Inclusive Global Value Chains

George Manzano and Kristine Joy Martin

        Inclusiveness is a big word in the development community. Given the increasing ubiquity of global value chains (GVCs), policy attention has turned towards making these more 'inclusive.' APEC, for one, is promoting inclusiveness of GVCs through international cooperation.

        APEC is interested in GVC because it is perceived to be a game changer, i.e. a new paradigm that will increasingly define the patterns of international trade. Indeed, GVC has shaped the current global business environment in more ways than one. It has shifted the focus of the unit of trade from trade in goods to trade in tasks. Secondly, GVC encourages firms and countries to specialize in specific tasks and business functions based on their comparative advantages in order to ratchet up efficiency in production. GVCs provide potential mechanisms for all countries - whether these countries are large or small, developed or developing - to improve their income, employment, and productivity.

        The emergence of GVCs thus raises many important trade policy questions, which can be discussed and for which a consensus for collective policy action can be drawn out in APEC.

Why does APEC have to raise inclusiveness in GVCs as a policy objective?

        APEC raises the issue of inclusiveness for a number of reasons. Firstly, inclusiveness is at the very heart of development, i.e. what development is for, if not for people. Secondly, because participation in GVCs does not automatically lead to inclusive outcomes, there is a groundswell for a policy stance. In addition, as GVCs, by nature, reaches beyond borders, there are avenues for cooperation. APEC is thus, an appropriate forum to discuss and initiate policy responses, either at the collective level or at the level of individual APEC members, to promote inclusiveness in GVCs.

Inclusiveness at the extensive margin

        Inclusiveness can be understood in various ways. One way is to consider inclusiveness across countries, i.e. getting more countries to participate. Different countries, of course, have different initial capacities to participate in GVCs. Such differences may be due to different factors that are fixed, such as, country's geographic location and resource endowment. Conversely, the differences can also be due to public policy, such as, a country's human capital, physical infrastructure, and overall investment climate. Thus, to facilitate the entrance of developing countries into the GVC, proper trade and investment policies that aim to liberalize exchange of goods and services worldwide should be encouraged and implemented. We call attempts to broaden inclusiveness across countries as the extensive margin.

        Because of the nature of GVCs, where parts and components necessarily cross borders multiple times, countries with low trade barriers have better chances of participating. It also has been observed that GVCs tend to propagate in industries or product groups that have been subject to global trade liberalization. The passage of the 1997 Information Technology Agreement (ITA), which calls for the liberalization of IT products on an MFN basis by many countries, has been credited with the blossoming of GVCs in the electronics sector. To the extent that sectoral liberalization such as the ITA has promoted the participation of many countries - developed and developing alike - in the electronic GVC, it can be said that such initiatives foster inclusiveness across countries.

        Thus, inclusiveness at the international level could be fostered if APEC could take the lead in promoting more sectoral liberalization on an MFN basis. APEC has a role because the sheer size and economic weight of its members is likely to give it the critical mass which is needed to push for sectoral liberalization. In addition, APEC is a forum for cooperation, which makes it an appropriate venue to gather consensus and support for sectoral liberalization in different sectors.

        It is, however, not easy for APEC to negotiate for more sectoral liberalization because of the 'free rider' problem. Free riding entails that the countries which are not signatories to a sectoral liberalization agreement will also enjoy additional market access even without having to offer tariff concessions of their own. To lessen the possibility of free riding on the trade liberalization efforts by APEC, the challenge is to identify those areas in which the benefits of trade liberalization would redound mostly on APEC members rather than on non-members. These product groupings would be the promising candidates for sectoral trade liberalization. Wonnacott suggested a trade liberalization scheme on a selective product-by-product basis wherein countries choose the commodities for early liberalization based on a pre-defined criteria1.[1]

Inclusiveness at the intensive margin

        Inclusiveness in GVCs could also be enhanced among the elements of the value chain within a country. Inasmuch as there are lead countries at the international level, there are also lead firms that coordinate production across a series of producers, each with different tasks, along a domestic supply chain. The lead firms, which could be producers or traders, thus act as the nexus between the international and the domestic supply chain. By and large, policies aimed at promoting inclusiveness within countries deal with getting more small and medium establishment (MSMEs) and fostering more linkages especially between foreign firms with local firms. We call policy actions directed to promote inclusiveness within the country as the intensive margin.

        Making GVCs more inclusive can be achieved through many means. In this article we focus on (1) intensifying existing participation of Micro Small and Medium Enterprises (MSMEs) and (2) developing linkages of lead firms with local firms.

MSMEs

        Because GVCs are export-oriented, the firm-actors are operating under a very competitive environment. They are agile enough to modify products to suit the changing tastes and to adopt technology and production practices to remain cost effective. For these reasons, MSMEs that join GVCs are likely to enjoy positive spillovers of production technology as well as best managerial practices. However, the literature is replete with accounts of the many barriers that MSMEs face as they attempt to join, deepen and widen their GVC participation. These barriers are usually related to trade costs which could have structural or policy induced origins.

        Thus, government plays a big role in lessening trade costs for MSMEs. For example, it can provide financial aid to help companies access credit for more efficient operations. More importantly, it can also facilitate MSMEs compliance to international standards, especially since MSMEs find it difficult to adjust to global standards and regulations at public, private, and civil society levels. Note that the GVCs, standards and certifications are at the heart of a firm's ability to participate and compete.

Linkages

        The linkages of MSMEs and other local firms - especially those outside the special export processing zones (SEZs) - with lead firms or large multinational enterprises (MNEs) can also promote GVC inclusiveness. SEZs do not necessarily help in creating spill-over if the participating firms engage in processing activities with very little interaction with the local supplier firms. Thus, enclaves with little connection with the local firms are created.

        An opportunity to make GVCs more inclusive is through forging partnerships among lead firms and local firms outside SEZs. Local firms can be suppliers of manufactures while the lead firms can be the buyers. This would increase the smaller partner's market and capabilities which can eventually hook them to the GVCs [2].

        Policy should be directed at strengthening the linkages between the lead and the supplier firms in the GVC model that have the weakest link. APEC, being a body that supports economic and technical cooperation can consider initiating capacity-building programs or advocacy where linkages can be deepened in pursuit of inclusiveness, in the following areas:

1. On standards and international certification: Participation of firms in a GVC is conditional on their ability to meet the product or process standards of the lead firms. APEC can spearhead initiatives such as designing capacity building initiatives in certification compliance so as to facilitate the ability of small local firms to participate meaningfully in the production chain.
2. Entrepreneurship: In certain industries, supplier firms may have started as informal subcontract suppliers. However, transitioning towards formal status could be problematic. Given this difficulty, it is recommended that policy attention be directed towards facilitating the transition of informal establishments to the formal sector by reducing red tape and enforcing of property rights [3]. In addition, company programs where managers in lead firms could be trained and 'spun off' to head supplier firms could be explored.
3. Trade facilitation: Trade costs act as tax on supplier firms or as a fixed cost to internationalization. Trade costs need not necessarily be monetary in nature (tariff, taxes, etc). Delays can be particularly debilitating to the tight process flows of GVCs, thus any policy that improves export-import procedures at the border could encourage local firm participation. Programs to cluster service suppliers can create economies of agglomeration, lower transaction costs, and diminish the enclave behavior of lead firms.

Final Remarks

        The advent of the GVCs, on the crest of network economics, is an important development to warrant keen policy attention. APEC, for one, has taken an interest in GVCs, because fostering this mode of integration raises many policy issues that can be discussed in the context of economic cooperation. Missing out on the policy questions surrounding GVCs would make APEC less relevant. Furthermore, APEC desires to imbue regional integration with an inclusive character for developmental purposes.

        We suggest two broad areas to promote inclusiveness in APEC. The first deals with increasing the potential for GVCs. The proliferation of GVCs could only increase the possibilities for developing countries to participate. APEC, as a collectivity, could engage in initiating sectoral liberalization. The second avenue addresses fostering linkages between lead firms, which are usually foreign, with local suppliers (small businesses or otherwise) within the country. The idea is to prevent enclaves of foreign led GVCs. Though there is a host of complementary policies that could improve linkages, we highlight those that will help local supplier firms acquire the necessary standards, deepen entrepreneurship and benefit from trade facilitation measures.

References:

1.  Wonnacott, P. (1994) "Merchandise trade in the APEC region: Is there scope for liberalisation on an MFN basis?" The World Economy, Special Issue on Global Trade Policy: 33-51
2. Ibid.
3. Organization for Economic Cooperation and Development (OECD), World Trade Organization (WTO) and UNCTAD. "Implications of Global Value Chains for Trade, Investment, Development and Jobs." Prepared for the G-20 Leaders Summit Saint Petersburg (Russian Federation), August 6, 2013