The international dimension of industrial policy: Opportunities and challenges from the new global environment

1. The international dimension of industrial policy: Opportunities and challenges from the new global environment Bineswaree Aruna Bolaky Africa Section Division for Africa, LDCs and special programmes United Nations Conference on Trade and Development UNCTAD

2. Outline of Presentation • The multilateral system at the WTO • Rising powers of China, India and others • Climate change • Global Value-Chains Source: UNCTAD (2011). Note: Any use of the material from this presentation must be please referenced as UNCTAD’s work.

3. Purpose of presentation • Examines the challenges and opportunities facing African countries stemming from: current and emerging international trade rules; the rise of industrial powers from the South; concerns about climate change; and the phenomenon of global-value chains. • Makes suggestions on how African countries could either overcome the challenges or seize opportunities created by the changing global environment to push their industrialisation agendas forward

4. The WTO and the shrinking of policy space • Over the past two decades, the global environment has changed significantly in many respects. International trade is increasingly under regulation in ways that limit the policy space available to governments, and developing countries are beginning to play important roles in the global market for manufactured goods, with consequences for the ability of African countries to penetrate export markets. In addition, concern for climate change is generating interest in the use of environmentally-friendly technologies and methods of production. Furthermore, production is increasingly being fragmented and located across national borders thereby intensifying competition. • The strategic design and implementation of Africa's industrial development programmes will have to take into account these new realities because they have implications for the choice and feasibility of policies to promote industrialisation.

5. The WTO and the shrinking of policy space • Since the establishment of the World Trade Organisation (WTO) in 1995, the scope of the rules-based-trading system has shifted from a narrow focus on trade in goods, under the General Agreement on Tariffs and Trade (GATT), to broader issues such as trade in services, intellectual property rights, and trade facilitation. • Furthermore, unlike in the GATT, there has been more enforcement of compliance with trade regulations under the WTO (DiCaprio and Gallager, 2006). • There are concerns that the widening scope and enforcement of trade agreements and rules have limited the set of instruments and policies that developing countries could possibly use to promote industrialization (Njinkeu and Soludo 2001). • With respect to Africa, the shrinking of industrial policy space under current and emerging trade rules is evident in the following areas: - The imposition of tariff cuts under the emerging, but not yet finalized, "Non-Agricultural Market Access" (NAMA) negotiations; - Regulations on subsidies imposed under the Subsidies and Countervailing Measures (SCM) Agreement; - The Trade-Related Investment Measures (TRIMs) Agreement; - The Trade-Related Aspects of Intellectual Property Rights (TRIPS) Agreement and; - The replacement of preferential trade agreements with reciprocal Economic Partnership Agreements (EPAs) in conformity with WTO rules.

6. The WTO and the shrinking of policy space 1. Tariff liberalisation under NAMA • Under the emerging NAMA rules in the Doha round negotiations, developing countries, with the exception of LDCs, have to reduce their import tariffs on industrial products and bind tariff rates below a certain ceiling. Developing countries have the option, however, of applying deeper cuts in tariff lines in exchange for greater flexibilities and vice versa. Flexibilities are in the form of exempting a certain percentage of sensitive product lines from tariff cuts as long as their import shares in total NAMA imports do not exceed a certain threshold. However the exemption of a whole sector from tariff cuts will not be possible. This implies that non-LDC African countries will have less room for pursuing import-substitution strategies behind high tariff barriers or through gradual and selective tariff liberalisation. This is further compounded by the insertion of the "national treatment" principle in WTO laws, whereby foreign firms and foreign goods are to be granted the same treatment as local firms and locally produced goods in the country. • Developing countries will apply tariff cuts according to a "Swiss" formula. Countries that apply the deepest tariff cuts will be able to "make smaller or no cuts in 14% of its most sensitive industrial tariff lines, provided that these tariff lines do not exceed 16 percent of the total value of its NAMA imports". • That country can also keep "6.5 % of its tariff lines unbound or exclude them from tariff cuts, provided they do not exceed 7.5% percent of the total value of its NAMA imports" (WTO). LDCs will not face tariff reductions but will have to raise the percentage of their tariff lines that are bound. • The WTO text mentions that additional flexibilities will be negotiated at a future date for South Africa, Botswana, Lesotho, Namibia, Swaziland and members of the South African Customs Union (SACU). According to the WTO, "the tariff reductions will be implemented gradually over a period of five years for developed members and ten years for developing members, starting 1 January of the year following the entry into force of the Doha results".

7. The WTO and the shrinking of policy space • Proponents of NAMA reforms argue that, in a low-tariff world, developing countries will benefit in the form of increased market access for their industrial products to other countries, especially developed countries. For instance, in developed countries the proportion of industrial imports entering on a duty-free basis has jumped over the last fifteen years from 20 % to 44%. • However, critics of NAMA reforms argue that the emerging rules will lead to de-industrialisation in countries that are in their early stages of industrialisation (Shafaeddin 2006). • Furthermore, they argue that the parameter of interest for developing countries should not be the average industrial tariff rate imposed by developed countries on imports but the actual rates imposed by the latter on the exports of interest to developing countries. It is not clear that such rates have been considerably lowered in return for increased market access. • There is also the fear that NAMA liberalisation will lock poor developing countries into their current or existing patterns of export specialisation. In order to build dynamic comparative advantage in higher value-added activities, entrepreneurs need to be rewarded with higher expected returns in exchange for the higher risks involved in undertaking strategic investments in new industries and new technologies. However the emerging trade rules will make it harder for developing countries to turn to selective tariffs and subsidies to provide such returns to their entrepreneurs (Shafaeddin 2006).

8. The WTO and the shrinking of policy space 2. Subsidies • With respect to the use of subsidies as a tool for promoting industrial development, under WTO rules subsidies linked to either export performance (export subsidies) or the use of domestic over imported goods (local content subsidies) are prohibited, except for LDCs and countries with less than US $1,000 GNI per capita. • When linked to export performance, export subsidies can provide appropriate incentives to domestic firms to invest in building their competitiveness rather than stay complacent. However, such type of subsidies can no longer be used. Other types of subsidies, for example production subsidies, are allowed but are now actionable which means that their use can be challenged if deemed to damage the interests of other parties. In import-competing industries with high sunk costs, there may be a case for subsidizing production by domestic infant firms, albeit temporarily, in order to promote greater entry and more competition in the long-run. As a result of WTO rules, it is now more difficult to nurture local infant industries through subsidies.

9. The WTO and the shrinking of policy space 3. Investment measures • The Trade-Related Investment Measures (TRIMs) Agreement under the WTO prohibits countries from using local content or trade balancing requirements. In addition, as discussed in the preceding section, countries cannot subsidise firms to favour use of domestic inputs over imported ones. • This means that these industrial policy instruments used by currently advanced and emerging economies, are no longer available to the non-industrialised countries. While Brazil for instance was able to use local content requirements to establish a local auto manufacturing industry, Indonesia had to review the local content provisions of its National Car Program in 1999 under the WTO (DiCaprio and Gallager, 2006). • Under the TRIMs agreement, countries can no longer use local procurement programs to minimize import leakage rates, optimize the domestic value-chain and promote the building of production linkages across sectors in their industrial policy programs. • TRIMs also prohibits the use of performance requirements in FDI policies for the purpose of maximising benefits from FDI such as promoting use of local industrial products, inserting local enterprises in the production chain of transnational corporations (TNCs) and facilitating technology transfer to local suppliers.

10. The WTO and the shrinking of policy space How developing countries have used FDI to promote industrial development? • Amsden (2001) identifies 2 groups of countries: • The independents whose characteristics are (i) minimal reliance on FDI and MNCs; (ii) technology development of the country relies on strengthening domestic firms and a heavy emphasis on domestic skill building and R&D (iii) a pervasive use of industrial policies to create national champions. In some cases the state acts as a venture capitalist or as a pioneer. • The second group, called integrationists, itself comprises 2 groups • Active integrationists rely on spillovers from MNCs to access new technology and make a significant use of selective policies to move into high value-added activities • Passive integrationists: do not select MNCs but attract them through the use of a large number of welcoming policies, offering a stable macro-economic environment, low wages, disciplined and semi-skilled labour and a good location

11. The WTO and the shrinking of policy space How developing countries have used FDI to promote industrial development? • South Korea clearly belongs to the independents group. FDIs were permitted only if they were the only way of obtaining some technologies or gaining access to world markets. But even in those cases, they were subject to tight state control • During the industrialization process, the Taiwanese government also made a substantial effort to attract FDI in technologically advanced sectors in which domestic firms were still very weak. • The government sought to maximize benefits from FDI for domestic firms by (i) promoting local sourcing and subcontracting (ii) imposing local content rules and (iii) introducing the obligation for foreign firms to transfer skills and technology to subcontractors, with the objective to raise the technological capabilities of domestic firms. • At the other extreme, Singapore’s technological upgrading process has been dominated by MNCs which provided state-of the art technologies and access to global networks. Singapore’s government attracted MNCs by using a wide set of welcoming policies, selective instruments in skills, technology and infrastructure. All these policies were directed at meeting the specific needs of selectively targeted FDI.

12. The WTO and the shrinking of policy space 4. Intellectual property rights • The "Trade-Related Aspects of Intellectual Property Rights" (TRIPS) agreement, through its strict intellectual property protection regime (IPR), makes it harder for developing countries to access and adapt foreign technology for local industrial development purposes. • India was able to take advantage of a weaker intellectual property regime under GATT to develop a local pharmaceutical industry based on generic drugs. Such a scenario would not have been possible under TRIPS. • It has been pointed out that countries such as Japan, Korea, Taiwan or even the USA would not have been able to achieve their current levels of technological sophistication had they faced IPRs of the strength required by TRIPs in their early stages of industrialisation. • Furthermore, there is the concern that IPR can prevent developing countries from engaging in technological learning through imitation and reverse engineering of mature foreign products in the early stages of industrialisation (Lall and Albaladejo 2003; Kim 2002).

13. The WTO and the shrinking of policy space 5. Economic partnership agreements and WTO compatibility • The preferential trading arrangements that existed between the European Union (EU) and Africa under the Cotonou and Lomé accords have to be replaced by the so-called Economic Partnership Agreements (EPAs) in order to make them compatible with WTO rules. • Although full EPAs are yet to be finalised between the EU and most African countries, decisions reached in the negotiations will have important repercussions on the future industrial policy space of African countries. • For example, while some proposed EPAs allow the use of export taxes in special circumstances such as protection of infant industries, they also specify that export taxes cannot be allowed to increase or that their use is subject to periodic review. • In addition, the EPAs contain stand-still clauses that do not allow countries to increase or re-impose tariffs that had been eliminated and to introduce new tariffs once the EPAs have been signed.

14. The WTO and the shrinking of policy space 5. Economic partnership agreements and WTO compatibility • These two instances represent an important loss of policy flexibility for countries in the course of implementing their industrial strategies and adapting such strategies to changing circumstances. Export taxes have historically been used as a means to support local infant industries, generate value-added by promoting the local processing of raw materials into industrial goods, and raise government revenues. • Successful examples include support to the plywood industry in Indonesia in the 1980s, and support to the textiles industry in England in the period 1275-1660 (Third World Network 2009). • Furthermore, the EPAs contain a "Most Favored Nation" (MFN) clause which obliges African countries to extend to the EU any concessions granted to other development partners, whether on tariffs or non-tariffs issues. This may compromise the ability of African countries to grant preferential treatment to developing-country partners such as China, India and Brazil that could play an important strategic role in Africa's industrialisation.

15. The WTO and the shrinking of policy space • The emerging rules guiding trade and investment under the WTO and EPA will no doubt constrain the industrial policy space of African countries. • However, the following points should be noted. • First, the negotiations under the WTO and the EPA are still ongoing and have not yet been cast in stone. Therefore, African countries still have an opportunity to influence the final outcomes of these negotiations to ensure sufficient flexibility in designing and implementing their industrial policies. • Second, despite the limits imposed by current and emerging trade rules, there remains some scope for African countries, particularly the LDCs, to engage in industrial policy-making. • Third, a few of the WTO rules, such as the provision of the TRIPS agreement related to technology transfer from developed countries to LDCs, offer opportunities for African countries to engage in industrialization, as long as they are creative enough in harnessing such opportunities to their own benefits.

16. The WTO and the shrinking of policy space Policy recommendations • Promote industrial growth by strengthening regional integration. • Make better use of instruments allowed under existing rules. • Foster South-South cooperation. • Seize opportunities created by the special treatment of LDCs • Use WTO provisions to further economic development objectives

17. Rising powers of China, India etc • The growing role of large developing countries such as Brazil, China and India presents opportunities as well as challenges for industrialisation in Africa • Opportunities: Through the attraction of foreign direct investment and non-equity modes of investment such as alliances, partnerships and subcontracting, Africa can benefit from its developing-country partners' expertise, skills and technology in designing industrial programmes adapted to its specificities and endowments. Furthermore, through partnership with developing-country TNCs Africa could develop technologies that are adapted to its industrial needs and produce industrial products adapted to the requirements of its low and middle income consumers. • Challenges: However amidst the opportunities also lie challenges. For example, there is some evidence that the rise of the large developing-country partners, particularly China, in the global market for light manufactured goods has had a harmful effect on sub-Saharan manufacturing exports

18. Rising powers of China, India etc • Within the South-South partnerships, Africa's relations with China and India assume paramount importance for 4 reasons. • First, China and India can be co-operative partners as well as the main competitors to Africa in industry especially manufacturing. • Second, like most investors in Africa, Chinese and Indian interests in Africa lie primarily in exploiting Africa's natural resources and this represents a danger in that further development in the Africa-China and Africa-India partnerships may accentuate the trend of Africa being a primary commodity exporter and an importer of manufactures (EDAR 2010), thereby delaying the structural transformation that industrialization is meant to engineer. Africa's pattern of being commodity dependent in its trading relations with the North should not be replicated with its Southern partners.

19. Rising powers of China, India etc • Third, as finance and investment with China and India rise at the expense of development assistance flows disbursed on governance conditionalities by Northern partners, there is the danger that this may undermine incentives for African governments to improve governance and overall competitiveness in Africa. As mentioned previously, improving competitiveness is an important element for attracting investments in industry. • Fourth, as China and India rise in pre-eminence in Global-Value Chains, whether as producers or consumers, this has important implications for Africa in terms of harnessing its partnerships with the two Asian countries to position itself in these GVCs as suppliers.

20. Rising powers of China, India etc FACTS AND FIGURES ON INDIA/CHINA • China and India in 2009 accounted for 13.7% of global manufacturing exports and judging by the phenomenal growth rates of their manufacturing sectors over the past 10 years, expectations are that this share will increase further in coming years. • Manufacturing value-added growth in China averaged a yearly 12.9% for 2005-2008 and 11.1% in 2000-2005. In India yearly manufacturing growth averaged 8% for 2005-2008 and 6.9% in 2000-2005. Comparable figures for the world were 1.5% and 2.9% respectively, for Africa 5.9% and 2.9 % and for developing countries bar China 5.4% and 4.3%.

21. Rising powers of China, India etc FACTS AND FIGURES ON INDIA/CHINA • China is a world production leader in several 2-digit ISIC lines of production such as textiles (accounting for 43.2% of global production), wearing apparel (38.7%), leather, leather products and footwear (43.2%), chemical and chemical products (21.1%), basic metals (41.6%) and electrical machinery and apparatus (27.8%) (UNIDO 2010). • Among developing countries, China has no major close competitor in most lines of products. • The share of China in Sub-Saharan African (SSA) world manufacturing imports rose from 4.5% in 2000 to 15.1% in 2009 while India's rise was more modest shifting from 2.4% in 2000 to 5.3% in 2009.

22. Rising powers of China, India etc Impact of China and India on African manufacturing • There are claims backed by empirical evidence that cheap Chinese goods are flooding African markets thereby displacing local African industrial products and undermining intra-regional trade in Africa. • At a country level, there is evidence for instance from Ethiopia that small and medium enterprises in the footwear sector were forced to close or rationalize activity due to direct competition from Chinese imports (Tegegne, 2006). • Similar crowding out of African manufacturing exports by primarily Chinese competing imports are said to be occurring in Africa's traditional export markets such as the EU and the U.S and especially in low-cost manufactures such as footwear, clothing and textiles (Geda and Meskel, 2007; Giovannetti and Sanfilippo, 2009). • The case of the garment industry in Lesotho has been much cited as a victim of Chinese competition in third markets (Jenkins and Edwards, 2005).

23. Rising powers of China, India etc Impact of China and India on African manufacturing • Terms of Trade: The rise of China and India on the global manufacturing stage has led to a reversal of a trend in the manufacturing-commodity terms of trade. • While historically the case for industrialization has been grounded on the premise that manufactures are income-elastic and commodities are price elastic (Prebisch-Singer hypothesis), China and India have of late turned this hypothesis on its head. • By increasing demand for primary commodities and flooding markets with manufactures, China and India have been behind a decline in the terms of trade of manufactures relative to primary commodities (Kaplinsky, 2008). Given the size of their populations and their appetites for commodities, it is likely that the current terms of trade reversal may be more than a transient phenomenon.

24. Rising powers of China, India etc What are the implications of China and India on Africa's industrial strategy? • First, newly industrializing African economies may find it hard to engage in the traditional industrial growth trajectories based on developing first stepping-stone industries such as clothing, textiles, furniture and shoes and other low-cost segments due to intense Chinese competition in those basic industrial sectors (Kaplinsky and Morris, 2007). • African countries may need to adopt industrialization strategies that are from the start based on product differentiated, innovation-intensive, or technology-intensive niche products that offer continuous upgrading opportunities and with a marketing strategy emphasizing quality and branding

25. Rising powers of China, India etc What are the implications of China and India on Africa's industrial strategy? • However China’s threat in manufacturing to developing countries should not be exaggerated neither. • Research by Hanson and Robertson (2008) for instance demonstrates that China’s increased export supply capacity in manufacturing was only a modest negative shock to the 10 countries that were the most specialized in export manufacturing for the period 2000-2005. • There is evidence from the study by Geda and Meskel (2007) that, in the clothing and accessories sector, India's manufacturing exports were complementary rather than competitive towards African exports in third markets and that the displacing effect of Chinese manufactures on African exports were declining over time, even reversing to complementarity by 2004.

26. Rising powers of China, India etc What are the implications of China and India on Africa's industrial strategy? • Over time both China and India are likely to aim at moving up in the product value-chain, graduating away from producing low value-added labor-intensive products towards fabricating high technology, high capital--intensive goods and eventually acting as lead designers in GVCs, if not even move to other GVCs. • Such an upgrading by China and India will open up opportunities for Africa to integrate in GVCs and fill the manufacturing gap left behind by these 2 Asian giants in certain segments and categories of GVCs (e.g. manufacturing and assembly segment for labor intensive or medium-technology products).

27. Rising powers of China, India etc What are the implications of China and India on Africa's industrial strategy? • Second, in Africa export-orientation policies will have to be mixed with domestic-demand driven strategies, with the latter becoming more important as incomes rise on the continent and regional integration accelerates. • African firms will be facing increasingly competitive manufacturing export markets subject to increased volatility. Inroads in these export markets will depend on the region's ability to significantly improve its competitiveness and in being innovative at creating niche production lines in sectors facing rising world demand in order to stay ahead of the industrial curve. • The region should also consider diversifying into non-traditional export markets especially targeting the growing middle class in emerging economies.

28. Rising powers of China, India etc • Third, at a political level, the African continent needs to establish room for negotiating with China and India on economic-related matters and to do so with a coordinated voice. • Fourth, Africa needs to stand ready to exploit in turn the large industrial markets that China and India will create as its urban middle classes expand in years ahead. It is estimated that by 2030, 59% of the global middle class will originate from Asia compared to 23% in 2009, due to burgeoning emerging middle classes from China and India (Kharas, 2010). Buyer-driven GVCs will gravitate from Northern markets to the South (Kaplinksy and Farooki, 2010) with implications on the nature of industrial import demand. • While emerging economies such as Brazil, China, India, Malaysia and South Korea have a clear strategy in Africa, Africa does not seem yet to have a strategy towards them (UN, 2010). As stated in EDAR2010 report, African countries must harness and use its development partnerships to further its long-term development goals and doing so requires African countries to take a pro-active approach to the partnership process.

29. Climate change Constraints • Current and future international obligations on climate change mitigation and adaptation imposes constraints on how Africa should industrialize. • Imposition of environmental standards by developed countries on imported products • In the future environmental friendliness can become another dimension of industrial competitiveness, even more so if climate policies are linked to trade policies. Industries that fail to “go green” may be at a competitive disadvantage in the global marketplace. As the momentum to transit to low-carbon economies gathers pace, African industries may have no choice but to “go green” in the future in order to be competitive on world markets • But climate change also presents opportunities for Africa

30. Climate change • In particular, obligations to mitigate and adapt to climate change and to “go green”, though costly, can actually represent an opportunity for African countries. • As a latecomer in the industrial game, Africa has indeed an opportunity to be at the forefront of the green industrial revolution by implementing a green industrial development based on low energy-intensity, low carbon emissions and clean technologies. • While industrially advanced economies will have to bear the costs of transiting towards a low carbon economy in the medium to long-run, the continent has the opportunity to avoid such adjustment costs by leapfrogging directly into a “clean” industrial development right from the start. • Doing so will allow the region to develop “first-mover” advantages over other industrialized economies while waiting for investment and trade to be integrated in climate-friendly global policies. Future global policy developments for instance may link trade preferences accorded to developing countries to their mitigation and adaptation efforts

31. Climate change • Opportunity: Greening" industrial growth –implementing “green” industrial policies • Africa’s green industrial policy can be couched within a three-pronged approach that aims at: 1. Powering industrial production in Africa with clean, renewable energy sources such as solar, wind power or bio-fuels over fossil fuel sources. While historically, the African continent, especially Sub-Saharan Africa has not been a major emitter of GHG due to its low electrification rate and energy use, it is potentially the region, bar South Asia, where the highest growth rate in GHG could originate in the future, should the continent succeed in increasing access to electricity for its 587 million citizens that still live without it. Africa cannot industrialize unless it secures access to energy and water for its entrepreneurs. However in order not to impede world-wide efforts against climate change mitigation, that increased energy use needs to be mostly non-fossil based. While Africa needs to industrialize to achieve poverty reduction and development, it has to do in a sustainable way that limits the carbon use of its industry.

32. Climate change 1. Powering industrial production in Africa with clean, renewable energy sources such as solar, wind power or bio-fuels over fossil fuel sources. • The development of the renewable energy sector in Africa needs to go hand in hand with its industrial development. Africa’s green industrial policy needs to be accompanied by a renewable energy policy. Renewable energy is needed to fuel the region’s industrial growth while by itself the renewable energy sector can be a significant component of Africa’s industry. • Initiatives such as the one led by Desertec that aims at producing clean solar and wind energy in Northern African deserts to supply the EU-MENA region needs to be multiplied

33. Climate change 2. Lowering the energy intensity, resource intensity and carbon footprint of African industry, especially manufacturing by stimulating investment in, and adoption of, clean and energy-efficient technologies and methods of production 3. Positioning African industry as a supplier of environmental industrial products that targets “green” customers as part of Africa’s niche production export strategy. -identify potential “green” niches - integrate into “green” global value-chains

34. Climate change • So far only 13 African countries have established National Cleaner Production Centers (NCPC) that can assist in the promotion of clean production methods and environmentally sound technologies • The NCPC programme was established by UNIDO and UNEP to provide assistance to business, government and other stakeholders in implementing cleaner production methods, practices, policies and technologies in their home country. The programme now covers 47 developing and transition countries including in Africa Cape Verde, Egypt, Ethiopia, Kenya, Lebanon, Morocco, Mozambique, Rwanda, South Africa, Tunisia, Uganda, United Republic of Tanzania and Zimbabwe. • Throughout the region, greater investment is needed in Research and Development in the private sector and in Science and Technology at educational institutes. • To succeed on its green industrial pathway and be process and product innovative, the region will have to devote more resources at strengthening the nexus between universities, research institutes and business and at training scientists and researchers.

35. Global Value-Chains (GVCs) • What is a Value-Chain? The value chain describes the full range of activities that firms and workers carry out to bring a product from its conception to its end-use and beyond. That includes activities such as design, production, marketing, distribution and support to the final consumer. • An important feature of the new global environment is the increased internationalization of industrial production. • Production is being increasingly segmented in different stages located in different countries, according to the competitive advantages of each location. This so called globalization of the value-chain (or Global Value Chains) allows producers to improve on competitiveness by making better strategic use of available global endowments, skills and capabilities to lower costs. • It also creates opportunities for a greater number of countries to take part in the global industrialization process and in so doing spur their own national industrial development.

36. Global Value-Chains (GVCs) • See UNCTAD LDC Report 2007: Knowledge, Technological Learning and Innovation for Development (Chapter 2 and Chapter 3 on IPR) Opportunities from GVC • GVCs often represent one of the very few options — or perhaps the only one — for local firms and suppliers to secure access to larger (international) markets and to innovative technologies. • LDC firms can enhance their technological capabilities by exporting (learning-by-exporting) or, alternatively, they can become marginalized from GVCs. • Participation in GVCs may be associated to the upgrading of firms. In this perspective, four types of upgrading have been distinguished from enterprises (Humphrey and Schmitz, 2000): - Process upgrading is transforming inputs into outputs more efficiently by reorganizing the production system or introducing superior technology. - Product upgrading is moving into more sophisticated product lines in terms of increased unit values. - Functional upgrading is acquiring new, superior functions in the chain, such as design or marketing, or abandoning existing lower-value-added functions, so as to focus on higher-value-added activities. - Inter-sectoral upgrading is applying the competence acquired in a particular function to move into a new sector.

37. Global Value-Chains (GVCs) • For small firms in less developed countries, participation in value chains is a means of obtaining information about the needs of global markets and gaining access to those markets. • Although this information has high value for local small and medium-sized enterprises (SMEs), it is less clear what role the leaders of the GVCs play in fostering and supporting SMEs’ upgrading process. • Whether LDCs’ firms and farms will benefit from the relationships with foreign buyers depends on a number of circumstances that may or may not arise. The upgrading process is fraught with difficulties and obstacles, which are particularly great for LDC firms. • Issues: How to participate into buyer-driven GVCs? Barriers to entry, importance of reputation and trust (high transaction costs), Risks of exclusion and marginalization • Issues: Asymmetric power relations and the distribution of rents, switching costs • Issues: Upgrading and technological learning

38. Global Value-Chains (GVCs) Issue 1: Participation of LDCs in GVCs • Access to the fastest-growing market segments depends upon satisfying the demands of retailers and competing with other suppliers. Large retailers become gatekeepers to markets, hindering and/or fostering access. These difficult changes represent opportunities but may also threaten exclusion for those suppliers that are unable to respond to the challenge. • Since the mid-1980s lead firms have required more functional capacities (i.e. the range of activities, and the related conditions and skills, that suppliers are required to carry out) from first-tier suppliers in all cases, and sometimes also from second- and third-tier suppliers. At the same time, lead firms require higher performance levels from second-tier suppliers (i.e. compliance with standards for carrying out those activities). These increasing demands by buyers differ by sector and by specific value chain. • Buyers and chain leaders are becoming more and more demanding, but they do not necessarily provide support or transfer knowledge and capabilities. The key agents for knowledge transfer and organization vary from chain to chain.

39. Global Value-Chains (GVCs) • The “lead” firm may not be responsible for ensuring technical competence along the supply chain. In fact, much of the work of value chain organization and management is being outsourced by lead firms, which establish a first tier of suppliers and push responsibility towards them to an increasing extent. First-tier suppliers in turn increasingly rely on a series of second- and third-tier suppliers. Firms from LDCs rarely qualify — that is, they do not have the capacity, skills and volumes — to become first-tier suppliers, and in the best case may become second- or third- tier suppliers. • According to most recent empirical evidence, by far the most demanding entry barrier increases have been for first-tier suppliers (Gibbon and Ponte, 2005). This is perhaps less worrying for LDCs, as no firms from those countries play the role of leader, and very few that of first-tier (or often even second-tier) supplier. • What are the consequences of those increasing demands by buyers for second-tier suppliers in LDCs? The risks involved have been described as the risks of marginalization and exclusion (Gibbon and Ponte, 2005). The former refers to the possibility of downgrading within the same GVC and being relegated to less remunerative and more vulnerable segments of activity, while the latter refers to the eventual inability to enter, and being utterly excluded from global chains. • Public policies explicitly directed to favoring SME inclusion into GVCs may help

40. Global Value-Chains (GVCs) • See UNCTAD 2010: Integrating developing countries SMEs into Global value-chains UNCTAD (2010) highlights a series of policy recommendations that are relevant for African industries. It notes that promoting an enabling business environment is a prerequisite for SME's to integrate into GVCs. This can range from stable macroeconomic policies; streamlining and efficiently applying business procedures, laws and regulations; setting up complementary policies in competition, trade and investment to supporting human resource development and improving access to finance. Public policy interventions to support SMEs, should, according to UNCTAD (2010b), focus on skills development and training, investments in appropriate technologies for continuous technological upgrading, enhancing compliance with international standards, fostering linkages between SMEs and MNEs via specific promotion measures especially targeting MNEs that are known to establish linkages with SMEs, setting up business development services, promoting clusters such as setting up science and technology parks or industry villages, enhancing intellectual property protection and developing productive capacities.

41. Global Value-Chains (GVCs) • The uncertain support provided by global buyers and their variable engagement with local suppliers lead some authors to argue that LDCs-based firms should aim at “trading down” (Gibbon and Ponte, 2005). • This means consolidating their suppliers’ role, focusing on economies of scale, high specialization, and simple and labour-intensive technologies, and aiming at mass markets via large-scale retailers. However, if trading down implies withdrawing from the attempts to develop, strengthen and deepen technological capabilities, it should clearly not be the strategy for LDC suppliers. The search for specific market niches to exploit advanced capabilities always offers potential benefits. • However, if technological capability development comes together with “trading down” –– that is, a focus on high specialization, economies of scale and firm-size expansion –– this may be an option to choose on the basis of a very pragmatic and ongoing assessment.

42. Global Value-Chains (GVCs) • One of the few cases of detailed studies of specific GVCs in sub-Saharan Africa analyses cotton, clothing, citrus, coffee, cocoa, and fresh vegetables GVCs, concluding that there have been relatively few examples of clearly successful upgrading (Gibbon and Ponte, 2005). • Acquiring larger volumes — and economies of scale — appears central in most cases, and this sometimes suggests an interesting scope for regionalization (large regionally integrated markets) and for SMEs growing to medium-sized status. • Several Kenyan exporters consolidated their supply of fresh vegetables to United Kingdom supermarkets in the late 1990s by expanding their scale (including through investments in the United Republic of Tanzania), improving quality assurance, and diversifying into snow/snap peas and cut flowers. • Regarding cotton, the experiences from the United Republic of Tanzania and Zimbabwe are the opposite. While the former experienced downgrading in the 1990s, the Zimbabwean company Cottco consolidated its minor first-tier supplier status by vertically integrating into spinning of cotton knitting yarn, acquired a cotton concession in Mozambique and gained economies of scale in the regional market.

43. Global Value-Chains (GVCs) • Main strategy: Target niches and strengthen technological learning for upgrading