Rethinking the value of global value chains

Instead of undertaking wholesale trade liberalization to participate in global value chains, what developing countries need is to build up their production capacities in order to gain a greater share of value added.

__________________________________________________________________________________________

Today’s discourse on global value chains (GVCs), propagated mainly by developed countries and also the WTO secretariat, seems to be stating the following:

l       Global value chains offer new opportunities to developing countries. For developing countries to get a bigger part of GVCs, they should liberalize their borders since products are “Made in the World”. Tariffs on goods should therefore be eliminated or reduced considerably.

l       Trade in services should be liberalized. This is because services now play a major role in the value chain. According to the proponents, all the following services are important – logistics, distribution, telecommunications, business, financial services etc. Countries should therefore liberalize these and other services sectors for their own benefit.

l       A trade facilitation agreement should be concluded in order to facilitate trade and lower trade costs.

l       There should not be export restrictions, for example, export taxes imposed on raw materials, since this would increase the production costs for all and prevent the smooth functioning of the GVC.

This article gives an overview of developing countries’ experiences with GVCs and will show that in fact, other strategies than the above are needed if developing countries are to grow beyond mainly supplying raw materials or being factor economies providing assembly lines.

The discourse on GVCs

The following is an excerpt from a March 2013 speech by then WTO Director-General Pascal Lamy on this matter (bold texts are additions):

“By virtue of being global, these chains lead to the very same goods or services being produced in multiple geographical locations. It is not only finished products or finished services that cross territorial boundaries, but the vast majority of trade is actually in intermediate products and services, i.e. components. As these components travel into one country, and out another, to finally form a finished product, what producers are telling trade policy makers is that trade barriers, whether at the border or behind borders, are having a far worse impact than ever before. They disrupt entire supply chains. A country’s imports, in today’s world, are at once its exports…

“It is therefore not surprising that the share of services more than doubles when trade is measured in value-added terms. The figures for 2008, immediately before the global economic crisis, show a rise from 23% of total trade, measured in the traditional way, to 45% if one incorporates value-addition. According to our new figures, services are thus the chief contributors to global trade, while the manufacturing industry’s share of international trade falls (from 65% to 37%). So the first lesson for trade negotiators is that they must pay much greater attention to services trade, and to removing the barriers that obstruct it [i.e., liberalize services].

“The second lesson is that in shooting down your imports, you may actually be firing at your exports. They are progressively becoming very much the same. Today almost 60% of trade in goods is in intermediates and the average import content of exports is around 40%. In other words, to export, a country must import too. I am convinced that the new statistics we published will allow a better appreciation of this global interdependence, which in its turn will foster a more cooperative — and less mercantilist — approach to trade negotiations [i.e., eliminate tariffs on goods]…” (“In value chains, ‘what cannot be counted does not count’: Lamy addresses Turkish think tank”, 14 March 2013, www.wto.org/english/news_e/sppl_e/sppl270_e.htm)

What are the interests behind the GVC discourse?

The GVC discourse is about facilitating the operations of global transnational corporations (TNCs). This explains the interests of key corporate players such as the US Coalition of Services Industries.

It suggests a far-reaching menu for negotiations that bypasses:

l       the areas of “balance” developing countries want to see in the current Doha Round of WTO talks (e.g., agriculture subsidies)

l       the fact that the Singapore issues have been rejected, with the interests behind the GVC discourse seeking to put it back on the agenda (e.g., investment liberalization)

l       special and differential treatment for developing countries when cutting tariffs.

The GVC discourse explicitly or implicitly encourages:

l       tariff liberalization

l       investment liberalization

l       far-reaching services liberalization (logistics, distribution, telecoms, business, finance)

l       no capital controls

l       opposition to export restrictions, i.e., it wants the free flow of raw materials exports

l       plurilateral approaches if the multilateral approach to trade opening is too slow.

The discourse hides the interests behind its agenda (i.e., the TNCs) and presents it as a neutral agenda that is good for all countries and players. Those having difficulties [e.g., least developed countries (LDCs)] should simply be supported to enter GVCs. The discourse does not reveal the fact that power is differently distributed along the GVC and there are real and structural barriers facing the small players (e.g., lack of access to new technologies, difficulties in providing economies of scale, etc).

With the financial and economic crisis, trade liberalization has been discredited. The GVC discourse attempts to enact the same skit, but in different clothing.

There is also an attempt to bypass the stalemated areas of interest to most developing countries in the Doha Round and find a quick way to move on to issues mainly of interest to the bigger players (e.g., non-agricultural market access, services, investment).

The discourse makes the false assumption that the market is self-regulating, which is far from the case. South African Ambassador to the WTO Faizel Ismail has noted that its analysis of globalization “is divorced from the experiences of the majority of people in the world suffering the effects of a continuing economic and social crisis reflected in: rising unemployment, inequality and poverty”.

How much of the value added in GVCs is in

the hands of developing countries?

Using the OECD-WTO database on Trade in Value Added (May 2013), the UN Conference on Trade and Development (UNCTAD) provides a breakdown of the distribution of the global value added (R. Banga, “Measuring Value in Global Value Chains”, UNCTAD, 2013):

l       67% accrue to OECD (i.e., industrial) countries

l       8% for Newly Industrialized Countries I (NICs I – Singapore, Hong Kong, Taiwan, Korea)

l       3% for Newly Industrialized Countries II (NICs II – Malaysia, Thailand, the Philippines)

l       9% for China

l       5% for the other BRICS countries (India, South Africa, Brazil, Russia)

l       8% for other developing countries and all least developed countries.

Developing countries’ experiences with GVCs

Developing countries have been grappling with difficulties in relation to GVCs. Since the 1970s, they have already noted their disproportionate share in value chains as raw material exporters. The discourse since the time of Prebisch has been to increase developing countries’ value added.

In the “deepening smile” curve (see figure), developing countries are mostly in the low-value manufacturing part of the chain, as opposed to producing the concept, being the technology holders and designers or being in sales or marketing, where the value added is much greater. Lead firms tend to outsource the lower-value-added activities (e.g. final assembly) and retain higher-value-added areas, e.g. R&D, intellectual property, design, distribution (UNCTAD 2011).

According to Derick, Kraemer and Linden (2009), case studies for China show that for the Apple iPod, only $4 out of the total value of $150 is attributed to producers located in China. Most of the value accrues to the US, Japan and Korea.

Most developing countries, outside of a few Asian newly industrialized countries, are not the source of lead firms. At best, developing countries are second- or, more commonly, third- or fourth-tier suppliers. They have real difficulties getting into GVCs (apart from providing the raw materials) and moving up the GVC chain.

A quick look at a Boeing aircraft, for example, shows that the components come from the OECD countries (including Korea), principally the US, the UK, Japan, France, Sweden and Italy. Components for Samsung phones are mainly sourced from the US, Taiwan, Korea, Italy and Japan.

UNCTAD has provided examples of the experiences of developing countries’ small and medium enterprises (SMEs) in GVCs:

l       Microsoft and Egypt – Egyptian firms translate software products of leading brands into Arabic, provide support package to users and run call centres. They have branched into software development in the Middle East.

l       IBM and Vietnam – Firms provide IBM software services to clients – banks, enterprises, the government. Others distribute software.

UNCTAD (2010) concludes: “Participating in the TNC’s GVC enhances the prestige and credibility of the SMEs making it easier for them to expand. It also makes continuous upgrading easier as they have access to the TNC’s technical staff and training … However, since they are selling or adapting established products and services, genuine innovation is still in its infancy.”

In the case of Toyota in South Africa and Volkswagen in Mexico, a few companies became first-tier suppliers in these countries to the TNCs; however, UNCTAD notes that “many independent local suppliers have not managed to either link with global sourcing partners or upgrade their own capabilities … In Mexico, for instance, among the local suppliers interviewed no local SME in the second and third tiers has been able to leverage its link to GVCs as a springboard for its own internationalization.”

Countries can export more, but they may not be “gainfully linked” into the GVCs. What is increasing may not be the domestic content of their exports but the foreign value-added content. In the latest UNCTAD analysis on value added (Banga 2013), the US is the country with the highest increase in the domestic value-added content in its exports from 2005-09. Even Korea and Germany register increasing exports but falling domestic value added in exports during the same period. The paper’s conclusion is that “Country experiences therefore show that linking into GVCs may not bring gains automatically. In fact, it makes aiming for trade-led growth more questionable.”

The “glass ceiling” faced by developing countries’ SMEs includes:

l       Being technology-savvy is critical – knowledge-intensive products are critical to the cutting edge of manufacturing. Low-income countries tend to be involved in low-value-added segments of chains and are in sectors where chains are shorter and less technologically intensive, e.g., apparel and agriculture.

l       Need medium to large enterprises for large-scale production

l       Require investments to ensure timely shipments and high-quality output

l       Management expertise is necessary to meet complex GVC management issues

l       The size of the domestic market matters as it attracts foreign firms. Smaller developing countries have less leverage to create such a strong linkage with lead firms

l       Meeting the standards required in the GVC is expensive and requires technological knowhow.

Developing countries also experience unstable contracts with lead firms which benefit from severe competition amongst identical suppliers. They select those which meet their short-term requirements (UNCTAD 2011).

An alternative discourse

The existing trade rules in the WTO remain imbalanced in a range of areas, hence developing countries’ attempts to put forward these concerns under the agenda of implementation issues and special and differential treatment (S&D) in the Doha Round. Fairer trade rules and special and differential treatment would give developing countries’ SMEs a better chance in participating in world trade.

Developing countries would therefore benefit from the satisfactory conclusion of the Doha implementation issues agenda as well as the S&D issues agenda (going beyond the 28 Cancun items). Some areas (to name only a few) in this negotiating agenda include:

l       extension of TRIMs for countries demonstrating difficulties (can have local-content requirements)

l       review GATT Article XVIII (Governmental Assistance to Economic Development) – taking measures to control imports for balance-of-payments reasons, or promote establishment of an industry to raise people’s living standard

l       strengthen GATT Article XXXVIIIC on infant industry to make it effective and operational

l       sanitary and phytosanitary measures – establishing equivalence (expedite further implementation of Article 4 of the Agreement on the Application of Sanitary and Phytosanitary Measures)

l       anti-dumping – simplified procedures for LDCs to take up anti-dumping cases, changes to make it less easy for others to invoke cases against developing countries

l       subsidies – subsidies for development, diversification and upgrading of infant industries should be non-actionable

l       Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS) – transition period for LDCs extended as long as they are LDCs, technology transfer should be operationalized.

In developing countries, industrialization, supporting agricultural production (especially of small farmers) and services development are critical. This needs explicit government policies and they will not simply “happen” through participation in the low end of GVCs (where most developing countries are). For industrialization to take place, it is not across-the-board liberalization that will be a help, but deliberate and dynamic tariff and government regulatory policies.

The GVC discourse on goods and services liberalization will make it difficult for developing countries to strategically use the opportunities of their own national and regional markets to jumpstart their industrialization process. This does not mean that developing countries should impose high tariffs across the board, but that they should have the flexibility to raise or lower their tariffs over time according to the needs of their industries. The same applies in the services sectors – in order to grow their own services industries, government supports and regulations are important.

Rather than setting their sights only on the need to participate in global value chains, developing countries are already creating and can continue to create their own national and regional value chains. The reality is that for many developing countries, domestic and regional markets are very important and could offer more opportunities for value addition. For example, Africa is the primary market for sub-Saharan Africa’s processed goods, as compared to the EU or the US.

For all that they say, developed countries continue to use protective policies to reinvigorate their own industries and agriculture, such as agriculture subsidies, anti-dumping measures, quantitative restrictions and tariff rate quotas (in agriculture), subsidies (by the billions) to the auto and financial sectors during the recent economic crisis, and government procurement policies. The US provided $65 billion in loans to GM and Chrysler in 2008; they also used “voluntary” quotas on foreign cars imported into the US market (R. Pollin, “Industrial policy and the revival of US manufacturing”, 2010).

Trade facilitation is touted in the GVC discourse as a panacea. Developing countries in fact have already taken and can continue to take unilateral action to modernize their customs procedures. The need for a binding commitment at the WTO is questionable since these commitments are very expensive to implement, and the rules imposed would be the customs procedures of developed countries and would thus be suited primarily to their needs and economic interests. Trade facilitation could also increase imports by reducing trade costs, and this could have an impact on developing countries’ SMEs and their access to their own national or regional value chains.

Local content and the regulation of investors when entering a country is very important. The promotion of investment liberalization under the GVC discourse must be viewed with tremendous caution. It is about allowing TNCs to come in and out of the country and operate with the same advantages as local companies. This is likely to have a very detrimental impact on local firms that cannot compete and need governmental support. The concerns developing countries had raised at the WTO’s 2003 Cancun Ministerial Conference in calling for the Singapore issues, including investment, to be dropped from the Doha Round agenda remain the same today.

In conclusion, the GVC discourse, as noted by Faizel Ismail (2012), does not provide a framework for helping developing countries develop beyond their current comparative advantages. UNCTAD’s latest analysis of the value-added trade data also shows that more exports does not necessarily mean more value-added exports. Countries could be linked to GVCs but not “gainfully” linked.

The GVC discourse comes from the place of wanting to further ease the operations, movement and access of TNCs across global markets, with real dangers for developing countries’ firms and industries. All developing countries do participate in GVCs to varying degrees. However, the priority for developing countries is the building of production capacities. In that context, in contrast to the GVC discourse of “more liberalization”, the flexible and dynamic use of trade policy instruments (tariffs, government regulations) that support industrialization and agricultural and services development, complemented by fairer trade rules, are necessary.                

The above is an edited extract from “Global value chains from a development perspective”, an Analytical Note (July 2013) produced by the Trade for Development Programme of the South Centre. The full text is available on www.southcentre.org.

Third World Economics, Issue No. 552, 1-15 Sept 2013, pp 12-15