The ‘Smile Curve’: where Value is Added along Supply Chains

In this paper we analyze where value is added along supply chains on a sample of more than 2 million of firms in the European Union. We detect a non-linear U-shaped relationship between the value added generated by firms and their position on a productive sequence, for which tasks at the top and at the bottom show higher value added. Our findings are in line with previous hypotheses on the existence of a so-called 'smile curve', resumed by both business and economic studies and discussed at length in international fora. Our results are robust to different empirical strategies for flexible functional forms. As far as we know, ours is the first firm-level successful attempt to test for value generation along supply chains. Further, we find empirical support for a phenomenon of domestic retention of value added by MNEs, which may prefer keeping at home the tasks at higher potential to safeguard present and future competitive advantages. By country, intermediate stages of production are at higher value when performed by foreign affiliates, whereas domestic producers retain higher value at the very top and at the very bottom of the supply chain, organized either as independent suppliers or as domestic affiliates. Although an economic theory is still missing for explaining how and why value generation is non-linear along a typical technological sequence, here we argue that a microfoundation with firm-level data is useful for understanding the growth potential of countries' specialization patterns along different segments of supply chains.