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Global Value Chains

Author Names: Mohammed Faiz Shaul Hamid, Khalid Ibnou Walid Kane,Ahmet Enes Demirhan

Global Value Chains

Making Markets Work for Development

Author Names: Mohammed Faiz Shaul Hamid, Khalid Ibnou Walid Kane, Ahmet Enes Demirhan, Ahmed Elkhodary

IsDB Strategy
Development can be driven by the competitiveness of industries that are connected to the global market through GVCs.

This focus on value chains allows the Bank to prioritise its projects in areas with highest impact and at the same time provide greater opportunity for countries to be interconnected through the GVCs.

Although there has been steady progress in manufacturing output and employment, this in itself is not enough. The Report of the United Nations Secretary General on Progress of SDGs in 2017 calls for renewed investments to double the industry’s share of GDP by 2030.

The Bank’s move in championing value chains in MCs supports this agenda and allows markets to mobilise resources for development. To address these needs, IsDB is adopting a completely new business model that promotes a change of narrative for development by adopting a growth mindset focused on sustainable value creation. Changing global production patterns and trade will have an immediate impact on the developing and least developed countries, which often experience a disconnect between the state and private sectors, driven by changes in external markets affecting opportunities for production and trade at the domestic level. Such changes require the state to view the global production process from the angle of GVCs and to adopt new industrial transformation policies.

Policymakers, in turn, need to understand global firms and assess linkages within GVCs as well as build the productive capacities that would allow countries to move up the value addition ladder. Successful participation in GVCs can instigate higher levels of productivity and profitability in participating sectors. Given that GVCs shape global trade flows and current global trade patterns reflect a network of GVCs, it is important that IsDB MCs are ready to participate in them.

The Bank’s approach to GVCs is based on the belief that all countries, including those that do not have natural resources, should be able to connect to value chains and that industrial policy should be targeted at enabling this sort of inclusivity. Increasingly, production processes are organised around GVCs, with many countries’ inputs to larger GVCs consisting of trade in tasks rather than in goods. IsDB is working to ensure that MCs prioritise GVCs in their national development plans so that they can take advantage of an enabling environment for engagement with GVCs.

This is especially critical since more than half of manufacturing inputs consist of intermediate goods and more than 70% of service imports consist of intermediate services. The Bank believes that the resulting enhanced inclusivity and product specialisation associated with GVCs will boost sustainable growth. IsDB is taking a proactive and forward-looking approach to identifying potential value chains, using a methodology that focuses on country competitiveness based on industries and products.

In this way, the Bank can help its MCs to use all the tools at their disposal to meet their targets regarding the SDGs. Value chains also have considerable significance as a core part of the basis of engagement with MCs through Member Country Partnership Strategies (MCPS). This allows for prioritisation of projects on the basis of their potential to achieve sustainable and inclusive growth while promoting industrialisation.

In the past, countries with low resources were unable to enjoy the benefits of GVC participation because of the complexities of identifying a value chain for a particular country. The Bank’s new approach to GVCs ensures that no country misses out on engagement with GVCs, since it enables low and medium-income countries to join in the global network.

The issues that will be discussed are centered around IsDB MCs participation in GVCs, the impact and examples of GVC approach in development, the success story of industrialization and integrating in the GVC for Malaysia and empirical findings on GVC approach. The discussion will be with the following background:

At the country level for members of the Bank, participation in the GVC or international trade for manufactured products is quite limited. Evidently, the manufacturing value added (MVA) share per GDP for all member countries has gradually declined from 13.7% to 9.91% between 2001 and 2016, and at the same time the share of manufacturing in total employment and value added is still low (SESRIC, 2017). The Bank’s MCs also face huge trade deficits in manufacturing products and manufacturing activities, with the exception of a few member countries such as Turkey, Malaysia and Indonesia. This shows that most MCs have insufficient capacity in manufacturing and rely heavily on imports for manufactured products, weakening their competitiveness in the global economy.

The most alarming impact for MCs is the widening trade deficit for manufactured products. As demonstrated in Figure 4, the top 10 HS2-level products with huge trade deficits have been growing larger since 2001 to 2017. Product of HS84- Machinery, mechanical appliances grew from $22 billion to $142 billion during this period. At the same time, other essential manufacturing products also reveal a widening trade deficit.

The huge trade deficit in these products supports the idea of a growing over-reliance on external imports for manufactured products and the inability of the IsDB MCs to catch up in the GVC. Persistent and growing trade deficits also have negative consequences for economic growth and stability. Empirical studies have found positive correlations between unemployment and trade deficits, which is a general challenge faced by most member countries (Felbermayr, Prat, & Schmerer, 2010).

At the level of manufacturing industries, IsDB member countries recorded only 3 out of 25 manufacturing industries with a trade surplus; the other 22 industries had a trade deficit. The manufacture of petroleum products (without crude oil), wearing apparel and non-ferrous metals were the only industries with trade surpluses. The over-reliance on manufactured imports reflects the fact that member countries are not able to integrate into the global production network in an effective manner.

At the Bank member-country level, there is only quite limited participation in the GVC or international trade for manufactured products. Among the 25 manufacturing industries, there are only 4 where the Bank’s MCs have a revealed comparative advantage: manufacture of food, manufacture of petroleum products, manufacture of rubber products and manufacture of non-ferrous metals. There are two general themes reflected in these manufacturing industries. First, these industries involve no transformation (in the case of raw materials) or a low level of transformation, particularly in the last three industries listed. Second, the manufacture of food in the Bank MCs usually involves rudimentary processes with a low level of complexity, making it vulnerable to technological disturbances.

The key issue in the value chain is how producers—whether firms, regions or countries—participate in the global economy rather than whether they should do so. If they get it wrong, they are likely to enter a ‘race to the bottom’; that is, a path of immiserizing growth in which they are locked into ever-greater competition and falling incomes. A comprehensive value chain analysis provides a key entry point into this evaluation as well as into the policy implications that arise, including addressing the nature and determinants of competitiveness. Such an analysis also makes a particular contribution in raising the sights from the individual firm to the group of interconnected firms by focusing on all links in the chain (not only on production) and on all activities in each link (for example, the physical transformation of materials in the production link). This comprehensive analysis thus helps to identify which activities are subject to increasing returns and which are subject to declining returns.

The ability to make these distinctions between the nature of returns throughout the various links in the chain can essentially guide policy-makers in formulating appropriate policies and making necessary choices. These may include interventions that may protect certain links in the value chain or facilitate the expansion of the links in order to generate greater returns or exports.