Testing the Smile Curve: Functional Specialisation and Value Creation in GVCs

This paper addresses the ‘smile curve hypothesis’ which suggests that the potential for generating value added varies significantly across the value chain with the production stage being the least promising segment. Based on granular greenfield FDI data a metric is developed that allows capturing the functional specialisation of countries in global value chains at the industry level. The measure not only provides new insights into the specialisation of countries as ‘factory economies’ or ‘headquarter economies’ but is also used to test and confirm econometrically the smile curve hypothesis by showing that countries specialised in the production stage of the value chains tend to generate less value added per unit of output produced than those specialised as headquarter economies.