN}}\end{array}\right]$

Where:

G – Total amount of gross production in economy i needed to meet final demand in economy j

X – Gross output produced in economy i and absorbed in economy j

Y – Gross output produced in economy i and consumed in economy j

Then we create the value added production matrix $\hat{V}$GY

$\left[\begin{array}{ccc}\widehat{V}1& \cdots & 0\\ ⋮& \ddots & ⋮\\ 0& \cdots & {\widehat{V}}_{\mathit{N}}\end{array}\right]\left[\begin{array}{ccc}{X}_{11}& \cdots & X_{1\mathit{N}}\\ ⋮& \ddots & ⋮\\ X_{\mathit{N}1}& \cdots & X_{\mathit{NN}}\end{array}\right]$ = $\left[\begin{array}{ccc}{\hat{V}}_1{\sum }_j^N{G}_{1\mathit{j}}{Y}_{\mathit{j}1}& \cdots & {\hat{V}}_1{\sum }_j^N{G}_{1\mathit{j}}{Y}_{\mathit{jN}}\\ ⋮& \ddots & ⋮\\ {\hat{V}}_{\mathit{N}}{\sum }_j^N{G}_{\mathit{Nj}}{Y}_{\mathit{j}1}& \cdots & {\hat{V}}_{\mathit{N}}{\sum }_j^N{G}_{\mathit{Nj}}{Y}_{\mathit{jN}}\end{array}\right]$

The diagonal matrix elements represent the value-added absorbed domestically. All elements of the diagonal matrix represent the value added embodied in a partner’s gross exports. Since our focus was on the foreign value-added embodied in gross exports, we omitted some equations related to domestic content. The foreign value-added embodied in gross exports can be formulated as

$\mathrm{FV}=\mathit{mathop}{\sum }_{\mathit{j}\ne \mathit{i}}^N{V}_j{G}_{\mathit{ji}}{E}_{\mathit{i}\ast }$= ${\sum }_{\mathit{t}\ne \mathit{i}}^N{\sum }_{\mathit{j}\ne \mathit{i}}^N{V}_t{G}_{\mathit{ti}}{Y}_{\mathit{ij}}$ + ${\sum }_{\mathit{t}\ne \mathit{i}}^N{\sum }_{\mathit{j}\ne \mathit{i}}^N{V}_t{G}_{\mathit{ti}}{A}_{\mathit{ij}}{\left(\mathit{I}-{\mathit{A}}_{\mathit{jj}}\right)}^{-1}{Y}_{\mathit{jj}}$ + ${\sum }_{\mathit{j}\ne \mathit{i}}^N{V}_t{G}_{\mathit{ti}}{\left(\mathit{I}-{\mathit{A}}_{\mathit{jj}}\right)}^{-1}{E}_{\mathit{j}\ast }$

where ${\sum }_{\mathit{t}\ne \mathit{i}}^N{\sum }_{\mathit{j}\ne \mathit{i}}^N{V}_t{G}_{\mathit{ti}}{Y}_{\mathit{ij}}$ is the foreign value added embodied in final goods exports; ${\sum }_{\mathit{t}\ne \mathit{i}}^N{\sum }_{\mathit{j}\ne \mathit{i}}^N{V}_t{G}_{\mathit{ti}}{A}_{\mathit{ij}}{\left(\mathit{I}-{\mathit{A}}_{\mathit{jj}}\right)}^{-1}{Y}_{\mathit{jj}}$ is the foreign value added embodied in gross exports of intermediate products; ${\sum }_{\mathit{j}\ne \mathit{i}}^N{V}_t{G}_{\mathit{ti}}{\left(\mathit{I}-{\mathit{A}}_{\mathit{jj}}\right)}^{-1}{E}_{\mathit{j}\ast }$- double-counted value added of intermediate goods produced abroad.

Eventually, the decomposition of gross exports may be formulated as follows.

$\mathrm{GEX}=[V_{\mathit{i}}{\sum }_{\mathit{j}\ne \mathit{i}}^N{G}_{\mathit{ii}}{Y}_{\mathit{ij}}+V_i{\sum }_{\mathit{j}\ne 1}^N{G}_{\mathit{ij}}{Y}_{\mathit{jj}}+V_i{\sum }_{\mathit{j}\ne \mathit{i}}^N{\sum }_{\mathit{t}\ne \mathit{ij}}^N{G}_{\mathit{ij}}{Y}_{\mathit{jt}}$] + [${\sum }_{\mathit{t}\ne \mathit{i}}^N{\sum }_{\mathit{j}\ne \mathit{i}}^N{V}_t{G}_{\mathit{ti}}{Y}_{\mathit{ij}}$ +

(1), (2), (3), and (4)

${\sum }_{\mathit{t}\ne \mathit{i}}^N{\sum }_{\mathit{j}\ne \mathit{i}}^N{V}_t{G}_{\mathit{ti}}{A}_{\mathit{ij}}{\left(\mathit{I}-{\mathit{A}}_{\mathit{jj}}\right)}^{-1}{Y}_{\mathit{jj}}$ + ${\sum }_{\mathit{j}\ne \mathit{i}}^N{V}_t{G}_{\mathit{ti}}{\left(\mathit{I}-{\mathit{A}}_{\mathit{jj}}\right)}^{-1}{E}_{\mathit{j}\ast }$] + [$V_i{\sum }_{\mathit{t}\ne \mathit{ij}}^N{\sum }_{\mathit{j}\ne \mathit{i}}^N{G}_{\mathit{ij}}{Y}_{\mathit{ji}}$ +

(5), (6) and (7)

$V_i{\sum }_{\mathit{t}\ne \mathit{ij}}^N{\sum }_{\mathit{j}\ne \mathit{i}}^N{G}_{\mathit{ij}}{A}_{\mathit{ji}}(\mathit{I}-A_{\mathit{ii}}){ }^{-1}{Y}_{\mathit{ii}}$ + $V_i{\sum }_{\mathit{j}\ne \mathit{i}}^N{G}_{\mathit{ij}}{A}_{\mathit{jt}}(\mathit{I}-A_{\mathit{ii}})$⁻¹ $E_{\mathit{i}\ast }$

(8) and (9), respectively.

We should be aware of some limitations of this approach. First, the results are obtained in nominal terms and the data is available only for main industries. Perhaps, if the classification of the industries had been more detailed, we could have obtained different results. Secondly, the analysis focuses on gross export decomposition and omits the demand side. Third, the COVID-19 pandemic, war in Ukraine and technological decoupling between China and the U.S. have changed the landscape of production networks; the only question is whether the changes are short term or long term. Anyway, this study does not cover this period. Moreover, this analysis is on the macro level and industry level, and it should not be considered as a replacement for the firm-level analysis of GVCs.

Appendix B

Table B1. Imbalances in pairs of economies’ relations between 1995–1999 and 2015–2018.

Type of flows	Economies	1995–1999	2015–2018
ICT services in manufacturing	CEE-Germany	4.39	1.69
	China-Germany	2.30	0.60
	CEE-China	2.32	4.29
Telecommunications in manufacturing	CEE-Germany	2.66	2.16
	China-Germany	4.34	1.26
	CEE-China	1.02	3.39
Computer programming, consultancy and information services activities in manufacturing	CEE-Germany	9.45	2.70
	China-Germany	1.57	1.75
	CEE-China	8.70	2.38
ICT services in transport equipment	CEE-Germany	5.01	2.58
	China-Germany	4.61	2.26
	CEE-China	1.53	1.62
ICT services in computer, electronic and electrical equipment	CEE-Germany	4.10	2.50
	China-Germany	1.85	1.06
	CEE-China	2.81	5.15

Source: Based on data (OECD 2023).

Table B2. Changes in servitization of manufacturing between 1995–1999 and 2015–2018 – summarise (%).

	ICT services in manufacturing	Telecommunications in manufacturing	Computer programming, consultancy and information services activities in manufacturing	ICT services in transport equipment	ICT services in computer, electronic and electrical equipment
Germany to CEE	−3.39	−0.94	5.62	3.18	6.38
CEE to Germany	4.52	1.12	7.45	5.65	4.78
Germany to China	−0.97	0.97	5.31	3.10	3.32
China to Germany	3.06	2.57	2.73	2.86	4.67
China to CEE	1.70	2.97	2.97	2.48	6.30
CEE to China	0.22	0.52	1.78	1.50	1.06
An average	0.86	1.20	4.31	3.13	4.42

Source: Based on data (OECD 2023).