Is domestic value addition the key to GVCs?

• Global value chains make it strategic and convenient for developing countries to move away from export reliance on unprocessed primary products to become exporters of manufactured products and services.
• India, despite its success in certain hi-tech areas, spends only about half a percent of GDP on R&D. In fact, most emerging markets do not even report consistent data on R&D because it is such a small part of their economies.
• There is growing service content embodied in manufactured products, which is also due to increasing fragmentation of value chains. Given these trends, it is not surprising that the most technologically advanced countries tend to be very open to trade and investment in services.
• India, too, has set a target for its services sector to have a 4.2% share in global services exports by 2022, which will help India to improve our position for foreign value-added exports. 

Global value chains (GVCs) have become a dominant feature of world trade. In response to policy questions raised by the growing importance of GVCs for trade and investment, OECD and WTO embarked on an initiative to measure trade in value added (TiVA) terms to provide an accurate view of the underlying economic importance of trade. Developing economies like India need to grow their manufacturing sector and integrate into the value chain of a given industry.

For upgrading our global exports, mainly of manufacturing and industrial products, it is indispensable for India to integrate with robust Global Value Chains. India’s involvement in value chains was limited and has not grown significantly in the post-reform period, but India has strength and potential to participate in GVCs and export those products, which have a share of 70% in global exports. By raising its exports in GVCs, India can avail ancillary advantage in terms of competitiveness in exports of industrial and manufactured products, skill upgradation and escalation in employment. 

Global value chains make it strategic and convenient for developing countries to move away from export reliance on unprocessed primary products to become exporters of manufactures and services. Before the development of GVCs, a country had to specialize in the production of an entire product, from the first stage to the finished stage in order to export it. GVCs allow countries to specialize in a particular activity and join a global production network. As a developing country moves from export of primary products to export of manufactured products and services via GVCs, the ratio of domestic value added to gross export value tends to fall.

Developing countries often place themselves at the end of value chains (downstream participation), with labour-intensive assembly of parts produced elsewhere. Gross exports from the country can be very large, but the country’s value-added contribution to exports is much smaller. Many developing countries worry about this phenomenon and aspire to increase their foreign value-added contribution to exports. There are a number of reasons why this objective should be approached cautiously.

It may seem like simple math that a higher domestic value-added share means more total value added exported and hence more GDP. But that simple idea ignores the reality that imported goods and services are a key support to a country’s competitiveness. If a country artificially replaces key inputs with inferior domestic versions, the end result is likely to be decrease in both gross exports and total value-added exports. Thus, value added exports require decoding within the framework of domestic and foreign inputs. If the economy is simply concentrating on escalating domestic value addition, it might lose global integration and it will be daunting to increase participation in the upstream ladder of GVC.

Technological upgradation is an important instrument to ensure a surge in foreign value addition while exporting the product. Developing countries that are integrated into the global economy have generally delivered more rapid total factor productivity growth and foreign value-added exports. Developing countries can absorb pre-existing technologies through direct foreign investment and learning. As they progress, it is natural for developing countries to begin spending resources on inventing new technologies so the more advanced developing economies are both absorbing existing technologies and innovating new ones.

Emerging markets in general still spend very little on research and development which makes their outlook to increase foreign value-added exports difficult. India, despite its success in certain hi-tech areas, spends only about half a percent of GDP on R&D. In fact, most emerging markets do not even report consistent data on R&D because it is such a small part of their economies. The advanced economies generally spend between 2 and 3% of GDP on R&D, and China has now joined that club. In both China and the U.S., about one-fifth of R&D is financed by the government, with the rest primarily coming from industry. This reveals that it is difficult for the government to have much direct effect on R&D. Subsidies, usually in the form on tax breaks, play some role.

But, in general, R&D is based on corporate decisions which are influenced by availability of technical labor, investable surplus and other aspects of the business and policy environment. One of the most important aspects of the policy environment for R&D is intellectual property rights protection. Since the vast majority of R&D funding comes from industry, it is aimed at developing commercial innovations and new technologies for providing goods and services.

The logic of IPR protection is to provide a temporary monopoly for the innovator. This is necessary to create a financial incentive to innovate. If innovations could be instantly copied, then there would be no incentive for Research & Development. On the other hand, once innovations exist, it is socially optimal for them to diffuse, and for that reason IPR protection tends to be temporary and imperfect, allowing reasonable offshoots to develop quickly. One of the striking differences between the advanced economies and emerging markets is in the quality of IPR protection.

The most technologically advanced countries have seen their domestic value-added exports decline in recent years as they make proportionally greater use of imported inputs. These economies also tend to have large shares of foreign value in their exported value added. This rising foreign value addition share reflects two factors. First, there is growing service content embodied in manufactured products, such as software in automobiles and appliances; second, as value chains become more fragmented, services such as finance, telecom, and transport are increasingly important in managing them. Given these trends, it is not surprising that the most technologically advanced countries tend to be very open to trade and investment in services. In these sectors, trade and investment tend to go together because it is hard to trade most services without an investment presence

India too has set a target for its services sector to have a 4.2% share in global services exports by 2022 which will help India to improve its position for foreign value-added exports. The Ministry of Commerce and Industry has identified 12 champion sectors and dedicated a fund to help achieve their true potential. These are IT/ITeS, tourism and hospitality, medical value travel, transport and logistics, accounting and finance, audio visual, legal, communication, construction and engineering, education, environmental services, and financial services. The overall aim of Indian policymaker should be on growing the share of foreign value-added exports in gross exports. Domestic value addition may reflect a fallacy in terms of participation under GVC.