Global value chains and services: Implications for African countries

13 August 2012

The emergence of Global Value Chains (GVCs) has produced remarkable changes in the pattern of world trade over the past 25 years. Rather than trade in goods that are produced solely at one location and exported to the consumer in another location, production of goods and, increasingly, services involves a combination of intermediate inputs and services activities that are sourced globally to make up a finished product. World trade is being conducted through “trade in tasks.” Increased trade in intermediate inputs is producing an expanded ratio of trade to world GDP (from 16 percent in 1990 to 27 percent in 2008). Intermediate inputs now represent more than half of the goods and services imported by OECD economies and almost three-fourths of the imports of large developing economies, such as China, India, and Brazil. GVCs increasingly blur the distinction between imports and exports and falsify the designation of a product or service as having been produced in one location only. The WTO has recently coined this new trading paradigm as “Made in the World.”

At present, Africa is not a major player in the system of GVCs and faces several challenges in order to take greater advantage of this new dynamism. These include creating the conditions that will allow African firms to insert themselves in the GVC structures – namely, improving the logistics supporting trade flows, telecom infrastructure, workforce skill training, and a generally enabling business environment.

The changing  structure of world trade
The changing structure of world trade through the operation of GVCs has implications for both trade policy and economic development. For trade policy, GVCs limit the relevance of bilateral trade balances, as they do not reflect value-added (that is, the value of exports minus imported inputs). In a parallel fashion,  the importance of exports is overstated in the presence of GVCs because it is actually specialisation through product and services differentiation in intermediates that drives the productive process. Lastly, the cost of protectionism in a world of GVCs is higher than might be imagined. Putting tariffs or other restrictions on intermediates is the equivalent of eliminating a country’s ability to participate in GVCs on a cost-competitive basis.

World trade dynamism and GVCs
At present, the world’s most dynamic trading regions are those that have become linked in the network of GVCs. Unfortunately, Africa is not a significant part of the value chain network, putting the region at a disadvantage in terms of trade dynamism. Drivers of the development of GVCs are generally accepted to be: lower transportation costs; information and communication technologies; telecommunication infrastructure; technological innovations; education and skills of the workforce; competitive labor costs; political, social, and cultural environments; stable legislation and ability to enforce contracts; proximity to supply sources; and proximity to market. Encouraging African firms to insert themselves into GVCs requires policy makers to pay attention to these factors.

Services and GVCs
Services play two roles in the new trading environment of GVCs. Whilst they act as the “glue” at each point of the goods supply chain, they also constitute GVCs themselves. Embedded services, if they could be measured, may be found to account for as much as half of world trade. Services, which are currently contributing more to GDP growth in low-income countries than in high-income ones, may provide the most attractive and viable route for African firms to insert themselves into GVCs. Targeting specific “tasks” as part of services offshore activity would be a promising way for smaller African firms to integrate into world markets and might also be a way to “leapfrog” stages of development. At present only three African countries – Egypt, Morocco and South Africa – are considered promising locations for services offshore activity. However, this could change rapidly with greater government attention upon the service sector and an improvement in key facilitating factors including human capital, telecommunications infrastructure, and broadband build-out.

Centers for supply and demand for offshore services
Service activities that are the object of offshore demand, namely “other commercial services,” have become more important than the traditional “travel” and “transport” components of world services trade, and are now the fastest growing segment of world trade overall. The biggest contributors to recent growth have mainly been business services such as telecommunications and IT services, R&D services, and financial services, among others.

The three main components of the offshore services value chain are Information Technology Outsourcing (ITO), Business Process Outsourcing (BPO), and Knowledge Process Outsourcing (KPO). Many of the lower-value BPO services can potentially be ‘captured’ by African firms, including activities such as network management, application integration, payroll, call centers, accounting, document management, logistics, supply chain management, and human resource management. Some of the higher value-added activities within the ITO component, namely services to support IT infrastructure and software as well as IT consulting and software research and development, should also be within range of certain firms. The objective of African firms, once inserted into a GVC, is to upgrade its activity, as firms attempt to ‘climb’ the value chain for offshore services, much in the same way as they do for global manufacturing value chains.

Some African countries have been making strides in capturing activities that are part of the ITO/BPO offshore services value chains. These include Tunisia, Ghana, Senegal, Kenya, and Mauritius, where some of these activities are now being provided as part of the operation of larger firms in other locations. These five countries share some common characteristics, namely a large component of qualified workers, a growing penetration of internet use and broadband availability, stable political regimes, and an attractive business environment. These countries have also encouraged demand-supply side linkages.

Opportunities for Sub-Saharan African countries
Within the flux of this intensely competitive global landscape there are unique opportunities to be seized by SSA countries that possess the capacities and resources to integrate global apparel value chains. For instance, the development of garment manufacturing is relevant to job creation and poverty alleviation in low-income SSA countries. It is the fragment of the chain most suited to domestic circumstances, capital requirements are affordable, backward linkages allow for vertical integration into upstream activities, knowledge and skill intensities are variable, and it creates a springboard for the upgrading of capabilities into higher value and more diversified industrial and service activities. To this end, a few notable dynamics occurring in the world market are worth highlighting:
- China will remain the dominant exporter for the foreseeable future but rising labour costs and an increased share of production channelled to meet domestic demand imply that Chinese suppliers will conceivably cede export (and import) opportunities.

- Growth markets like India, Russia, Turkey, Brazil, Indonesia, and China are developing strong consumer bases. Opportunities will arise in these economies as the demand for clothing rises at a faster rate than economic growth.

- The projected rise in income in SSA households over the next generation could provide an important incentive for added investment in local production.

- Some firms are also hedging their risks by diversifying part of their outsourcing activities to second-tier suppliers.
Given appropriate policy frameworks, SSA is endowed with three primary factors that, combined, could secure its long-term competitiveness and bolster its future status as an investment destination of choice in labour intensive garment manufacturing: 1) SSA has an abundant pool of semi-skilled (young) labour available at comparatively low wages. 2) Many African countries hold a comparative advantage in the production of quality cotton with favourable fibre characteristics. The opportunity lies in creating downstream linkages and in developing production networks that permit vertical integration of cotton-product value chains so that different stages of the transformation process are retained either locally or regionally. 3) SSA also has a huge untapped reservoir of renewable sources of energy that could power a fairly energy-intensive production cycle (especially in textiles). Environmentally sustainable manufacturing practices are the future in Africa as elsewhere.

The ability of African firms to insert themselves into GVCs is a vital condition for Africa’s economic development. To facilitate this, African governments must devote more attention to the services sector, along with improving the conditions vital for attracting off-shore services to the continent. Key enabling factors for BPO/ITO growth in Africa are within the reach of government policy. These include the creation of an attractive business environment with reduced transaction costs of doing business. The creation of transport corridors and the smoothing out of port bottlenecks come to mind as priorities, as well as improvements in customs procedures. Incentives for the operation of SMEs and programs for the creation of skilled workers for activities that are part of the BPO/ITO supply chain are also high on the list. Providing access to courses in English, in computing skills, in business management operations would facilitate the supply of trained personnel. And ensuring an efficient telecommunications infrastructure is essential, which means allowing for open telecom markets in order to attract foreign investors, together with the development of independent telecom regulators to enforce rules against anti-monopoly behavior.

Author: Sherry Stephenson, Senior Advisor for services trade at the Organization of American States in Washington DC. She is also Senior Fellow with the ICTSD.
Reference: The shifting geography of global value chains: Implications for developing countries and trade policy, WEF.

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