Economic growth through fragmentation and global value chain

Wednesday, 19 February 2020 00:02 -     - {{hitsCtrl.values.hits}}

Countries can contribute to the global value chain through commodity production, limited manufacturing, advanced manufacturing and services and innovative activities


 

The global value chain will continue to enhance economic growth, create better job opportunities and shrink poverty in developing countries. As far back as the 1990s, through international trade, global value chain benefits were experienced by poorer countries and paved the way for their economic growth.  

Fragmentation of production was the key methodology, where a production process could be broken down into many subsections and take place across other neighbouring countries. In other words, different companies specialise in specific tasks and get involved in producing the final product. In this process, raw materials with value addition may cross the border of a country and reach another country for value addition, as semi-finished goods can be assembled as a final product for consumption.  

It is vital for authorities to address required policy changes and enhancements in order to ensure the continued participation in global value chains.

Technological developments taking place globally, containerisation and policy reforms contribute immensely to reducing the cost of trade. The integration of China, Eastern Europe and the North American Free Trade Agreement (NAFTA), establishing the World Trade Organization in 1995, have contributed enormously to the development of international trade. This situation provides greater opportunities for developing economies to connect with the industrial bases of developed economies, rather than trying to rebuild the entire industry from scratch. Through the concept of product fragmentation, firms operating in developing economies have access to foreign markets with a lower cost, better productivity and improved management practices and provide higher paying and better quality jobs that ensure faster economic growth.             

Trade growth and global value chain formation have not reached their maximum potential since the financial crisis in 2008. The main reasons behind this could be trading partners such as Europe contribute one-fourth of global output and one-third of global trade, and China, the second largest economy in the world, could provide a larger contribution to the same.    

There are many ways that countries participate in the global value chain. Argentina, Ethiopia and Indonesia are engaged in simple manufacturing production chains but Algeria, Chile and Nigeria are engaged in exporting the commodities and raw materials required for production processes. It is noteworthy that India and the US are producing more services required by complex production processes elsewhere; almost half of world trade is considered to be taking place through global value chain transactions.  

Few regions, some sectors and some large multinational firms are efficaciously engaged in the global value chain. East Asia, Europe and North America are providing good examples and account for very large production capacities in electronic, machinery and transport equipment manufacturing, fragmented broadly across countries. These firms contribute more than 80% to their total trade flows. The expansion of value chains is taking place both regionally and globally. Europe is considered to be the most integrated region in this aspect. The North American situation is somewhat different, with it having more global partnerships than regional links. It is interesting to note that value chain partnership linkages are now becoming more global than regional. 

 

Contributors to GVC development 

With advanced development taking place in Information and Communication Technology, manufacturing firms find it easier to subcontract and organise much more complex activities from a distance while ensuring the excellence of a product. Lowering transport, mainly declining air and sea freight costs, also contributed positively to trade and global value chain development. Reliability and the inexpensive cost of communication contributed vastly to the development of the services sector. Trade and investment liberalisation activities taking place both within developed and developing economies are having a positive impact on reducing barriers of trade for goods and services. The reduction of non-tariff barriers is also offering a boost to trade but the expectations of the business community are still high, and much more has to be done in this area. 

The facts, such as the creation of the EU single market, China, India and Russia effectively integrating with the global economy, created huge labour and product markets. Firms were able to derive deep benefits from the global value chain and address economies of scale issues while relocating their factories to cheap labour markets, maximising profits and finding better suppliers.        

There are four different ways that countries participate in the global value chain, namely commodity production, limited manufacturing, advanced manufacturing and services and innovative activities.     

According to the World Bank report, countries in the commodities group have a small share of manufacturing exports and limited backward global value chain integration. Argentina, Armenia, Bosnia and Herzegovina, Cambodia, Costa Rica, Cyprus, El Salvador, Ethiopia, Indonesia, Kenya, Nepal, Serbia and South Africa had been in commodities and moved in to limited manufacturing in the recent past. Jordan and Lesotho downgraded their status from limited manufacturing to commodities. 

Countries such as China, Estonia, India, Lithuania, the Philippines, Poland, Portugal, Romania, Thailand and Turkey have advanced manufacturing and services in global value chain integration, having a high share of manufacturing and business service exports and high backward global value chain integration.

Countries like Austria, Canada, Finland, Ireland, Israel, Italy, South Korea, Singapore and Spain made their moves to innovative activities. Intellectual property receipts as a percentage of GDP and research and development concentration as a percentage of GDP are the measuring instruments of innovative activities. 

East Asia, Europe and North America are engaged in advanced manufacturing and services and innovative activities, whereas Africa, Central Asia and Latin America are mostly involved in commodities and limited manufacturing. 

 

Example of Vietnam 

Today, Vietnam provides one of the best examples of global value chain integration. Being the second largest smartphone exporter in the world, Samsung produces 40% of its phones and employs 35% (over 160,000) of its global staff in Vietnam. Other global players such as LG, Canon, Panasonic, Foxconn, Intel and Microsoft also operate in Vietnam.

The geographical location of Vietnam is an encouraging factor for global value chain integration, with it especially close to China, Japan and South Korea, which are electronic component and parts suppliers.  Vietnam managed to attract Foreign Direct Investments (FDIs) and acquired much-needed capital, technology and management skills. Improvements in transport and communication infrastructure and efforts to make the logistics industry competitive further leveraged it.    

Key policy level factors backing this development in Vietnam are the World Trade Organization’s Trade Facilitation Agreement, the agreement with the United States, being a member of ASEAN (Southeast Asian Nations) and having many free trade agreements, EU bilateral trade agreement and making a total of 16 trade agreements. With this background, Vietnamese exports comprise more than 90% of its GDP.   

Bangladesh in GVC

Bangladesh can be considered a good example for global value chain participation. Apparel and footwear exports in Bangladesh equated to roughly 1% of global demand in 1988. Since then, the annual growth they achieved was roughly 18%, and Bangladesh is currently the third largest exporter of apparel and footwear, holding a 7% stake, with China and Vietnam in possession of first and second position.  

Trade growth and global value chain formation have not reached their maximum potential since the financial crisis in 2008. The main reasons behind this could be trading partners such as Europe contribute one-fourth of global output and one-third of global trade, and China, the second largest economy in the world, could provide a larger contribution to the same

 

This sector contributes 89% of the country’s total exports and 14% of its GDP. Further, this sector engages 3.6 million workers, of which 55% are women. Against this background, the agriculture share of GDP declined to 38% by 2018 from 70% in 1988. The extreme poverty level has also reduced from 44% to 15% in the stated period.  

Through global value chain participation, local firms were able to effectively share technology with their business partners. They no longer need to master the entire production of an item through hyper-specialisation. Countries can produce one or more tasks of a final product so that they can master a particular task, maximising productivity and technology usage. The facts have confirmed that within three years of linking to the global value chain, an economy has the capability to increase by 20% on a per capita basis and create better quality jobs. 

 

Increasing market size through liberalised trade policies 

Domestic market size and limited local inputs are always a constraint for small countries. Negotiating trade liberalisation agreements with other economies may offer a solution. Import and export regulatory measures such as tariffs and quotas may limit the country’s ability to be integrated with the global value chain at large. Cross-border activity efficiencies should be increased to their maximum level, reducing the cost of imports and exports and the time taken for such activities.    

 

Cross-border facilitation and National Single Window (NSW)

The National Single Window comes into the picture in providing the above mentioned facilities in a very methodical and efficient manner. The National Single Window for foreign trade is a facility created using information technology and telecommunication platforms initiated by a Government to facilitate import, export and transit bureaucracies by offering a single point for the submission of standardised information and documents in order to fulfill official demands and facilitate logistics. 

It handles all public and private administrative procedures in foreign trade. This single submission may be lodged through a single window for reuse across a range of Government agencies by trader organisations and even by individuals. The basic principles of a single window are built on this single submission of data, hence, it may be reused by the system wherever required without additional data entry. 

Further, single window attributes include a single point of payment, improved business processes at Government agencies and speedier turnaround for approvals and decisions. It gives an opportunity for traders and their agents to connect with ministries of trade, agriculture, health, food security and finance and so on to electronically lodge licence applications and customs declarations.

It is a known fact that information technology advancement and innovation have produced great benefits for international trade development. Automated Custom clearances, port operations and import and export authority requirements were able to be complete much more effectively than before. In an increasingly globalised environment, many economies needed a much more effective system than the automated customs operations from the 1980s, namely Asycuda.  

Many single windows were implemented globally and the ‘Doing Business Index’ for the first time in 2017 went to the extent of measuring the effectiveness of single window systems through Trading Across Borders. It is considered a system which receives trade-related information and disseminates it to the Government authorities and many private sector stakeholders and individuals.

 

Taxation, challenging situation for global value chain

The different tax systems that exist in countries are creating a challenging situation for the global value chain and product fragmentation by adding to the cost of production, making the final product uncompetitive in the market. So countries are under pressure to maintain corporate tax levels at a more competitive rate and attract more Foreign Direct Investment and domestic investment through global value chain integration and fragmentation. 

Lowering the cost of transportation and communication services as well as improving the quality of such services will have a positive impact on the economy. Many multinationals make serious decisions to relocate their production facilities based on these the aspects. Policy consistency is also considered a sensitive factor for making business decisions.   

(The views expressed do not constitute any opinion of the institution or employer that the writer is affiliated to. The writer can be reached through bandudissanayake@gmail.com).

 

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