Ganeshan Wignaraja (ADB) | Building global supply chains for economic transformation: lessons from Asia

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Photo credit: Yang Aijun / World Bank

11 December 2015

The world’s trade ministers are concentrating on the outcome of 10th World Trade Organization (WTO) Ministerial Conference in Nairobi and its aftermath. The intense discussions under the Doha Development Agenda seek to advance a multilateral trade deal and to restore credibility in the WTO’s trade negotiating function. But the real issue for trade ministers is whether latecomer African economies can emulate the success of first mover East Asian economics in joining global supply chains and achieving rapid economic transformation.

Global supply chains have been an important feature of the world economy for several decades. They refer to the geographical location of stages of production (such as design, production, assembly, marketing, and service activities) in a cost-effective manner. Different production stages are increasingly located across different countries, linked by a complex web of trade in intermediate inputs and final goods. For instance, the Toyota Prius – a hybrid electric mid-size hatchback car – for the United States market was designed in Japan and is presently assembled there. But some parts and components for the Prius are made in Thailand, other Southeast Asian economies, and the Peoples Republic of China. This type of sophisticated industrial organization is a far cry from the simple textbook notion of a single large vertically integrated factory situated in a country.

Global supply chains are sometimes labelled as production fragmentation, global value chains, or global production networks but essentially mean the same basic concept with subtle differences. This new pattern of international specialization is intertwined with the international integration processes of globalisation and regionalization. It is also underpinned by corporate strategies of multinational firms, technological advances (e.g., information, communications, and transport technologies), developments in logistics and trade facilitation, and falling barriers to trade and investment. Global supply chains were initially visible in clothing and electronics and have since penetrated a wide range of industries including consumer goods, food processing, automotives, aircraft, and machinery.

The role of services in global supply chains are increasingly important but have been underestimated due to serious data problems. Small and medium enterprises (SMEs) can participate in global supply chains initially as suppliers to large exporters and then gradually become independent exporters or investors.

The structural transformation of East Asia from a poor, less developed agricultural periphery to become a wealthy global factory over half a century is considered an economic miracle. The extent of East Asia’s participation in global supply chains is significantly greater than elsewhere and has spurred the region’s global rise to the coveted “Factory Asia” league with rapid economic growth over a long period. In 2009-2013, East Asia accounted for 48% of global supply chain trade compared with 28% for the European Union and 7% for the United States. Eastern Europe and Latin America each had 6% of global supply chain trade. However, Africa is a relatively small player as it accounted for less than 1% of global supply chains. As wages and other business costs rise in East Asia, it is possible that some global supply chains (e.g. in clothing) may shift to latecomers including Africa.

Adjusting business strategies and national policies have been critical for expanding East Asia’s role in supply chain trade. The size of firms matters when joining supply chain trade – being a big firm naturally creates advantages to participating in supply chains, due to a larger scale of production, better access to technology from abroad, the ability to pay higher wages for skilled labour and to spend more on marketing. It is key for economic transformation to work with large firms. Hence, smart business strategies, such as mergers, acquisitions and forming business alliances with multinationals or large local business houses, are rational approaches.

East Asia’s experience suggests that under some circumstances, nimble SMEs can also join supply chains. By clubbing together in industrial clusters, SMEs can overcome some of the disadvantages of being small and rely on the benefits of interdependence. Small firms located in clusters can jointly finance a training centre or a technical consultant to upgrade skills. Business associations can facilitate clustering by mitigating trust deficits to cooperation among SMEs, and by coordinating collective actions for cluster formation. For instance, major industrial clusters are located in Vietnam near Hanoi and Ho Chi Minh City, where large firms are surrounded by thousands of SME suppliers and subcontractors making garments, agricultural machinery and electronics goods.

The national policy environment – which consists of myriad incentive and supply side interventions (such as investing in physical infrastructure, upgrading education and training, and support from technology institutions) – also matters for firms in supply chains in East Asia.

The coverage and quality of business support services counts. The better and more affordable the type of technical, marketing and professional services firms especially SMEs have around them, the more the chances they grow and enter supply chains. A sound and effective financial system (with specialist financial products and institutions) is crucial. Modern and cost competitive physical infrastructure – particularly transport, telecommunications and electricity – is another. Finally, open trade and investment regimes which transmit price signals and induce competition are important. So too is streamlining procedures to business start-up and operation.

More controversial perhaps is resorting to industrial policies to support the entry of particular sectors or firms into global supply chains. The experience of East Asia is replete with some successes and many costly failures in the use of industrial policies. Some often cited examples of failures include Korea’s Heavy and Chemical Industry push, Malaysia’s National Car Project (the Proton Car) and the Peoples Republic of China’s home grown 3G mobile Technology (TD-SCDMA). More research is needed on what works and what does not, as there is a high risk of government failure associated with the application of industrial policies.

East Asia’s experience underlines that there is no one-size-fits-all approach to helping latecomers including firms in Africa to join supply chains. Smart business strategies, facilitating business associations and supportive national policies are all useful ingredients, while firms and governments working together is essential to tailor these ingredients to national circumstances.

 

References

1. Baldwin, R., and J.V. Gonzalez (2014). Supply-Chain Trade: A Portrait of Global Patterns and Several Testable Hypotheses. The World Economy. Online version. DOI 10.111/twec.12189.
2. Athukorala, P, (2011), Production Networks and Trade Patterns in East Asia: Regionalization or Globalization? Asian Economic Papers 10(1): 65–95.
3. Wignaraja, (2016 edited), Production Networks and Enterprises in East Asia: Industry and Firm-level Analysis, Springer.
4. Wignaraja, G (2015). Factors Affecting Entry into Supply Chain Trade: An Analysis of Firms in Southeast Asia. Asia and the Pacific Policy Studies, 2:3, pp.623-642, September. http://onlinelibrary.wiley.com/doi/10.1002/app5.78/abstract.