January 31, 2008

Globalization, alliances and networking: A strategy for competitiveness and productivity (Part 5)

Globalization, alliances and networking: A strategy for competitiveness and productivityBy Joseph Prokopenko (From:Enterprise and Management Development Working Paper - EMD/21/E, International Labour Organization).....Part 5

Table 1: Export roles in the global economy occupied by major Third World regions

Primary commodity exportsExport-processing assemblyComponent-supply subcontractingOriginal equipment manufacturing (OEM) Original brand name manufacturing (OBM)



Southeast AsiaXXX
Latin America & CaribbeanXXX



Sub-Saharan AfricaXX

Source: Gary Gereffi

The newest phase in the industrial development cycle is original design manufacturing (ODM), a key ingredient in product innovation. Some firms in the East Asian NICs have already entered this stage.

The prominence and sequencing of these export roles vary markedly across Third World regions. In part, this reflects differences in the timing and impact of outward and inward-oriented development strategies. The East Asian approach was to combine export-oriented industries (EOI) with selective forms of state intervention (export subsidies, import licenses, non-tariff trade barriers, preferential credit, privileged access to quotas and the like), and then to roll back these policies under internal and external pressure after successful export industries had been established.

In Latin America and other Third World regions, however, state intervention was used to promote import substituted industries (ISI) and not EOI. When the liberalizing reforms of the 1980s took hold, many nations opened their economies before they were internationally competitive. The resulting import surge has led to far-reaching domestic economic dislocations involving a haemorrhage of plant closures (especially among small and medium-sized firms), widespread job loss and a worsening of income distribution. The same has happened in a number of eastern European countries in the 1990s.

In contrast to those who would argue that EOI by itself can lead to sustained economic growth, the experience of the East Asian NICs actually shows that a diversified array of backward linkages is essential in moving toward the more complex component-supply, OEM and OBM roles. However, the directions the East Asian economies can move in terms of industrial upgrading are constrained by the shortage of natural resources. The importance of these raw material supply networks for successful export industries creates opportunities for resource-rich regions of the Third World. East Asian countries have been forced to adjust to their escalating production costs and labour shortages by gravitating to higher-order forms of competitive advantage that are durable, add more value, and lead to constant improvement, industrial upgrading and competition.

5.3 Strategies for improvement

Both technological advance and organizational learning are required to climb the ladder of industrial development. Progress requires a dynamic enterprise base, supportive state policies, and improving skills and higher wages in the work force. Third World nations have utilized several strategies in recent decades to try to improve their global positions. These include:(19)
-government policies and organizational initiatives to increase productivity;
-new relations with foreign and local capital; and
-participation in regional economic blocks.

Let us discuss these strategies briefly.

Narrowing the productivity gap. A major problem is that most Third World countries fail to use internationally available "hard" and "soft" technologies. This is apparent in outdated equipment, obsolete production methods, a deficient organization of labour, rigidly vertical industrial relations, inadequate product quality, poor after sales services, etc.

In their efforts to narrow the productivity gap, Third World countries have pursued a variety of policy and institutional reforms. A coherent macroeconomic programme that emphasizes stable exchange rates, low inflation, and moderate to high interest rates is widely assumed to be a necessary starting point for improved economic performance. There is much less agreement, however, on the role to be played by micro-economic policies that directly affect the operations of firms in specific industrial sectors. Institutional support has been forthcoming from governments in order to attract the foreign capital needed for EPZs. Serious questions have been raised, however, about the contributions made by these low-wage export industries to broader development objectives, such as upgraded skills, technology transfer, backward linkages to local suppliers and improved living conditions.

The East Asian NICs, meanwhile, are moving in the opposite direction. They have diversified their exports in the face of substantial appreciation (rather than devaluation) of their currencies, rising (not declining) real wages, and labour scarcity (rather than labour surpluses).

New relations with foreign and local capital. A country's stance toward foreign capital is an important element in a coherent and well-balanced national development policy package that typically includes both macroeconomic and political stability, good infrastructure, modern economic institutions, and a clear sense of the ground rules by which enterprises must operate.

The trend towards a liberalization of foreign direct investment (FDI) policies which accelerated during the 1980s is continuing. These regulatory reforms have been complemented by privatization programmes. Old restrictions are starting to change in capital-intensive service industries such as telecommunications, transportation and public utilities. The process of technology transfer has shifted from harder to softer technologies where the contribution of MNCs is critical. Regional and global strategies by MNCs are replacing those geared to maximizing profits in individual countries as a result of a rise of networks and other non-equity ties with foreign buyers in the developing countries, and the prominence of buyer-driven commodity chains.

The challenge for Third World governments is to harness the productive potential of MNCs while at the same time learning how to benefit from multiple ways of linking up with the global economy (see an example of the UK in the box below).

Box 2: The case of UK: MNCs bring productivity
Some of the overall productivity catch-up of the 1980s has been due to the entry of international business to the UK. Forty per cent of the Japanese and US investment in Europe has been attracted to UK and this includes the entry of some of the most productive companies in the world. Their presence has introduced new companies to the economy which now produce almost a quarter of UK manufacturing output at a productivity level which is far above the UK average. They have introduced techniques of quality control and managerial style which has spread very widely to British-owned companies.

Hence, there has been a favourable impact on productivity which goes far beyond the 23.5 per cent of output which is actually produced by foreign-owned companies. The strong continuing attraction of foreign-owned business to the UK is also due to the taxation which is lower than that in virtually every other country in the EU.

FDI policy should involve explicit commitments with respect to key national priorities such as export promotion and technological innovation, and that successful local firms are an important element in national development strategies. Average capital per worker is US$13,000.- in developing countries and US$150,000.- in industrial countries - to 12 times more. Today private capital flows to developing countries at record levels. These flows are estimated to have totalled US$175 billion in 1994, more than 4 times the 1989 figure of US$42 billion.(20) There are a number of reasons why these flows have accelerated:

-the economic reforms that many developing countries have undertaken (about two-thirds of recent total long-term flows have gone to the private sector, compared with only 44 per cent in 1990);
-the debt reductions of the early 1990s;

- and the fall in world interest rates.

Other important conditions attracting foreign capital are its ability to earn a high return combined with a low risk which demands an attractive domestic environment and the guarantee of repayment.

Thus, the key determinant of a successful capital-attractive strategy is to have an attractive domestic environment - good infrastructure, abundance of skills, social and political stability. Repayments depend on the aggregate external balance of the host country. If the capital inflow takes the shape of a foreign-denominated loan, the probability of receiving full repayment depends on the availability of foreign earnings from exports. In summary, to attract foreign capital the host country must demonstrate:
-flexibility to handle external risks (the possibility of protracted distributive fights scare away potential lenders and investors);
-a commitment to fiscal stability to avoid too high international borrowing or high taxation; and
strong links and integration with the global markets.

MNCs have been a major vehicle for this globalization of the manufacturing industry in which relatively cheap labour in developing countries has been equipped with capital and modern techniques in management, communication and production methods. Five million of 8 million jobs created by MNCs between 1985 and 1992 were in developing countries.(21)

Flows of foreign direct investment (FDI) now respond rapidly to new profit opportunities, shifting production to places where wages are low relative to potential productivity and where there is higher flexibility of labour. Increasing capital mobility allows developing countries to access foreign savings, but it also means that domestic savings can quickly disappear as residents move their liquid capital, such as bank deposits or financial, out of the country in search of higher or less risky return elsewhere. Capital flight reduces the resources available for investment and can put financial intermediaries in a serious financial squeeze. Capital increasingly flees countries that fail to adjust promptly to negative shocks and this flight tends to magnify the shocks and to exacerbate the effects of policy failures. There is no alternative to prudent macroeconomic policies and to close attention to export-friendly reforms that increase creditworthiness.

In most of the East Asian NICs the state has induced local private capital to take a mercantilistic approach to global markets, where overseas sales are equated with enhanced national security and prestige. The states employed financial control, export and import licenses, and other bureaucratic devices to exercise leverage over exporters. Domestic firms were there not only to export but also to establish extensive backward linkages to local suppliers. The economic restructuring of the 1990s has changed the incentives for NIC leading manufacturers who have responded to rising wage rates and labour shortages at home and protectionism abroad in three ways:
-industrial upgrading to higher value-added export products;
-offshore sourcing to low-cost export platforms in the developing countries for labour-intensive products in the triangle manufacturing networks;

-and diversification into more profitable economic activities, such as services and real estate.
These changes are consolidating a two-tier pattern of cross-border FDI in manufacturing in Asia: from Japan into the regional NICs, and from the NICs to China, Indonesia, Malaysia, the Philippines, and Thailand.

Shifting pattern of regional integration. While trade tends to promote regional integration, FDI appears to be better at spanning different regional blocks and moving towards global economic integration. The latter involves the production of goods and services as a results of TNCs strategies and network structures. The world economy seems to be evolving toward this more complex form of integrated international production containing a multitude of buyer-driven, as well as product-driven, commodity chains. East Asian firms, by contrast with Latin America, have used their experience as global exporters to move along the EOI path to the sophisticated OEM and OBM export roles, which involve a much deeper pattern of functional integration in global markets.

The increasing interconnection and interdependence has been one of the major factors driving regional economic integration. The drive for larger internal markets and the fostering of sharper competition have also been used in an attempt to force greater productivity out of an increasing range of sectors which are subject to trade and international competition.

For example, through APEC (Asian Pacific Economic Co-operation) the countries are seeking to strengthen the institutional basis of cooperation in the region. If in 1960 East Asia accounted for just 4 per cent of world economic output, today its share accounts for 25 per cent. Between 1992 and the year 2000, 40 per cent of all purchasing power created in the world will be in East Asia and the region will absorb between 35 per cent and 40 per cent of the global increase in import. East Asian central banks now hold close to 45 per cent of the world's foreign reserves, and while US and the major European countries keep piling up debt, Japan, Taiwan, Singapore and Hong Kong are in the remarkable position of not having any.

Economic growth combined with the largest concentration of population on earth mean that the Asian-Pacific region has a potential to play a dominant role in the future of the global economy.

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