GVCs and developing countries

Thursday, 25 July 2013 00:23 -     - {{hitsCtrl.values.hits}}

Global Value Chains (GVCs) are very much in fashion today. GVCs can be described as cases where different stages of production of a particular item are spread across many countries according to the most optimal location factors. A result of globalisation, GVCs have a dispersion of value chain activities such as design, production, marketing, distribution etc. across a number of countries. GVCs coordinated by Trans National Companies (TNC) are said to account for some 80% of global trade. According to the UNCTAD report, due to the global economic fragility and recovery taking longer than expected, FDI in 2013 is expected to remain close to 2012 levels while an increasing trend could be expected in 2014 and 2015. In 2012 for the first time, developing countries absorbed more FDI flows than developed countries, accounting for 52% of global inflows. Developing countries also generated almost one third of global FDI outflows and continued on this upward trend. As reinvested earnings can be an important source of finance for long term investment, the report notes that the rate of return on FDI, which is 7% globally, is higher in developing countries at 8% and transition economies at 13% than in developed countries, which is at 5%. On average, nearly one-third of global FDI income was retained in host countries while two-thirds were repatriated. The share of retained earnings has been highest in developing countries at about 40%, showing the importance of FDI earnings as an important source of financing. Indian TNCs are said to be leading developing countries in FDI inflows, particularly to LDCS. The importance of GVCs being such, recently a WTO initiative known as Aid for Trade – a subject on which WTO has regular meetings – at its recent annual meeting dealt specifically with this subject. Aid for trade has now become tied up with the subject of GVCs as developed countries who are aid for trade givers work through their TNCs in giving aid. While the importance of GVCs in aiding the development of a developing country’s economy cannot be ignored, a recent publication by UNCTAD on global investment trends in 2013 highlights the risks involved. As most governments are keen to attract and facilitate foreign investment as a means of productive capacity building and sustainable development, national investment policy making is getting increasingly geared towards new development strategies. Patterns of value added trade in GVCs determine the distribution of actual economic gains between individual economies and are shaped to some extent by the investment decisions of TNCs. Countries with a greater presence of FDI relative to the size of their economies tend to have a higher level of participation in GVCs and to generate relatively more domestic value added from trade GVCs. They have a direct economic impact on value added, jobs and income and helps developing countries to build productive capacity through technology innovation and skill building and industrial upgrading. With all its plus factors, UNCTAD notes that GVC involvement is not without risks. GVC contribution can be limited if only a small share of the value addition chain is captured or if the value addition is relatively low. There can also be negative effects on environment, society, working conditions, occupational safety and health and job security. Also footloose activities could increase vulnerability to external shocks. Therefore the report points out the need for countries to make a strategic choice whether to promote GVCs, after weighing the pros and cons of such participation, keeping in mind that such participation is only one aspect of a country’s overall development strategy. If a country decides to actively promote GVC participation, the report advises policy makers to first determine where the country’s trade profile and industrial capabilities stand and then evaluate realistic GVC development paths for strategic positioning. Involving GVCs for upgrading opportunities requires a structured approach by including them in industrial development policies and creating a conducive environment for trade and investment and by having infrastructural prerequisites and building productive capacities and skills in workforce of local firms. In order to mitigate the risks of GVC participation, there should be a strong environmental, social and governance framework with strengthened regulation and enforcement and capacity building support to local firms for compliance. UNCTAD also proposes three other initiatives to minimise the adverse effects: synergistic trade and investment policies and institutions, regional industrial development compacts and sustainable export processing zones. The first of these three initiatives is suggested because trade and investment policies often work in silos and in the context of GVCs they can have unintended and counterproductive reciprocal effects. Governments must carefully review policy instruments which simultaneously affect investment and trade in GVCs. Also, at institutional level, there should be close coordination and collaboration between trade and investment promotion agencies. The second initiative is suggested because the relevance of regional value chains underscores the importance of regional cooperation. Regional industrial compacts could encompass regional trade and investment agreements focusing on liberalisation and facilitation and establishing joint trade and investment promotion mechanisms and institutions, etc. Such developments call for partnerships between governments in the region between governments, and between public and private sectors. The third initiative, sustainable export processing zones are important hubs for GVCs as they can offer benefits to GVCs. In addition to the existing benefits, they could offer expanded support services to become catalysts for CSR efforts. Therefore, transforming EPZs into centres of excellence is important. All in all, GVCs are important particularly for developing countries to develop their economies. But as the UNCTAD report points out, careful planning is required to minimise the risks of them being a crucial instrument of development. (Manel de Silva holds an Honours Degree in Political Science from the University of Ceylon, Peradeniya and has engaged in professional training in Commercial Diplomacy at ITC and GATT. She has served as a trade diplomat in several Sri Lankan Missions overseas and was the first female Head of the Department of Commerce as Director General of Commerce.)

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