Россия и ВТО: присоединение и его последствия / Текущая аналитика / Paper Review for Chapter 7 of GVCs development report 2019 “Should high domestic value added in exports be an objective of policy?”, written by student-ITS18-Xuhui (Emma)

Paper Review for Chapter 7 of GVCs development report 2019 “Should high domestic value added in exports be an objective of policy?”, written by student-ITS18-Xuhui (Emma)

Introduction

Global value chains make it easier for developing countries to move away from export reliance on unprocessed primary products to become exporters of manufactures and services. As a developing country moves from export of primary products to export of manufactures and services via GVCs, the ratio of domestic value added to gross export value tends to fall. Developing countries often start out at the end of value chains, with labor-intensive assembly of parts produced elsewhere. For some individual products the ratio of domestic value added to gross export value can be very small, maybe only a few percentage points. The gross exports from the country can be very large, but this is an artifact of the position in the value chain. The country’s value added contribution to the export is much smaller. Many developing countries worry about this phenomenon and aspire to increase their value added contribution to exports. There are a number of reasons why this objective should be approached cautiously. It may seem like simple math that a higher domestic value added share means more total value added exported and hence more GDP. But that simple idea ignores the reality that imported goods and services are a key support to a country’s competitiveness.

The decline of domestic value added in exports in Japan, the Republic of Korea, and Chinese Taipei

After two decades of dedicated work among international economists in measuring international fragmentation, a consensus has more or less formed, that the trend of domestic value added in exports is declining. Starting from autarky, when the economy opens to trade, there are several reasons why the domestic content of exports would begin to decline. Opening up to imports of intermediate goods and services means that a country’s producers have access to the most competitive inputs and will make use of some of them. The decline in the share of domestic value added in exports in many cases is also the result of structural change in the export basket. So, in general, we observe a declining domestic value added ratio over time. Further, this indicator does not have direct welfare implication, so it is not appropriate to formulate policies around pursuing a higher domestic content ratio in exports.

For Japan, annual input-output tables date back to 1973. It is evident that the domestic content in overall exports has declined, decreasing roughly 0.12 points from 1973 through 2014. It can be seen that the domestic value-added ratio (DVAR) in manufactures is always below that of total exports, reflecting differences betweenmanufactures and primary products. The latter have relatively few intermediate inputs, and hence few imported inputs. The structural shift away from primary exports towards manufactured exports would pull down the DVAR in overall exports. In addition, various waves of trade liberalization gave Japanese producers better access to imported goods and services for production.

For the Republic of Korea, annual input-output tables date back to 1985. It is observed that the aggregate ratio of the domestic content in exports declined, with most of the change since 1995. As in Japan’s case, several factors may account for the decline in the ratio of domestic value added to export value, such as the continuing trade liberalization, international production fragmentation, and structural shift from primary exports to manufactures.

For Chinese Taipei, annual input-output tables date back to 1960s, and the domestic content of exports peaked in 1969 with a ratio of roughly 79 percent. Domestic content has fallen sharply over time, reaching 48 percent in 2011. Hence, the overall decline was around 30 percentage points, which is remarkable. Different from its Asian peers such as Japan and the Republic of Korea, Chinese Taipei is a typical small open economy. Given the growth of international production fragmentation, along with Chinese Taipei’s steady trade liberalization, it is expected that the ratio of domestic content to exports would see a sharp decline. As a strategy for the developing regions to integrate into the world economy, joining global production is one of the shortcuts. This is particularly true for small open economies. In this way, the domestic industry structure is no longer a prerequisite for producing internationally competitive products, as they can specialize in some particular stage of production, e.g. processing and assembly activities.

Developing countries’ experience of joining GVCs

This section will analyze the recent experiences of developing countries by comparing the domestic value-added (DVA) in exports and its implications for the labor market.

There is no single strategy that works for every economy. Each country has to realize the economic activity that can be integrated into the GVCs. Viet Nam, for example, has increased the backward linkages, that is, the use of imported goods and services in its production of exports.Viet Nam has primarily participated at the production and assembly stage of manufacturing sector (light manufacturing, electrical equipment, electronics etc.) Viet Nam has been able to shift a significant proportion of workers from the relatively less productive agricultural sector to the more productive manufacturing and services sectors. This remarkable progress has been achieved by embracing trade and investment openness by signing a Bilateral Trade Agreement with USA in 2002 and joining the WTO in 2007. These agreements encouraged Viet Nam to reduce the import tariffs and improve infrastructure to attract foreign direct investment (FDI). These policies resulted in importing better quality inputs as well as related services and focusing on the stage of production (primarily assembling and processing) where the Vietnamese firms/workers have comparative advantage.

In contrast, Indonesia has not seen much change in backward linkages since 1995 as its specialization lies in natural resources and hence, it has strengthened its forward linkages since then. Indonesia joined the global value chains in relatively upstream industries. Indonesia’s GDP per capita has also grown three times during the same period, though, this phenomenal growth has come through forward linkages in GVC participation.

In order to highlight the implications of directly targeting the DVA in exports as a national policy for development, we can compare Bangladesh and Pakistan’s approach towards the exports in the textile and clothing sector. The biggest exports of both countries have been textiles and clothing. Pakistan, being a cotton producer, incentivized the textile producers to use the local inputs and export the finished products. Bangladesh, mostly importing the raw materials for textile and clothing, focused more on the trade reforms and opening up the economy to foreign investors. Bangladesh integrated its textile and clothing sector in the global value chains, sourcing most of the raw material from abroad and exporting readymade garments to the developed world. This helped Bangladesh to slowly convert its comparative advantage in clothing into competitive advantage over time by using better quality inputs as well as foreign services by collaborating with the leading garments manufacturers. It can be seen that Bangladesh’s exports have risen much faster as compared to Pakistan despite having lower DVA in exports.

Another good example of the contrast between global integration and import substitution comes from the auto sector in Malaysia and Thailand, neighboring countries at similar stages of development. Malaysia tried to develop an indigenous auto industry and a national champion brand through protectionist policies, whereas Thailand strove to join GVCs around existing brands by attracting FDI from Japanese and American companies. Thailand’s strategy enabled it to integrate into successful value chains and become a significant exporter of auto value added, primarily via parts. Malaysia’s effort did not produce a globally competitive car and eventually had to be abandoned.

All the examples discussed above suggest that participation and integration into the GVCs help the economies to improve their trade competitiveness, achieve higher GDP per capita growth and improve female labor force participation despite falling DVA in gross exports. Global technological advancement as well as falling trading costs have resulted in the fragmentation of production across borders. This reduction in trade costs helps the firms to exploit the comparative advantage of each country in the specific stage of production and hence, there is a reduction in DVA in gross exports.

Policies for technological upgrading

Technological upgrading is an important part of the convergence process. Developing countries that are integrated into the global economy generally have had more rapid total factor productivity growth – our best way to measure technological advance – than the already developed economies. Developed economies are at the frontier and have to invent new technologies, which is costly and difficult. Developing countries can absorb already existing technologies through direct foreign investment and learning. As they progress, it is natural for developing countries to begin spending resources on inventing new technologies so the more advanced developing economies are both absorbing existing technologies and innovating new ones.

We conclude from these patterns that it is reasonable for a developing economy to aspire to more rapid technological advance, which will contribute to higher living standards both directly and indirectly (because technological advance raises the return to investment and encourages capital accumulation). In certain periods, this may lead to an increase in the DVAR, but in the long run it is likely to lead to declines in DVAR as has been witnessed in all of the advanced economies. It is an easy mistake for developing countries to see the causality going the other way.

From a policy point of view then, developing countries should encourage technological advance but remain indifferent to whether inputs are sourced locally or internationally. That is a choice best left to the firm. There are policies that countries can use to encourage technological innovation, such as support for STEM (science, technology, engineering, and mathematics) education, subsidies to R&D, intellectual property rights (IPR) protection, and openness to foreign trade and investment.

Every economy in the world has an opportunity to join GVCs irrespective of the type of human and physical capital available in the economy. If the domestic economy has relatively higher skilled workers like Singapore or Hong Kong, China, they will join the GVCs at higher value-added segment like designing or high-end services (like marketing, financial etc.). On the contrary, if the economy has relatively more unskilled workers, it would join the GVCs in lower value added segments like assembly and packaging. Even if the economy joins at the lower value-added segment, it still helps the economy to generate more and better job opportunities for the unskilled workers. Every country needs to assess how skilled (or unskilled) the workforce is, which region it is located in and what comparative advantage it can exploit to join the GVCs in a specific sector. Once it is integrated, to enhance the value-addition (or move up the value-chain), following the Chinese example, the domestic economy needs to invest in upskilling workers, R&D and technology adoption by firms, as well as supporting ICT and physical infrastructure by converting comparative advantage into competitive advantage. If the economy tries to increase the DVA in exports by artificially supporting the inputs/intermediates by using tariffs and non-tariff measures, it will increase the cost of production and make the product less competitive in the international market, resulting in reduced demand for the product as well as workers in the exporting sector and will also affect the productivity and quality of the domestic firms as well, adversely affecting the welfare in the society.

(https://www.wto.org/english/res_e/publications_e/gvcd_report_19_e.htm)

Россия и ВТО: присоединение и его последствия

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