Public Disclosure Authorized 88053 MAY 2014 • Number 143 Public Disclosure Authorized Making Global Value Chains Work for Development Daria Taglioni and Deborah Winkler Global value chains (GVCs) are playing an increasingly important role in business strategies, which has profoundly changed international trade and development paradigms. GVCs now represent a new path for development by helping developing countries accelerate industrialization and the “servicification” of the economy. From a firm perspective, production in the context of GVCs highlights the importance of being able to seamlessly connect factories across borders, as well as protect assets such as intellectual property. From the policy maker perspective, the focus is on shifting and improv- Public Disclosure Authorized ing access to resources while also advancing development goals, and also on the question of whether entry into GVCs delivers labor-market-enhancing outcomes for workers at home, as well as social upgrading. GVCs can lead to develop- ment, but, at the country level, constraints such as the supply of various types of labor and skills and inadequate absorp- tive capacity remain. GVCs can create new opportunities on the labor demand side, but supply and demand cannot meet if the supply is missing. This potential gap illustrates the importance of embedding national GVC policies into a broader portfolio of policies aimed at upgrading skills, physical and regulatory infrastructure, and enhancing social cohesion. Global value chains (GVCs) can be thought of as factories the goods produced were not part of a global network, re- that cross international borders.1 Producing high-quality quested flows of know-how were less intense. The new charac- goods and services in GVCs involves more than simply trad- teristic of GVCs from a development perspective is that facto- ing goods and services internationally—it also entails the ries in developing nations have become full-fledged cross-border movement of know-how, investments, and hu- participants in international manufacturing networks. They Public Disclosure Authorized man capital. When Toyota makes car parts in Thailand, it are no longer just importing parts for assembly for local sales. does not rely on local know-how. Rather, it imports Toyota They are exporting parts and components that are used in technology, management, logistics, and any other bits of some of the most sophisticated products on the planet. know-how not available in Thailand since Thai-made parts Given the need to integrate production facilities interna- have to fit seamlessly with parts made in Japan and elsewhere. tionally, large multinational corporations (MNCs) seek to im- GVCs, in effect, “unbundle” factories by offshoring firm-spe- prove local innovation, knowledge-based capital, and econom- cific know-how along the stages of production, and these in- ic competencies. For example, the Samsung Group—which ternational flows of know-how are the key difference between employs 369,000 people in 510 offices worldwide—worries GVCs and other types of trade and investment. about shortages of technical and engineering skills in Africa Internationally fragmented production is not a new phe- and how this affects their efforts to embed its African work- nomenon. For decades, developing nations have imported force in their global production networks. In 2011, to address parts from countries with more advanced technology, though such shortages, it launched Samsung Electronics Engineering generally only for the assembly of locally sold goods. Because Academies in South Africa, Kenya, and Nigeria. Outstanding 1 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK   www.worldbank.org/economicpremise performers are sent to annual “Learnership Programs” in works necessarily involve contracting relationships between Seoul as part of Samsung’s program for young leaders. This agents located in countries with heterogeneous legal systems initiative serves the company’s broader goal to develop 10,000 and contracting institutions, “contracts are often neither ex- electronics engineers across the continent by 2015 (ACET plicit nor implicit; they simply remain incomplete” (Rodrik 2014). 2000).2 How different national systems deal with contractual The new GVC-enabled flow of know-how from devel- frictions and incomplete contracts is an additional dimension oped to developing countries is a key factor in determining driving firms’ choice of location, as well as firm boundaries in the role of GVCs in industrial development. Developing global sourcing (Antràs and Yeaple 2014). countries can now industrialize by joining GVCs instead of The connectivity of factories and the nature of contract- building their own value chain from scratch, as Japan and the ing across countries are therefore key determinants—along Republic of Korea had to do in the 20th century (Baldwin with capital intensity—of a firm’s decision to make or buy, and 2012). Developing countries can benefit from foreign-origi- whether to do so domestically or internationally. Figure 1 il- nated intellectual property, trademarks, managerial and busi- lustrates the above concepts using actual ownership relation- ness practices, marketing expertise, and organizational mod- ships among some of the key firms in the Sino-Japanese auto els. The result is that the flows of goods, services, people, industry. These relationships move from Japan to China, that ideas, and capital are now interdependent and need to be as- is, from the higher-income to the lower-income country. The sessed jointly. good connectivity between China and Japan and the proximi- ty of the two countries satisfy the first concern of lead firms: Connecting Factories and Protecting connecting factories. Meanwhile, the correspondence be- Assets When Doing Business Abroad: tween type of control and strategic importance of assets in the The Firm Perspective Sino-Japanese automotive sector accurately illustrates the sec- The international location of new production facilities is ulti- ond key concern of global investors: protecting assets. Control mately in the hands of GVC lead firms. Conceptually, it is of the subsidiary takes place in a variety of ways. The most useful to think of the new possibilities created by globaliza- strategic assets are tied to the lead firm through forms of direct tion and the information and communication technology capital control (for example, majority equity stakes). Assets of revolution as creating two distinct sets of necessities for firms lower importance (for example, an older technology) are in- that countries are asked to address: connecting factories and stead just handed over through licensing agreements. Techni- protecting assets. Since cross-border factories must work as a cal cooperation and arm’s-length trade signal looser forms of unit, lead firms within GVCs care about efficiently connect- collaboration. ing local factories with the relevant international production With the dramatic growth of outsourcing practices, com- network, and about protecting proprietary assets. petition between companies has shifted from being horizon- The predictability, reliability, and time sensitivity of tal (that is, firms compete in the same sector for the same cus- trade flows are important factors behind firms’ location deci- tomer base) to being vertical (that is, firms in the same value sions, according to both major trade and competitiveness in- chain compete to perform specific and specialized tasks). dexes and case studies (WEF 2013). In many cases, countries Lead firms compete with first-tier and lower-tier suppliers.3 In are unable to participate in certain portions of GVCs because figure 1, the linkages between Mazda, the fifth largest Japa- of requirements for timely production and delivery. In effect, nese car manufacturer in terms of production volumes, and time is money in GVCs. A day of delay in exporting has a tariff China’s FAW Car Group (FAW) illustrate the complex nature equivalent of 1 percent or more for time-sensitive products of vertical competition. While Mazda outsources the produc- (Hummels 2007). Slow and unpredictable land transport tion of the Mazda 6 and 8 to FAW, the latter is also a competi- keep most of Sub-Saharan Africa out of the electronics value tor of the former. FAW produces other models, under differ- chain (Christ and Ferrantino 2011). Lead firms and interme- ent brands, using technology from Mazda‘s competitors, diate producers in GVCs need reliable, predictable, and time- including Toyota, Daihatsu and Volkswagen, and has its own ly access to inputs and final products to satisfy demand on line of luxury cars that directly competes with models from time. the above-mentioned lead firms.4 Protecting firm assets is necessary because firms export Creating Linkages to the Local Economy: valuable, firm-specific technology and know-how, only part of The Policy Maker Perspective which can be protected through patents, trademarks, and other forms of intellectual property regulations. The know- In the same way that import substitution industrialization how embodied in business and organizational models, mana- strategies gave way to export-oriented industrialization, the gerial practices, production processes, and export processes latter is now being replaced by efforts to identify an entry cannot be patented or trademarked. As global production net- point into vertically specialized industries and to upgrade 2 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK    www.worldbank.org/economicpremise Figure 1. Inter-Firm Linkages between China and Japan in the Automotive Industry GAC Toyota FAW Cars Co., Ltd. Production outsourcing of Japan China Motor Co., Ltd. Mazda 6 and Mazda 8 30.5% equity stake; Tianjin FAW Xiali 47.7% FAW Group z, Mazda production of Camry, of Vit Automobile Co., Ltd. equity stake Corporation du ction Platz ity Camry hibrid, Yaris, Pro , and equ E'Z, and Highlander Belta 30% equity stake uity 50% take 25% equity stake eq s % 40% equity stake; 20 stake production of Vios, Tianjin FAW Toyota Changang Mazda Changan Ford Mazda Toyota ity Corolla, Crown, Motor Co., Ltd. Automobile Co., Ltd. equ Engine Co., Ltd. Reiz, Corolla EX, 25% take s and RAV4 50% equity stake 50% equity 50% 50% equity stake; stake Sichuan FAW Toyota eq Chongqing Changan production of Ford stak uity Coaster, Land Motor Co., Ltd. e Automobile Co., Ltd. Cruiser, Prado, Corolla, and Prius Source: Japan Automobile Manufacturers Association 2013. Data as of March 31, 2013. Note that the Japan Automobile Manufacturers Association states as follows with regard to this information: “In principle, the tie-ups shown above cover only technical cooperation related to motor vehicle production and exclude sales tie-ups.” Note: Japanese companies are red, while Chinese counterparts are blue. The arrows indicate ownership or other forms of control. within GVCs. Attracting offshored factories and ensuring open doors, they are not magical. Most of the hard work still domestic firm participation in international GVCs has be- has to be done at home with domestic pro-investment, pro- come a major priority for many policy makers in developing skills, pro-jobs, and pro-growth reforms. Creating a demand countries. for high-productivity workers must be matched with a supply From a policy perspective, however, the critical issue is of capable workers with the relevant skills. In other words, how GVCs integrate into the economy as a whole. It is not when thinking about the first step in facilitating GVC entry, enough to attract and keep offshored factories. The policy policy makers must have a clear roadmap of how it will lead to challenge extends to creating and strengthening linkages with the ultimate objective of economic and social upgrading. domestic firms and to ensuring that the host nation benefits They must keep a keen eye on their workforce’s competencies from technology transfers, knowledge spillovers, and in- and how these match up with the foreign investment. creased value addition generated in the country. But it is Creating world-class GVC linkages equally important to ensure that GVC participation benefits Countries can join GVCs either by facilitating domestic domestic society as a whole through more and better paid firms’ entry or by attracting foreign direct investment (FDI). jobs, better living conditions, and social cohesion. In a nut- The FDI option includes more direct access to foreign know- shell, the key question is: how can developing nations make how and technology. Nations like Costa Rica and Thailand GVCs work for development? have managed to attract FDI and turn it into sustainable GVC To systematically explore countries’ policy options, Ta- participation in very different ways. In all cases, however, it is glioni and Winkler (forthcoming) developed the strategic necessary to provide a set of conditions that include excellent framework illustrated in figure 2. The framework identifies infrastructure, streamlined export procedures, and a tariff- three focus areas (entering GVCs, expanding and strengthen- friendly environment. One effective way to jumpstart this ing participation in GVCs, and turning them into sustainable process, particularly for countries with poor national infra- development) and links them with specific objectives, strate- structure and high import tariffs, is to create export-process- gic questions, and ensuing policy options. ing zones (EPZs)—rapidly built sites equipped with excellent infrastructure, streamlined procedures, and favorable tax Joining GVCs: Policy Options to Facilitate conditions (such as tariff drawbacks on imports of intermedi- GVC Entry ates). In many lower-income countries, exports come over- The integration of domestic firms (suppliers and final pro- whelmingly from EPZs. The critical second step is then to ducers) into GVCs can help developing countries accelerate connect the EPZs to the rest of the economy (Milberg and their industrialization process. Facilitating GVC entry re- Winkler 2013). quires creating world-class GVC linkages and a world-class EPZs are a special case. Governments can also facilitate climate for foreign tangible and intangible assets. However, it domestic firms’ GVC participation through arm’s-length is important to realize that GVC participation is a necessary trade by helping them find “the right” trading partners but not a sufficient condition for development. While GVCs abroad, which can include setting up firm directories, offer- 3 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK    www.worldbank.org/economicpremise Figure 2. Strategic Policy Framework FOCUS OBJECTIVES STRATEGIC QUESTIONS POLICY OPTIONS AREAS Creating world-class GVC linkages Which tasks? • Attracting the “right” foreign investors • How can tasks be identified? • Jump starting GVC entry through creation of EPZs • Which form of GVC participation? • Helping domestic firms find the “right” trade partners abroad • Which risks? • Improving connectivity to international markets Attracting FDI and Which form of governance? facilitating domestic Entering GVCs firms’ entry • Which form of governance between Creating a world-class climate for foreign tangible and into GVCs lead firm and suppliers? intangible assets • Which power relations? • Ensuring cost competitiveness • Which foreign firm and country • Improving drivers of investment characteristics mediate • Organizing domestic value chains and improving spillovers? quality of infrastructure and services Strengthening GVC-local economy linkages on Promoting economic • Which transmission channels? the buyers’ and sellers’ sides upgrading and • Which type of economic upgrading? Expanding densification • Which type of densification? and Strengthening absorptive capacity strengthening • Maximizing the absorption potential of local actors GVC Strengthening to benefit from GVC spillovers participation Which domestic firm characteristics domestic firms • Fostering innovation and building capacity absorptive capacity mediate spillovers? • Complying with process and product standards • Bundling tasks • Which relationship between Creating a world-class workforce Turning GVC economic upgrading, social upgrading, • Developing skills Promoting social participation into and social cohesion? • Promoting social upgrading upgrading and sustainable • Which type of social upgrading? cohesion • Engineering equitable distributions of development • Is there a possibility of downgrading? opportunities and outcomes Source: Taglioni and Winkler forthcoming. Note: FDI = foreign direct investment. 4 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK  www.worldbank.org/economicpremise ing practical advice, and promoting exports and imports more medium enterprises (SMEs) find it more difficult to enter generally. In the long run, however, GVC entry requires the GVCs, unless its SMEs are part of a well-established and inte- improvement of a country’s connectivity with international grated industrial cluster, such as the Italian industrial districts markets. Bad connectivity means high costs, low speed, and (for example, Becattini [1990] and Porter [1990]). high uncertainty. Thus, successful participation in GVCs re- In designing investment promotion measures, there are quires policy makers to not just address barriers at the border, various important factors for policy makers to consider, par- but also increase the connectivity of domestic markets and ticularly those that explicitly target FDI. Policy makers enhance the resilience and efficiency of the domestic segment should, however, ensure that they do not discriminate of the supply chain. against domestic investors. Moreover, governments need to Barriers at the border refer to traditional trade barriers, identify and attract “the right” foreign investors. This in- such as preferential market access, domestic tariffs, and the cludes assessing the nature of investment and the motiva- like. For GVCs, the focus expands from traditional export tions of potential FDI (for example, efficiency-seeking/ex- barriers to also include import barriers: a country’s competi- port platform, resource-seeking, or market-seeking) as well tiveness and ability to participate in GVCs depends as much as their technology contribution and the technology gap on its capacity to efficiently import world-class inputs as on with domestic firms. Investment promotion should not its capacity to export processed or final goods. Customs effi- only focus on lead firms in GVCs, but also target turnkey ciency can be another obstacle at the border, particularly in global suppliers and possibly important lower tier suppliers developing countries, where delays add to the speed and un- (Farole and Winkler 2014). certainty of buying or selling in GVCs. Several developing Meanwhile, a light-handed industrial policy can help fos- countries have managed to improve their logistics perfor- ter both participation in GVCs and linkages with the domes- mance index (LPI) score by improving customs efficiency, for tic economy by overcoming market failures or capturing coor- example, Morocco combined border management reform dination externalities. An analogy can be made with urban with port investments, and the Lao People’s Democratic Re- policy: if individual initiatives are completely uncoordinated, public provides information on customs procedures via an the result can be over-congested cities that fail in the basic goal electronic platform. of improving the lives of residents. At that other extreme, gov- Domestic market connectivity is as important as interna- ernment control of every investment decision can stifle tional connectivity. The benefits of efficient transportation growth and innovation and thus also fail to improve lives. A and logistics at the border could be undermined by inefficient key difference between GVC-led development and other ave- domestic links (for example, the unreliability or high cost of nues of development is that government coordination needs domestic transportation, lack of cool chains for fresh prod- to take place at the microlevel. Nevertheless, it is not neces- ucts, and so forth) as well as regulatory bottlenecks. Foreign sary to pick a sector as the “winner,” but rather, to help plan investors evaluate the ease of access to efficient services and and encourage both entry into the appropriate tasks and, con- infrastructure in the host country, including access to cheap sequently, densification of GVC participation that has al- and reliable energy, finance and trade support, telecommuni- ready begun. cations (for example, for e-commerce or electronic transfers), Creating a world-class climate for firms’ assets and transport (Cattaneo et al. 2013). Indonesia, for example, Low wages may be a way for countries to enter GVCs, and managed to reduce vessel dwell time by reforming storage low-wage industrial jobs can be a big productivity step up fees, which improved the country’s LPI score. from subsistence agriculture, underemployment, and low- In addition, there are several other dimensions beyond skill service jobs. The goal, however, should be higher labor connectivity that need to be considered when designing poli- productivity so that the country can remain cost-competitive cies to attract FDI and facilitate domestic firms’ participation, despite rising wages and living standards. What matters are such as the ecosystem of firms in the host economy, the design unit labor costs, not wages per se. Chinese labor, for example, of investment promotion policies, and the type of industrial remains cost-effective despite rising wages because labor pro- policy. ductivity is also rising. Moreover, low unit labor costs alone With respect to conditions in the host economy, the so- are not sufficient—the capacity to meet production require- phistication and competitiveness of domestic firms are key ments must also be taken into consideration (Cattaneo et al. factors. Countries that are home to large and competitive 2013). Put simply, low labor costs will not attract GVC- companies have an advantage in attracting FDI and in foster- linked FDI without the right infrastructure or capacity ing domestic firms’ participation through arm’s-length trade, building. Hence, labor policies aimed at attracting FDI since the domestic firms can act as turnkey suppliers. Some of should be matched by other initiatives, including packages of these firms also have the potential to become lead firms them- infrastructure expenditures and public-private vocational selves. Countries in which firms are predominantly small and training initiatives. 5 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK    www.worldbank.org/economicpremise Secondly, removing restrictions and barriers to foreign • Technology spillovers, that is, improved productivity of investment, as well as increasing the protection of foreign as- local firms in the same or related downstream or up- sets, is key to attracting FDI. This implies policies such as al- stream sectors as a result of GVC production; lowing more foreign equity into domestic companies,5 facili- • Skills demand and upgrading, similar to technology spill- tating the movement and employment of key personnel, overs, but transferred through the training of and de- relaxing domestic content rules when their role and purpose mand for skilled labor; and is not clearly defined, relaxing rules on foreign exchange and • Minimum scale achievements, for example, GVC partic- repatriation of benefits, and strengthening investor protec- ipation may stimulate investments in infrastructure that tion and the right to challenge domestic regulations and deci- would otherwise not be profitable and that may spur lo- sions, among others. cal production in other sectors. Completing the Firms’ Ecosystem: These transmission channels enable GVCs to support de- Policy Options to Expand Development velopment and industrialization efforts in four ways (summa- beyond the Initial GVC Enclave rized in figure 3):7 First, GVCs—through forward and backward supply After entering GVCs, the next set of policy considerations chain linkages—generate a demand and an assistance effect in must aim at ensuring that GVCs are as integrated as possible the host country: into the domestic economy. The logic here is that strong link- • Demand effect: Lead firms tend to require more or better ages with the domestic economy should result in greater dif- inputs from local suppliers. fusion of knowledge, technology, and know-how from foreign • Assistance effect: Lead firms can assist local suppliers, for investors. The problem is that foreign investors do not actively example, through sharing knowledge/technology, ad- pursue—and sometimes resist—such integration for several vance payments, and other types of assistance. reasons ranging from economic constraints to technological In turn, the forward and backward linkages generate and quality gaps with domestic suppliers to shortages in spe- technology spillovers, thereby improving the productivity of cialized workers and skills. local firms through two mechanisms: For policy makers, economic upgrading and “densifica- • Diffusion effect: The assistance effect leads to diffusion tion” are key to turning GVC participation into sustainable of knowledge and technology in the suppliers’ industry. development. The concept of economic upgrading is largely • Availability and quality effects: GVC participation in- about gaining competitiveness in higher value-added process- creases the availability and quality of inputs. es and raising domestic labor productivity and skills. GVC Second, GVC participation can translate into pro- densification involves the creation of more and better domes- competitive market restructuring effects that are not lim- tic jobs, fostering spillovers from FDI, and engaging more lo- cal firms in the supply network. Part of this effort should in- ited to GVC participants, but extend also to nonpartici- clude understanding how the potential for FDI spillovers pants. Specifically: differs across firms, sectors and tasks, and to the design of in- • Pro-competition effect: GVC participation leads to in- vestment attraction policies that do not discriminate against creased competition for limited resources in the country domestic players.6 (between MNCs and local firms, but also between par- Finally, it is also important to ask what economic upgrad- ticipants and nonparticipants in GVCs), increasing over- ing through GVCs means for average living standards—em- all average productivity in the medium run. ployment, wages, work conditions, economic security—or to • Demonstration effect: Knowledge and technology spill- wider social upgrading—distributional concerns and nonma- overs arise from direct imitation or reverse engineering terial factors such as democracy, labor rights, human rights, by local firms (both GVC and non-GVC participants) gender equality, environment, cultural issues, respect for mi- of GVC products, business models, marketing strate- nority rights, and more. gies, production processes or export processes, among Transmission channels for economic and social upgrading others. To efficiently target policy efforts, it is useful to identify the Third, minimum scale achievements have a twofold main transmission channels for achieving economic and so- impact: cial upgrading, which include: • Amplification effect: Minimum scale achievements am- • Forward linkages, that is, sales of GVC-linked intermedi- plify pro-competition effects. They stimulate investment ates to the local economy, thus spurring production in in infrastructure and backbone services, which would various downstream sectors; not be realized without the scale of activity generated by • Backward linkages, that is, GVC-linked purchases of lo- GVCs. Once the infrastructure is in place, it is likely to cal inputs, thus spurring production in various upstream spur local production in other sectors and in the non- sectors; GVC economy. 6 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK    www.worldbank.org/economicpremise • Sustainability effect: Minimum scale achievements also pacity of local firms requires both general and industry-spe- strengthen the ability of the country to sustain GVC par- cific investments to upgrade technical capacity and, most ticipation over time. GVC literature is rife with examples importantly, achieve quality standards. Both industry-spe- of the key role of improvements in backbone infrastruc- cific and general education policy are critical to sustaining ture and services, such as logistics, to improve timeliness long-term spillovers. and reliability in transporting goods, parts and compo- An important part of absorptive capacity is bolstering nents, and therefore enable countries to successfully ver- productivity, production and innovation capacities, includ- tically integrate into GVCs (see WEF [2013]). ing human capital and other resources, for example, by (i) Finally, GVCs also benefit labor markets through the fol- developing public-private partnerships aimed at research lowing three mechanisms: and development collaboration; (ii) increasing the supply of • Demand effect: GVC participation is characterized by sufficiently qualified researchers in local universities; and higher demand for skilled labor from MNCs or other (iii) efforts to align higher education curricula and training GVC participants. Multinationals may temporarily bid specializations with local economic activities. Second, policy away human capital by paying higher wages or offering makers should help domestic firms comply with process and enhanced employment benefits. This effect tends to dim, product standards. Such public, private, or voluntary stan- however, as soon as the productivity of domestic firms is dards need to be respected throughout the entire value also raised or the market adjusts to the tightening labor chain, because every stage of production can affect the qual- supply. ity of the final product or service, which could affect the lead • Training effect: Local firms participating in GVCs are firm’s reputation. Finally, a country cannot offer a single more likely to receive training (for example, from MNCs task, but must offer a bundle of tasks. Diversification into or their international buyers). services tasks and promotion of services exports offer a large- • Labor turnover effect: Knowledge embodied in the work- ly untapped income potential for many developing countries force of participating firms (for example, MNCs or their (Cattaneo et al. 2013). local suppliers) moves to other local firms. Creating a world-class workforce and engineering equitable Strengthening absorptive capacity distributions of opportunities and outcomes The degree to which local firms and workers benefit from Developing skills is a key element of competitiveness and of knowledge and technology spillovers ultimately depends on the ability to participate in GVCs and achieve economic and the absorptive capacity of domestic actors. This is the area social upgrading within GVCs. Economic upgrading requires of GVC-spillover policy in which governments play their the availability of new skills and knowledge either by increas- most important role, particularly in helping local firms and ing the skill content of a country’s activities (and thus work- workers access opportunities. Building the absorptive ca- force), or by developing competencies in niche market seg- ments (Humphrey and Schmitz 2002). In other words, Figure 3. GVC Participation Transmission Channels economic and social upgrading are linked and dependent on each other. There are indeed strong incentives for lead firms Backward / forward • Demand effect to train their workforces to comply with their standards. Be- linkages • Assistance effect yond private initiatives, there is a strong case for public invest- • Diffusion effect ment in skills development to meet the needs of international • Availability and quality trade and participation in GVCs (Cattaneo et al. 2013). Impact of GVC participation at home effect Technology Empirical evidence suggests that economic upgrading spillovers may drive social upgrading, but this is not automatically the • Demonstration case. There is a role for complementary policies to promote effect social upgrading and maximize the sustainable development Market • Pro-competition effect impact of GVC activities. Social policies are needed to create restructuring • Demonstration effect an equitable distribution of opportunities and outcomes. Without social cohesion and policies that ensure all segments Minimum scale • Amplification of pro- of society benefit from GVC participation, development achievements competition effect would indeed be unsustainable. Social upgrading can be sup- • Sustainability effect ported through labor regulation and monitoring, such as oc- • Demand effect cupational safety, health, and environmental standards in Labor markets • Training effect GVC production sites. Well-functioning labor markets are • Labor turnover effect also important, because the process of integrating into GVCs Source: Taglioni and Winkler forthcoming. requires a reallocation of resources. 7 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK    www.worldbank.org/economicpremise For social upgrading to translate into social cohesion via Acknowledgments better living standards, countries must ensure equal opportu- This note introduces topics and concepts more widely dis- nities and outcomes, which strengthen social cohesion by cre- cussed in the forthcoming publication “Making Global Value ating a sense of belonging and active participation, promoting Chains Work for Development” (Taglioni and Winkler forth- trust, offering the opportunity of upward social mobility, and coming), which aims to provide concrete tools for policy mak- fighting inequality and exclusion. Equal access to jobs (in- ers in developing countries to ensure that GVC participation cluding for women or minorities) is the most important op- helps accelerate industrialization and development. Both portunity in the context of GVCs. Access to widely adver- publications are part of a broader, multiyear work program of tised information about job vacancies and practical advice on how to get these jobs is a precondition (for example, through the World Bank’s International Trade Unit, which offers both job search assistance). But workers also need to be informed a strategic framework and analytical instruments to system- about their rights. Farmers, self-employed, or informal work- atically assess a country’s competitiveness and performance ers in particular are often unaware of their rights in relation to potential in GVCs, and also provides policy guidance to make landowners, traders or employers, despite the important role GVCs work for development. The authors are grateful to this segment of the labor market plays in developing coun- Richard Baldwin for his valuable expertise and consultation. tries. Cooperatives, associations, and trade unions can be ef- They would also like to thank Olivier Cattaneo, Thomas fective channels of information. Farole, Michael Ferrantino, Gary Gereffi, Mariem Malouche, But these information channels require that freedom of and William Milberg for discussions and useful perspectives association and collective bargaining rights already exist in on the topic, as well as Amir Fouad for editorial help and the the country. These provisions encourage pro-active social dia- Japan Automobile Manufacturers Association for permission logue that can address tensions before they lead to conflict. In to use their material. addition, facilitating access to jobs for excluded or disadvan- About the Authors taged groups helps economies tap a largely idle segment of the workforce with productive potential and leads to increased Daria Taglioni and Deborah Winkler are Senior Economist and social cohesion. Antidiscrimination laws and mandatory or Consultant Economist, respectively, in the World Bank’s Inter- voluntary affirmative action programs, such as proactive mea- national Trade Unit. sures for hiring women, minorities, or other groups, are an Notes important prerequisite to more equality of opportunities (OECD 2011; World Bank 2013). 1. The phenomenon has been called vertical specialization by Balassa (1967) and Findlay (1978), slicing up of the value Conclusion chain by Krugman (1995), and many other names by other Participation in GVCs can be linked to development out- economists, including international fragmentation of pro- comes. By joining GVCs and expanding their GVC partici- duction (Arndt and Kierzkowski 2001), transnational pro- pation, domestic firms (suppliers and final producers) can duction (Feenstra 1998), and global production networks help developing countries accelerate their industrialization (Ernst and Kim 2002; Henderson et al. 2002). Vertical spe- process. To do so, firms must be able to seamlessly connect cialization identifies a production structure where tasks and factories across borders while simultaneously protecting business functions are spread over several companies that are strategic proprietary assets. That is, both connectivity and globally or regionally dispersed. “Tasks,” rather than sectors, legal stability are keys to increased GVC participation. For define the specialization of countries in the value chains, as development objectives to be truly achieved, however, firms’ indicated by Grossman and Rossi-Hansberg (2008). priorities must be balanced with the goal of policy makers to 2. Antràs (2013) lists a range of reasons for incomplete con- industrialize through GVCs in a sustainable way that pro- tracting in international settings, including: the limited motes prosperity for the entire society. This includes not just amount of repeated interactions; lack of collective punish- bringing jobs to a host nation, but improving living condi- ment mechanisms associated with international transactions; tions, strengthening social cohesion, and generating knowl- and natural difficulties in contract disputes involving interna- edge spillovers. The strategic framework on GVC participa- tional transactions, such as determining which country’s laws tion developed in this note, which maps focus areas for are applicable to the specific contract. Finally, even when it is policy with relevant objectives, strategic questions, and poli- clear which laws are relevant to the contract in question, local cy options, can be a helpful guide for policy makers in achiev- courts may be reluctant to enforce a contract involving resi- ing this balance. dents of foreign countries. 8 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK    www.worldbank.org/economicpremise 3. The extent of vertical competition varies depending on the focus should be on collaborative development of flexible lo- power relations within the specific value chain (see, for ex- calization plans where investors come up with their own pro- ample, Milberg [2004]). Interestingly, both horizontal and posals on how they will deliver spillovers to the local economy. vertical competition are driven by similar forces: the interplay It is also important to incentivize foreign investors to collabo- between traditional cost advantages, institutional factors, and rate with local universities, research institutes, and training proximity to the final consumer, which together determine institutes (Farole and Winkler 2014). what tasks are more profitable in given locations (Cattaneo et 7. The discussion on mechanisms triggered by GVC partici- al. 2013). pation partially evolves from the taxonomy introduced by 4. Daihatsu licenses the Terios SUV technology (an older Farole, Staritz, and Winkler (2014). technology phased out in the Japanese domestic market) to References FAW (Paultan.org). The latter engages in the manufacture and sale of passenger cars and related accessories. FAW offers ACET (African Center for Economic Transformation). 2014. 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Fragmentation: New Production can focus on models that are more strategic from a corporate and Trade Patterns in the World Economy. Oxford: Oxford Uni- versity Press. point of view, such as Premacy and Familia. Finally, FAW has Balassa, B. 1967. Trade Liberalization among Industrial Countries. its own brand: the Hongqi luxury car (FAW corporate Web New York: McGraw-Hill. site http://www.faw.com/). Hongqi cars have been manufac- Baldwin, R. 2012. “Global Supply Chains: Why They Emerged, tured since 1958, with the original models reserved for the Why They Matter, and Where They Are Going.” CEPR Discus- high-ranking party elite. They remained in production until sion Papers 9103. 1981 (The Economist, “The Home Team,” November 13, Becattini, G. 1990. “The Marshallian Industrial Districts as a Socio- Economic Notion.” In Industrial Districts and Inter-Firm Co- 2008, www.economist.com). The current Hongqi fleet in- Operation in Italy, ed. F. Pyke. Geneva: International Institute cludes the H7, which is an executive car based on the Toyota for Labor Studies. Crown platform. This intricate system of collaboration and Cattaneo, O., G. Gereffi, S. Miroudot, and D. Taglioni. 2013. “Join- business relationships is an excellent example of the degree of ing, Upgrading and Being Competitive in Global Value Chains: vertical competition in the automotive sector. A Strategic Framework.” Policy Research Working Paper Series 6406, World Bank, Washington, DC. 5. China has been effective in attracting FDI even with restric- Christ, N., and M. J. Ferrantino. 2011. “Land Transport for tions on joint ventures. However, this is largely due to China- Exports: The Effects of Cost, Time, and Uncertainty in Sub- specific conditions: a large domestic market and a large pool of Saharan Africa.” World Development 39 (10): 1749–59. low-cost but well-trained workers. Countries that do not have Ernst, D., and L. Kim. 2002. “Global Production Networks, Knowl- specific factors to attract investors, or to use as leverage, will edge Diffusion and Local Capability Formation.” Research Policy have less space for maneuvering when dictating joint venture 31: 1417–29. Farole, T., C. Staritz, and D. Winkler. 2014. “Conceptual Frame- conditions with foreign investors. work.” In Making Foreign Direct Investment Work for Sub-Saharan 6. Understanding the spillover potential of different FDI at Africa: Local Spillovers and Competitiveness in Global Value the microlevel is likely to become an important policy priority Chains, ed. T. Farole and D. Winkler, 23–55. Washington, DC: in the coming years. And this is not only the case for small and World Bank. lower-income countries that rely increasingly on FDI and have Farole, T., and D. Winkler. 2014. 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Rossi Hansberg. 2008. “Trading Tasks: A spotlight should be on value addition rather than in-country Simple Theory of Offshoring.” American Economic Review 98 ownership. Instead of rigid local content requirements, the (5): 1978–1997. 9 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK    www.worldbank.org/economicpremise Henderson, J., P. Dicken, M. Hess, N. Coe, H. W. Yeung. 2002. Policy Implications?” International Labour Review 143 (1–2): “Global Production Networks and the Analysis of Economic 45–90. Development.” Review of International Political Economy 9 (3): Milberg, W., and D. Winkler. 2013. Outsourcing Economics: Global 436–64. Value Chains in Capitalist Development. New York: Cambridge Hummels, D. 2007. “Calculating Tariff Equivalents for Time in University Press. Trade.” Nathan Associates for U.S. Agency for International OECD (Organisation for Economic Co-operation Development). Development. 2011. 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Logistics Performance Index. Trade Linked to Global Production Systems: What Are the ———. 2013. World Development Report on Jobs. Washington, DC. The Economic Premise note series is intended to summarize good practices and key policy findings on topics related to economic policy. They are produced by the Poverty Reduction and Economic Management (PREM) Network Vice-Presidency of the World Bank. The views expressed here are those of the authors and do not necessarily reflect those of the World Bank. The notes are available at: www.worldbank.org/economicpremise. 10 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK    www.worldbank.org/economicpremise