TNC FDI firms and domestic linkages: reflecting on SADC case studies

1. TNC FDI firms and domestic linkages: reflecting on SADC case studies Presentation of preliminary findings and issues arising from an UNCTAD funded project.Glen Robbins, Likani Lebani and Mike Rogan TIPS Seminar 25 April 2007

2. Structure of presentation • Background • Study brief and methodology • Issues of interest beyond the brief • FDI, TNC and SME debates informing the study • Country cases • Mozal • Lesotho aparrel • SA auto SMEs and Toyota • Reflections

3. Background to the research • What is UNCTAD? • Established in 1964, UNCTAD promotes the development-friendly integration of developing countries into the world economy. It focus on knowledge generation and inter-governmental processes around: • Trade • Investment • Enterprise development • Infrastructure and services • Thematic focus emerging from UNCTAD XI: “The Sao Paulo Consensus” – • Ensuring developing country gains from trade and FDI • Requires engagement with Trans-National Corporations • Enhancing competitiveness of developing country SMEs • These themes are likely to be endorsed again at UNCTAD X11 next week in Accra, Ghana

4. Study brief and methodology • Overall question: In what way can developing countries enhance linkages between TNC FDI firms and domestic SMEs? • Identify the major lessons from SME-TNC linkage programmes from 3 SADC case studies: • Mozambique: Mozal aluminium smelter • Lesotho: Clothing and textile investment related to AGOA • South Africa: SME suppliers and Toyota (from previous UNCTAD report) • Interview main stakeholders (TNC, government, SME and informed observers) • Review available project documentation and literature

5. Issues of interest beyond the brief • In a context where real and relative flows of ODA are in decline in relation to FDI, what is the scope for securing developmental impacts from FDI for developing countries? • ODA to developing countries was R70bn in 1990 and was R50bn in 2006 • FDI flows to developing countries were R50bn in 1990 and were at R300bn in 2006 • FDI can compensate for domestic savings shortfalls and reduce BOP imbalances. In what ways can it contribute to lasting structural change in developing country production and productivity dynamics? • To what degree do the sector dynamics of FDI activities influence the scope for widening the net of local benefit? • To what degree do host country relationships with major nodes of value chain governance (often represented by TNCs) impact on widening the net of local benefit? • What scope is there for different types of host country policy frameworks in widening the net of local benefit from FDI? Is it simply “a race to the bottom” or are there real points of leverage?

6. Knowledge informing the study • FDI and development • Capital shortfalls in developing countries result in a dependence on capital inflows (short and long term) to sustain economic growth • FDI projects often allow for exploiting opportunities to earn much needed export revenue to assist with balance of payments • FDI has been characterised variously as: • A critical element of any developing country strategy to achieve development goals • An extension of colonial dependencies that undermines sovereignty and exposes countries to capitalist exploitation • Policy interest has explored ways of enhancing hosting country gains from FDI (international regulation, domestic policy adjustment, capacity building) in a context where developing countries often engage in a “race to the bottom: to attract FDI (incentives, infrastructure discounts) • TNCs and development • TNC account for 10% of world GDP • Foreign affiliates of TNCs increasingly accounting for the majority of employment in many developing countries • Some estimates suggest 2/3 of world trade is generated with intra-TNC and inter-TNC networks • Developing country experiences with TNC have been variable and often exploitative • SMEs and development • The bulk of developing country economies are characterised by small and medium enterprises of varying levels of formality and capacity that provide a significant (if not the most significant) share of employment and domestic economic activity • Combinations of historic conditions, domestic policies, international asymmetries have contributed to the disconnections between these domestic SMEs and global economic processes • Facilitating linkages between domestic SMEs and TNC FDI firms is one of a number of possible strategies to enhance the gains from FDI through systemic improvements in firm competitiveness

7. FDI in SADC: The context • African FDI flows doubled 2004-2006 • Africa’s share of global FDI dropped from 3.1/% in 2005 to 2.7% in 2006 but is still higher than 1.2% in 1999 • African share of inward FDI dominated by extractive industries but services growing • Southern African trend heavily influenced by South Africa’s swings, but most countries FDI positive Southern Africa FDI inflows and outflows 2004-2006 • Lesotho and Mozambique have seen solid flows since 2000, although Mozambique FDI reflective of greater levels of capital investment • South Africa has had major swings depending on sales of interests, foreign listings etc. Case study country FDI inflows 2004-2006 (US$ millions)

8. Mozambique: FDI and the Mozal Experience

9. FDI Inflows 1992-2006 • Average GDP growth of 8% between 1994 and 2004 (IMF 2006) • Annual FDI has increased from US$21 million to US$153million between 1994 and 2000 (UNIDO 2002)- largely tied to mega project investments • Mega project intensive: 60-70% of total exports tied to mega projects (IMF 2006) (US $million) (Sources:UNIDO, UNCTAD and World Bank)

10. Aluminium Sector (Mozal) • Mozal smelter is the largest mega project in Mozambique and accounts for 75% of mega project contributions towards GDP, BoP and tax revenues (IMF 2006) • Southern Africa now produces 7% of the global aluminium supply and Mozal is currently one of the most efficient producers of aluminium in the world- exports 2% of global aluminium consumption (Pretorius 2005) • Mozal granted IFZ status which allows it to import inputs duty free, is exempt from VAT and pays no more than 1% of total sales as corporate tax (Castel-Branco 2004)

11. The Linkage Process • 1997- Linkages form a key component of the government’s Investment Attraction Strategy for 1997-2000 • 2001- SMEELP is initiated for a two year period to assist local firms to win contracts for the expansion of the Mozal plant • 2003- Mozlink I is introduced by Mozal to build on the successes of SMEELP • 2007- Mozlink II is an extension of Mozlink I and is planned to continue until the end of 2008. It is intended that Mozlink II be rolled out to other sectors.

12. Findings: Mozal • Success of linkages the result of a formal linkages programme initiated by government and supported by Mozal and international lending institutions = a good practice model • Mozal is perceived to be important by local SMEs themselves (Goldin 2004) • Between the first two phases of the linkage programme, local contracts increased from $US 5 million to $US 11 million • Evidence of SME expansion and increasing revenues (Goldin 2004) • Local SME performance has improved by roughly 20 per cent through the Mozlink programme (IFC 2007) • Challenges: • Low employment impact • Lack of transparency in contracts • How to work with other sectors where there is less TNC commitment • Driver project viability driven mainly by discount power and tax conditions

13. The experience of Lesotho with textile and apparel FDI

14. Background to apparel sector in Lesotho • Clothing industry dominated by export oriented manufacturing and subsidiaries of foreign owned firms (80% Taiwanese, balance China and SA) • Growth of clothing industry a result of the 2000 AGOA trade privileges. From 1999-2005, clothing industry grew form US$100m to US$460m. • Dominance of US markets, 93% of garments channeled to the US (for The GAP, Walmart, Levis etc) • Government has consciously focused on the garment industry due to its employment creation capacity • 40 000-55 000 workers employed in the garment industry out of a workforce of 84 000 • Clothing industry contributes 20% of GDP and 70% of exports

15. Global garment industry dynamics and country constraints • Post the MFA era a three-legged network has emerged: • production strategy & coordination is driven from Taiwan/Hong Kong; • Production – Lesotho; • Market strategy, design and sales – US/Europe • It is a buyer driven value chain but key decisions are taken on responses to this at production coordination hubs. Actual production hubs are very disconnected. • TNC articulated constraints which has impacted on the sector • Future status of 3rd country fabric provision • the Maloti-Rand which is pegged to the ZAR, Lesotho’s garments exports become less competitive when the Rand appreciates • Low productivity and wage demands • lack of local fabric mills (1 denim plant) • water quality and quantity • problems with solid waste disposal; • inefficient transport infrastructure impacting on lead times • excessive bureaucracy within Lesotho’s government departments • These concerns led to the formation by the Lesotho government of an Inter-Ministerial Task Team (IMTT) to address business concerns and create a viable environment for employment generating firms

16. Lesotho’s experience with linkages • This local SME service and supply linkages were not a priority for: • Government: “This is all about jobs” • TNC garment firms: “It is not our job to resolve the country’s economic problems. Things are already tough for us.” • Some attempts were made to secure outsourcing contracts but failed due to supplier shortcomings and financing problems. • Indirect linkages with a service orientation have been generated: • Accommodation • Transport • Business and legal services • New attempts are being contemplated by BEDCO but limited success forecast without comprehensive support mechanism

17. Findings: Lesotho apparel • Limited scope to engage local SMEs – Ownership structure, lack of interest by global players and the nature of global sourcing hinders linkage activities. Most decisions made in Taiwan - e.g. Trims pre-approved in Taiwan • No particular policy to create linkages, existing linkage activities are of an ad hoc and informal nature (e.g. transport, packaging, s-printing) • Lesotho government priority is employment creation and no consistent engagement has been pursued with TNC firms • Competition for FDI and the need to create employment is a major challenge for the government that dominates interaction • Lesotho SMEs lack the requisite capabilities to produce for TNCs. Major issues relate to quality, poor work ethics, pricing. • The combined effect of complex sector conditions, a meek government and unwilling TNCs does little to encourage linkages. • Is there any scope for Lesotho to use this TNC investment as a basis for future industrialisation? – especially with AGOA’s limited lifespan.

18. SA SMEs in Toyota’s global value chain

19. SMEs in South Africa’s auto sector • Prior to the restructuring of the early 1990s SA SME suppliers were: • Diversified operations supplying the auto sector as just one of their markets • Producing products of low value, low volume and low technical specifications • Operating licensed technology - much of it quite outdated • Reliant on personal and relatively informal trust relations rather than formal contracts • Often kept in the dark about OEMs strategy and price was the dominant aspect in many procurement decisions • Weak performers in relation to international benchmarks • One could conclude that they were marginal players in a relatively truncated South African automotive value chain

20. SMEs in South Africa’s auto sector • Since the early 1990s SME suppliers have: • Restructured relationships with domestic OEMs who have in-turn slotted in into global supply relationships • Needed to acquire complex standard and quality certifications • Either had to forgo the automotive market or to remain part of it • As aftermarket producers • As scaled up volume suppliers to the OEMs • Required major capital investment and re-organisation of production systems to maintain a foothold in automotive supply • Participated in emerging networks of collaboration between SME suppliers and the OEMs to deal with common problems • And have been supported through the Government’s Motor Industry Development Programme (MIDP) • Some supplier firms have strengthened their position in the value chain whilst for many their experience has been one of increased marginalisation

21. A look at some of the impacts • SA’s auto industry is now connected with the global arena: • Since 1995 exports experienced a 9-fold increase from R4.2 to R39.2 bn in 2004 • SA’s share of global auto production was 0.61% in 2000 and grew to 0.79% in 2006 • Total vehicle production in 2006 was 621 900 units – more than double the units produced in 1999

22. Toyota and its SME suppliers • In the late 1990s • TSA produced 80 000 units across seven model platforms • Almost exclusively for the South African market • It had 154 suppliers • 28% of suppliers to TSA could be characterised as global sourcing partners • In 2007 • TSA will produce over 200 000 units mainly across two models • 65% of production will be for export to Europe • The firm will have 78 suppliers (to be reduced in the next few years to 62) • 82% of suppliers which will be what TSA refers to as global sourcing partners • Global sourcing had seen South African costs for the production of the Corolla reduced by 32% in the past 5 years • Between 2003 and 2006 the proportion of supply into TSA from suppliers not party to global sourcing arrangements dropped from 41% of total sourcing to 18% • The value of local purchasing has increased in this period from R2.3 billion to R5.4 billion. Today 70% of the Hilux is sourced locally up from 60% five years ago.

23. Changing component supply proportions to Toyota SA Local SMEs Local SMEs Local SMEs Imports Imports Imports Locally based MNCs JVs: Local SMEs and MNCs Locally based MNCs OEM aligned MNCs Locally based MNCs JVs: Local SMEs And MNCs Prior to liberalisation Early liberalisation Alignment with Toyota GVC

24. Exploring SA’s SME policy response? • South Africa has sought to develop industrial policy and SME support systems favourable to: • reducing the bias against SMEs in the large-firm dominated economy, and • responding to growing international competition • However, the bulk of SME support has been geared to relatively recently established micro-enterprises • Some automotive component firms did qualify for some limited support such as that offered through manufacturing advisory centres • National sector strategies identified the imperative of supporting the role of SMEs and the MIDP created the space for a continued presence of SMEs in OEM supplier processes, but beyond creating the space there was little in terms of meaningful SME support • Government at the national, provincial and local level did, for a time, support nascent regional clusters of firms engaging in networking activities • It has been the locally framed cluster/firm networking activities – such as the Durban Auto Cluster and KZN Benchmarking Club - to which SME firms and OEMs attribute most of their linkage successes: MIDP was a necessary but not sufficient condition

25. Some reflections by the SA SMEs on GVC participation/linkages • Positive • Improved growth potential for firms on basis of increased volume orders allowing for scaling up • Investment and technical support • Access to knowledge networks of intermediary supplier firms • Greater strategic engagement on new model platforms • Negative • Threat to risk-diversifying non-auto activities – the need to specialise • Profit margins shrinking despite adoption of required standards • Inability to leverage many auto-supply systems and standards to other markets (no scope to recover investment through increased premiums) • Uncertainty about character of MNC suppliers acting as intermediaries with OEMs

26. Auto SME policy issues in SA • Supporting improved access of SMEs to GVCs must be combined with enhancing benefits to SME firms. This requires the examining of: • Global trade compacts, investment protocols and industrial policy frameworks • Continuous upgrading support for firms (quality, delivery reliability, innovation, lead time flexibility etc) • Countries need to continue to attend to basics of infrastructure quality, services costs and other operating environment factors in non-core sites where SMEs operate • Failure to address these weakens the SMEs links to chains of production • The importance of physical proximity for integrated JIT suppliers OEMs is being challenged by the growing importance of networked supply at key GVC nodal points – often via first tier suppliers … • Therefore SME support frameworks need to accommodate globalisation of firms and be flexible in relation to new geographies of firm activities • SMEs also continue to emphasise enhanced local networking with OEMs and their first and second tier follow suppliers. These need ongoing policy support with an emphasis on active and not just passive collaboration.

27. Reflecting on the 3 cases • FDI processes without negotiated and facilitated linkage effects to host country SMEs is a missed opportunity • Active facilitation and support from a range of institutions is critical to ensure the programmes function effectively • Firm and sector dynamics do matter in that they impact on the scope for and nature of linkage opportunities • The approach of TNCs to FDI in specific contexts is important – both in terms of TNCs position in the value chain and in terms of their attitudes • Host country governments, regional bodies and multi-laterals should work collectively to extend and enhance linkage processes alongside FDI related efforts in fields such as: • tax/royalty/incentives regimes • regulatory reform • export infrastructure