As Developing Economies Grow, Global Value Chains Reach a Turning Point

In the “flying geese paradigm,” Japanese economist Kaname Akamatsu explains that companies restructure to find the cheapest labor costs by moving low-value activities to nearby less-developed countries. Today that story rings truer than ever before as global value chains (GVCs) reach a critical turning point. Simply put, GVCs take a broader look at supply chains coordinated by multinational companies, but also encompass economic analyses of the countries involved with the activities.

Last year, for the first time in history, developing economies attracted more foreign direct investment (FDI) — 52% — than developed economies, according to the latest FDI report from the United Nations Conference on Trade and Development (UNCTAD) and the World Trade Organization (WTO). The impact of this report on GVCs, say Wharton and industry experts, could be profound.

“There is an enormous amount of change going on. The global supply chain is in flux,” notes Wharton operations and information management professorMorris A. Cohen. International supply networks have been in place for decades now, but the pace of global trade expansion has skyrocketed past the rate of the world’s GDP growth. “The recession of 2008-2009 has further increased trade with developing economies,” adds Anthony Mistri, economics expert at the World Trade Organization (WTO). “Nations may have borders, but businesses no longer do.”

How GVCs Are Changing

In 1990, developing countries had a 20% share in global trade. Today, that figure is more than 40%. Moreover, transnational companies coordinate around 80% of global trade, according to UNCTAD. This impact is particularly significant in developing economies, where value-added trade contributes to nearly one-third of a country’s GDP compared to almost one-fifth in developed nations.

The more foreign investments there are in a country, the higher the level of participation in GVCs, thereby resulting in higher domestic value added from trade. Moreover, developing economies with effective GVC participation can increase GDP per capita growth by 2% above average, says Axèle Giroud, an expert at UNCTAD who helped author the report. But that kind of change doesn’t happen overnight.

GVCs adapt dynamically, but depending on the sector, supply chains are shifting in different ways. “You see the disintegration or fragmentation of value chains in manufacturing,” says Wharton management professor Ann Harrison. But in agriculture, you see the opposite going on. Agribusiness is becoming more and more integrated.”

“Current technological advancements have made production processes become more fragmented,” Mistri adds. “Better communications have facilitated operating at a distance, not only for raw materials or components planning, but also in services and management. Participation in GVCs can commence with the smallest of components — and don’t involve building a complete new factory — creating more opportunities to participate.”

China has jumped to third place from sixth place as the world’s biggest investor, behind the U.S. and Japan, Giroud says. Though China is still officially categorized as a developing economy, Cohen adds, it’s debatable whether the nation is “developing” or “developed.”

According to Wharton operations and information management professorMarshall L. Fisher, China “is no longer the cheapest place to produce things, and it has accelerated people’s thinking about where to go from here.” Indeed, while Chinese labor costs are growing 20% annually, wage hikes in the U.S. are inching up by 2% due to lack of jobs and the recession, Cohen notes, adding that “the labor advantage is eroding, and the tipping point” could bring jobs back to the U.S., a phenomenon called ‘re-shoring.’ General Electric recently announced that it is reopening a manufacturing plant in Kentucky, and Apple plans to start assembling Mac Pros in the U.S., the company said in June.

“Near-shoring” could potentially move jobs to Mexico from Asia. China itself is setting up suppliers in lower labor-cost markets, like Vietnam, Cambodia and Indonesia, says Cohen.

Challenges and Solutions

While experts have long accepted Asia as the go-to region for cheap labor, that reality is quickly changing. Though Africa is one of the least developed continents, it is also the region with possibly the most potential. “FDI declined significantly worldwide by 18%, whereas inflows to Africa increased by 5%. That’s a really positive sign for Africa. It may not sound high, but it’s significant when everywhere else decreases,” notes Giroud.

Even so, while developed economies retain 31% of the value added from exports, Africa retains only 14% and Asia 27%, according to the UNCTAD report. That’s partly because extractive industries contribute to a large part of Africa’s exports, yet the processing end is woefully underdeveloped. Edwin Keh, a Wharton lecturer and former chief operating officer of Walmart’s global procurement division, calls it “the curse of the abundance of natural resources. Year after year, oil and minerals were pulled out of the ground. [African countries] didn’t need to manufacture anything to make ends meet. But what happens when these resources go dry?” he asks.

For example, Africa is the world’s biggest producer of cashew nuts, but about “90% of the crop gets exported raw to countries like India and Vietnam and then sent to the U.S. or Europe for roasting, salting and packaging,” says Miriam Gyamfi of the African Cashew Alliance (ACA) in Ghana. “That means that Africa, the biggest producer of cashews, is missing out on the most profitable part of the cashew value chain — the processing of the nut. ACA’s mission is to [help] African cashew industries by enabling access to finance, providing technical assistance and setting up market linkages to international industries.” The organization works with companies like Kraft, Costco and Red River Foods.

In comparison, processing and manufacturing in Asia account for a significant part of export value, thereby retaining more economic benefits regionally.

These disparities mean that developing countries need to plan a more sophisticated approach to maximize their role in GVCs with “good infrastructure, education and know-how; market access; the ability to produce at internationally recognized standards; security of finances, and geopolitical stability, to only list a few,” says Mistri. “Basically, the more entrepreneurial risks a country can mitigate, the higher the chances are it can attract multinational firms.”

According to Fisher, “in the last two to three years, Africa has been more prominent on people’s radar screen as potentially the next frontier.” Adds Keh: “The attraction [of] Africa is that people who get there first make the most money. The continent of Africa is significantly underdeveloped compared to China and Latin America.”

Another challenge is political stability. “We need law, rules and regulations, and globally accepted practices for accounting,” Keh notes. “We need orderly transition of governments and an effective civil service. Joint ventures can build up an economy, but we need long-term agreements that will stay in place for 10 to 15 years.”

Peter Draper, a senior research fellow at the South African Institute of International Affairs, adds, “There have been lots of problems with governments in Sub-Saharan Africa. Governments have been open to lobbying, corruption and all of that. It’s getting better but we have a long way to go.”

Meanwhile, African entrepreneurs have come up with innovative ways to adapt to some of these obstacles, says Mistri. For instance, M-Pesa is a mobile finance system that relies on cell phone networks, not brick-and-mortar banks. Bethlehem Tilahun Alemu, founder of soleRebels, an eco-friendly footwear company based in Ethiopia, manages her shoes and sandals from raw materials to finished products within the country before she ships $6 million worth of goods worldwide annually. “Developing nations, as soleRebels has shown, must be willing to reinterpret how they present their assets and then find ways to re-position and re-leverage those assets globally. In doing so, they will uncover a lot of unseen potential,” says Alemu.

In Spain, this business strategy has worked for clothing brand Zara. Harrison notes that the company has kicked the global trend by designing all of its goods and manufacturing about half of them in Spain. “The reason they give is they can respond rapidly to fashion trends. It’s worked for them,” Harrison says.

According to Isaac Esseku, an entrepreneur working on a venture to establish grocery retail chains in Ghana, “There is not a clear supply chain to try to engage the local produce. There are no refrigerated storage facilities so there is a lot of wastage. The transportation system with traffic and bad roads is a challenge. In the Western-style grocery chains in Africa and the developing world, it’s easier to sell imported packaged goods from Europe because they have a really long shelf life.” His plan is to expand local supply chains in concentric circles to create regional networks.

“The truth is [local supply chains] are not a priority for the government. The government should rightly focus on basic infrastructure, like roads and electricity, but [those efforts] are taking too long,” says Esseku. “Agriculture as an export commodity, like cocoa, is emphasized, but there should be an element of sustainable local agriculture to create a circulation of wealth within the system.”

The trick with GVCs “is not to rely only on the vertical chain to pull small-scale producers into productivity and prosperity,” notes Bill Vorley, a researcher at the International Institute for Environment and Development in London. He points to the success of the Kenya Tea Development Agency, which comprises 150,000 shareholders and runs a total of 63 tea processing factories. The collective has developed a partnership with Unilever, giving it a boost up the supply chain ladder. Another example, adds Harrison, is Olam International, which works with farmers in Africa to sell food ingredients worldwide. The organization started by exporting raw cashew nuts from Nigeria to India in 1989. Since then, it has moved its headquarters from London to Singapore and operates more than 16 platforms in 65 countries.

“The competitive advantage of China and Hong Kong is they have a developed supply chain. They start with raw materials and end with manufactured final products,” says Keh. Their expertise is leading to a rise of “South-South” investments, notes Harrison. “Multinationals in emerging markets are investing in other emerging markets. You see the Chinese investing in Africa, or Taiwanese and South Korean subcontractors making apparel in Indonesia. They can go into emerging markets very successfully.”

Solutions for a New World Order

As GVCs reach more complex levels worldwide, transnational companies and developing countries need to find ways to mutually benefit. “We need to think more dynamically … to synthesize trade and investment policies. We can build domestic capacity to support global firms so they give attention to social and environmental factors,” says Giroud.

“Developing regional strategies by integrating investment trade, joint capacity-building and cross-border industrialization” is one the first steps for emerging economies, suggests Giroud. Another recommendation, says Draper, is “establishing special economic zones that promote manufactured exports and allow duty-free imports. Any type of policy tried successfully elsewhere could work.”

At the end of the day, Keh adds, “global supply chains are all about total supply chain, upstream and downstream, from raw materials to final assembly. The developing world is disappearing. We’re a global society with big capacity for growth.”

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