OF SUBSTANCE AND SPIRIT

We concluded last week our two-part series on engaging in global value chains (GVCs) as a possible way out of lower middle-income trap with the warning that there are risks surrounding it. If only to stress the significant impact of this route to breaking through the income barrier, we argued that its positive impact could more than outweigh the costs.

Emerging markets and developing economies (EMDEs) can take part in GVCs through backward or forward linkages. Backward linkages involve one country using inputs from another country for domestic production via direct imports by local affiliates of an international firm or indirect imports, as when locally-owned companies import inputs from other countries. Forward linkages are leveraged when one country exports inputs for production in another country.

As Adnan Seric and Yee Siong Tong wrote in Industrial Analytics Platforms in August 2019, under GVC arrangement, goods cross several borders in different stages of production before they are assembled into final products. One estimate puts this trade in intermediate manufactures as a good proxy of GVCs and since 1995 through the last decade, they account for about half of global manufactured exports and imports. 

The GVC business in Asia is characterized by more imports than exports of intermediates. Seric and Yee suggest that this is indicative that the region is more into assembly than processing intermediates into final products. One good example is China’s trade in Apple iPhone. Citing an ADB Institute study, the authors wrote that China exported these smartphones to the US at a unit price of $179, of which $172 was comprised of imports of foreign intermediates from Japan, Korea, Germany and the US. China realized only around $7, motivating it to ascend to higher levels of processing and value-added. China employed more sophisticated levels of technology, and more industrialization took hold. Recent reports estimate that China’s value-added in Apple iPhone exports has risen and local suppliers had more than doubled in subsequent years.

Yes, GVCs could be a practical option for EMDEs’ goal to industrialize and exit the low or lower middle-income trap. With such a fragmented arrangement for production and unbundling of operations, these economies can opt to avoid creating complete products or value chains that would in turn require higher foreign investments. They could establish targeted industries by phasing themselves into a particular stage of production along the value chains that are more suitable to their existing level of capability and economies of scale. There are multiplier effects on economic growth, employment and income generation and tax revenues. Knowledge transfer is also possible that could lead to industrial upgrading. Once this kicks in, we should see improvements in product quality, operations and processes as well as in motivation for higher-value production.

But risks have emerged from global trade, pandemic disruption and a possible global recession that could test GVCs “like never before” as the ASEAN + 3 Macroeconomic Research Office’s (AMRO) Hoe Ee Khor and Suan Yong Foo wrote three years ago. These risks continue to haunt the future of globalization and in turn, GVC business.

In the June 2023 issue of the IMF’s Finance and Development, Yale’s Pinelopi Goldberg and World Bank’s Tristan Reed confirmed AMRO’s assessment. Beginning with hyper globalization, in the 1990s onward, Goldberg and Reed cited its great economic achievements that included poverty reduction, greater access to wide variety of goods and services and productivity gains, and prosperity.

However, deglobalization began in 2015 due to some official anxieties about globalization and competition. That was how Brexit, US-China tariff war and the resurgence of extreme views in Europe actually came about. The emerging big winners of globalization, the superstar transnational firms, benefited enormously from hyper-specialization of GVCs. But many were also left behind. Deglobalization is more of a defensive posture by some economies affected by global competition and specialization.

Deglobalization seemed to have gained more momentum with the call for resilience when the pandemic crisis struck in early 2020. The demand for quick action became elevated such that even small delays were considered significant despite the challenge of generalized business lockdown. Demand shocks were also magnified because of the increasing number of mortalities due to the virus. Calls, mostly unjustified, against globalization triggered protectionist sentiment. 

Russia’s invasion of Ukraine also produced a new wave of trade risks from Internationalization. Such an invasion threw into disarray supply chains involving not only Russia and Ukraine but also other countries in the supply chain. Trade with China also sent jitters across the globe because anything could happen to the second biggest economy in the world, and global supply chains could also be upset. 

So far, what has been the experience of the Philippines with GVCs?

In what might be described as a seminal paper on the Philippines’ participation in GVCs, Adrian R. Mendoza in his PhD dissertation at the UP School of Economics in August 2019 entitled “Philippine Firms in Global Value Chains: Innovation, Governance and Upgrading,” argued that the “country has emerged as one of the most globally-integrated economies in the developing world. GVC participation of Philippine firms is strongest in electronics and transport equipment manufacturing. Yet, it was claimed that“this has not translated to an industrial upgrading.” This is inconsistent with the experience of its neighboring economies. 

Using a stylized partial equilibrium framework of global fragmentation of production, Mendoza’s empirical results suggest that even if the local GVC firms are dominant against the rest of domestic manufacturing firms in terms of employment size, capital intensity and productivity, they continue to be narrowly specialized in labor-intensive and low-value adding functions in the global production networks. One of the reasons cited is their limited technological capabilities and relatively weak innovation. Most innovations are limited to incremental process and product improvements using imported inputs and technologies, something that follows from their choice to focus on scale and efficiency rather than on product differentiation. 

As we wrote in our previous columns, the challenge remains for Philippine GVC firms to move up the ladder of GVC production. True, Mendoza maintained that their technological capabilities are also dictated by “the power structure that governs their value chain participation.” The challenge then is for Philippine GVC firms to respond strategically to the lead firm’s explicit control by constant efforts to upgrade rather than stagnate inside the GVC framework. 

Globalization will exhibit ebb and flow, risks and opportunities, but it is up to us whether we should level up, or choose to remain in the trap of lower income and economic helplessness.