Policy Note 43: Free trade and prosperity go hand in hand

During the COVID-19 pandemic, there were increased calls to partially reduce the highly advanced international division of labour and to re-regionalize production in the future. Although these demands are understandable given the sometimes difficult supply situation for medical equipment during a global pandemic, they are not economically expedient. "As a small, open economy, Austria is strongly integrated into global value chains and benefits from the international division of labour through specialization advantages," says Wolfgang Schwarzbauer, one of the authors of the study.

This is clear from the importance of international final demand for Austria's economy. Foreign demand is directly and indirectly responsible for around one third of domestic economic output. At sector level, individual sectors have much higher quotas, especially in industry (e.g. motor vehicle manufacturing or metal production) but also in some service sectors (e.g. wholesale, transportation and finance). In industry, more than three quarters of value added is sourced abroad; in raw materials extraction, the figure is almost two thirds.

Germany, but also the USA, China and Italy, play an important role in this. For example, 6.6% of Austria's total value added is supplied to final demand in Germany. In individual sectors, the importance of the three central global economies of the USA, China and Germany is even clearer. For example, around 40 percent of Austrian motor vehicle production depends on final demand in these three economies.

The following table provides an overview of the main results:

Austria's position in global value chains can be described as central. Austria is neither considered to be strongly "upstream" like countries that produce raw materials (e.g. Russia and Norway) nor close to the end consumer like smaller Eastern European countries. At the same time, Austria's participation in global value chains is very high. Austria's companies are therefore strongly integrated into international production networks.

Against this backdrop, the COVID-19 pandemic in particular should not be used as a reason to re-regionalize international value chains. The intensification of free trade and deepening of value chains led to lower prices and welfare gains through efficiency gains and increased competition. A contrary development therefore has welfare-reducing effects.

Rather, the great importance of foreign end demand markets for the Austrian economy shows that international competitiveness should be expanded. Both the manufacturing sector and market services such as wholesale and transport are dependent on the internationalization of the Austrian economy and benefit from it. The aim must therefore be to strengthen the productivity of Austrian companies again, both in the short, medium and long term. This includes efficient support for research by Austrian companies, quality improvements in the education sector and the increased expansion of digital broadband infrastructure.

Ultimately, it is also important to continue shaping the development of European integration. Austria is one of the beneficiaries of the EU single market, the customs union, the Schengen Agreement and the euro, as numerous studies show. In the context of an internationally strong EU, Austria should also advocate the preservation of the World Trade Organization and the conclusion of bilateral and multilateral free trade agreements, which are the EU's only instrument for combating the erosion of legal certainty in international trade.