Making Global Value Chains Work for Development

PART I

WHY GVCs REQUIRE FRESH THINKING

Part I begins by asserting that global value chains (GVCs) must be rethought for the twenty-first century. Chapter 1—Here’s Why—shows that the new GVC-enabled flow of know-how from high-income countries to low- and middle-income countries is a key factor in determining the role of GVCs in industrialization and development. From a policy perspective, the critical issue is how GVCs integrate into the economy as a whole and how to maximize the benefits from technology transfers, knowledge spillovers, and increased value addition. But it is equally important to ensure that participation in GVCs benefits domestic society through more and better-paid jobs, better living conditions, and social cohesion.

To exemplify how this book can help policy makers find answers to that challenge, chapter 2—Consider Bulgaria—provides a case study of Bulgaria. The study shows how analysts can make use of the quantitative tools described in part II of this book, as well as the strategic policy framework developed in part III to identify a country’s position in GVCs, its scope for upgrading, and policies that can help achieve that goal.

Chapter 1

HERE’S WHY

Introduction

Global value chains (GVCs) can be thought of as factories that cross international borders (box 1.1).¹ Producing high-quality goods and services in GVCs involves more than simply trading goods and services internationally; it also entails the cross-border movement of know-how, investments, and human capital. When Toyota makes car parts in Thailand, it does not rely on local know-how. Instead, it imports Toyota technology, management, logistics, and any other bits of know-how not available in Thailand, because Thai-made parts have to fit seamlessly with parts made in Japan and elsewhere. GVCs, in effect, unbundle factories by offshoring firm-specific know-how along the stages of production, and those international flows of know-how are a key reason why GVCs offer unprecedented development opportunities to participating countries.

Box 1.1. Defining GVCs

From a business organization perspective, value chains describe the sequence of productive (value-added) activities that capital and labor (or firms and workers) perform to bring a good or service from its conception to end use and beyond.a Value chain analysis is intended as the science of identifying bottlenecks and opportunities between different stages of production and tasks. Value chains are said to be global when they include steps, processes, and actors from at least two countries;b they can be regional if the scope of production takes place within the same geographic region. From an economic perspective, the phenomenon of global value chains (GVCs) identifies a production structure in which tasks and business functions are distributed among several companies, globally, or regionally.c The key features of GVCs are therefore the international dimension of the production process and the contractualization of buyer and seller relationships, often across international borders.

GVCs, in effect, integrate the know-how of lead firms and suppliers of key components along all the stages of production and in multiple companies and offshore locations. Typically coordinated by lead firms, GVCs involve international trade flows within their networks of foreign affiliates (foreign direct investment), contractual partners (non-equity modes of investment), and arm’s-length external suppliers.d Well-functioning supply chains—which define the physical movement of goods all along the value chain, including domestic and international segments—are a key concern in GVCs. This is the case because good logistics, which defines the art of managing the supply chain and includes good connectivity, streamlined procedures for imports and exports, and low cost of logistics services, is an important determinant of countries’ ability to join and strengthen participation in GVCs and a key factor in determining the costs of sourcing from and supplying to global markets. Getting to the border is one of the most pervasive constraints for exports of firms in low- and middle-income countries (LMICs), while the costs of logistics services can be disproportionately high for smaller and younger firms or for more remote locations. Improving logistics is also where LMICs have the most potential to reduce trade costs, according to recent surveys. Finally, well-functioning trade facilitation measures enable GVC trade by reducing the time, cost, and uncertainty involved in importing and exporting.

But most production processes do not happen in a sequence of dependent activities. Instead, they take place in more complex networks of production, in which participating firms are specialists in one activity and external international sourcing arrangements imbue inter-firm trade with characteristics similar to intra-group trade: better control from the center, higher levels of bilateral information flow, tolerance of asset specificity, and harmonization and immediate integration of business processes that increase the potential for foreign activities to integrate seamlessly with activities performed at home. Large brand-carrying multinational enterprises (MNEs), such as IBM, Siemens, and Toyota, nowadays rely on a complex web of suppliers, vendors, and service providers of all kinds and in multiple locations. At the same time, a set of highly influential global buyers gained scale and influence in the 1990s, including retailers such as Walmart and Tesco and branded merchandisers such as Nike, Zara, and Uniqlo.e Building on successful experiments in the 1970s and 1980s by a handful of pioneering retailers, such as J. C. Penney and Sears, global buyers nowadays place huge orders with suppliers around the world without establishing any factories or farms of their own.f Unlike traditional MNEs, where equity ties link headquarters with foreign affiliates, global buyers link to their suppliers through non-equity external sourcing ties. Often, intermediaries (for example, trading companies such as Hong Kong SAR, China’s Li & Fung) are used to link buyers to producers in multiple countries.

To highlight the complexity of the interactions among global producers, recent literature makes reference to the concept of global production networks rather than chains.g Accordingly, in the more realistic metaphor of networks, links can be seen as connecting nodes, some more central and some more peripheral. Given the predominance of the term GVCs in the literature, this report uses it to refer generically to chains, networks, or both. When more specific references are needed, they will be explicitly mentioned in the text.

Capital and labor are not the only factors of production. Ideas can be singled out as a third factor of production, although they could also be understood as high-skilled labor input. In a global context, the value-added activity performed in one country crosses international borders in goods or services tasks. Different tasks of the value chain contain a different amount of such factors of production. For example, specialized workers tend to be necessary in higher value-added tasks of the GVC. In the automotive, electronics, and electrical appliance industries, ideas are more strongly embedded in the early preproduction stages, such as research and development and design, or in postproduction (logistics, marketing, and branding), thus requiring such specialized workers in those tasks. In other industries, notably the craft-based ones (such as furniture making), innovation development is maximized when ideas (product design) and manufacturing operations are joint,h because innovation in those sectors often stems from a bottom-up approach.i

a. Porter (1985); Sturgeon (2001).

b. Gereffi and others (2001); Gereffi, Humphrey, and Sturgeon (2005).

c. Grossman and Rossi-Hansberg (2012).

d. UNCTAD (2013).

e. Feenstra and Hamilton (2006).

f. Gereffi (1999); Ponte and Gibbon (2005).

g. Henderson and others (2002).

h. Buciuni, Coro, and Micelli (2013); Pisano and Shih (2009).

i. Breznitz and Murphree (2011).

Internationally fragmented production is not new. For decades, low- and middle-income countries (LMICs) have imported parts from countries with more advanced technology, although generally only for the assembly of locally sold goods. Because the goods produced were not part of a global network, flows of know-how were less intense. The new characteristic of GVCs from a development perspective is that factories in LMICs have become full-fledged participants in international production networks. They are no longer just importing parts for assembly for local sales. They are exporting goods, parts, components, and services customized to the needs of the intended buyers and used in some of the most sophisticated products on the planet.

Given the need for customization and integration of production facilities internationally, large multinational corporations (MNCs) seek to improve local innovation, knowledge-based capital, and competencies. The Samsung Group—which employs 369,000 people in 510 offices worldwide—worries about shortages of technical and engineering skills in Africa and how those shortages affect its efforts to embed its African workforce in Samsung’s global production networks. In 2011, to address such shortages, Samsung launched Samsung Electronics Engineering Academies in Kenya, Nigeria, and South Africa. Outstanding performers are sent to annual Learnership Programs in Seoul as part of Samsung’s program for young leaders. The initiative serves the company’s broader goal to develop 10,000 electronics engineers across the continent by 2015.² Other corporations are investing in building the skill base in LMICs, too.³ Lucent Technologies supports education and learning programs in 16 countries throughout Africa, Asia, Europe, and Latin America; Nike and the United Kingdom’s Department for International Development run a program to support access to economic assets for adolescent girls; Microsoft provides support to incorporate information technology (IT) into the daily lives of young people in the Philippines, Poland, the Russian Federation, and South Africa; Cisco provides funds, expertise, and equipment to create national networks of IT training centers in India, Mexico, South Africa, and the West Bank and Gaza, in addition to the work of the Cisco Networking Academy, which has 10,000 academies in 165 countries; finally, Nokia enhances life skills and leadership skills of young people in several countries, including Brazil, China, and Mexico.

The new GVC-enabled flow of know-how from high-income countries to LMICs is a key factor in determining the role of GVCs in industrial development. LMICs can now industrialize by joining GVCs without the need to build their own value chain from scratch, as Japan and the Republic of Korea had to do in the twentieth century.⁴ That enables LMICs to focus on specific tasks in the value chain rather than producing the entire product, thereby lowering the threshold and costs for industrial development. LMICs can benefit from foreign-originated intellectual property; trademarks; operational, managerial, and business practices; marketing expertise; and organizational models.

The result is that a new policy framework has emerged in which imports matter as much as, if not more than, exports and in which the flows of goods, services, people, ideas, and capital are interdependent and must be assessed jointly (box 1.1). Countries that understand the opportunities that GVCs offer and adopt the appropriate policies to mitigate the risks associated with them have the opportunity—through GVCs—to boost employment and productivity in all their agriculture, manufacturing, and services production. Job creation and labor productivity growth are sometimes viewed as competing goals, as higher labor productivity enables firms to produce a larger amount of value added without necessarily increasing the number of workers at the same rate (static productivity effects).

Research shows that GVC integration leads to higher net jobs but lower job intensity⁵ and has strong potential for productivity gains via several transmission channels (dynamic productivity effects), as discussed later in this chapter, which go in hand with increased labor demand caused by more vertical specialization and higher output in GVCs.

Firm and Policy Perspective

Connecting Factories and Protecting Assets When Doing Business Abroad: The Firm Perspective

The international location of new production facilities is ultimately in the hands of GVC lead firms. Conceptually, the new possibilities created by globalization and the information and communications technology revolution create two distinct sets of necessities for firms, which countries must address: (1) connecting factories and (2) protecting assets. Because cross-border factories must work as a unit, lead firms in GVCs care about efficiently connecting local factories with the relevant international production network and protecting proprietary assets.

The predictability, reliability, and time sensitivity of trade flows are important factors behind firms’ decision about a location, according to major trade and competitiveness indexes and case studies.⁶ In many cases, countries cannot participate in certain parts of GVCs because of requirements for timely production and delivery. In effect, time is money in GVCs. A day of delay in exporting has a tariff equivalent of 1 percent or more for time-sensitive products.⁷ Slow, unpredictable land transport keeps most of Sub-Saharan Africa out of the electronics value chain.⁸ Lead firms and intermediate producers in GVCs need reliable, predictable, and timely access to inputs and final products to satisfy demand on time. Hence, good infrastructure and efficient borders are critical, as they relate to the predictability, reliability, and time sensitivity of trade