South trading more but earning less

Prevailing patterns of trade and investment, which relegate developing countries to being low-skill, low-value-added links in international production chains, have not garnered rapid and sustainable income gains for the South. Instead, technological upgrading and productivity growth are now required for developing countries to advance further along the development path, TDR 2002 states.

by Chakravarthi Raghavan

GENEVA: Developing countries, since the early 1980s, have rapidly liberalized trade and foreign direct investment (FDI), their exports have grown faster than the world average, and they now account for one-third of world merchandise trade, with much of the growth in manufactured exports, which now account for 70% of their total exports.

Many developing countries also appear to have succeeded in moving into technology-intensive manufactured exports, among the most rapidly growing products in world trade, notably electronic and electrical goods, and have increased their share, between 1980 and 1998, from 5.5 to 22 percent.

Good news? Not really, says UNCTAD in its Trade and Development Report, 2002. The trade statistics, taken at face value, are quite misleading and can hide more than they reveal; and in many cases, developing countries have been trading more and earning less.

An increasing number of products, including high-tech exports, are assembled from parts and components produced in different locations.

The idea that greater participation by developing countries in the world economy through  trade will automatically bring equally large income gains needs to be qualified, says the report.

The basic policy issue, the TDR says, is not more or less liberalization, “but how best to channel the elemental forces of trade and industry to wealth creation and satisfaction of human wants.”

Underscoring the need for adapting trade negotiations to the new realities of the trading system, the report argues for improving policy coherence between trade, finance and development issues as well as widening the policy space available to developing countries for managing the integration into the system.

The report clearly brings out that despite the rhetoric about greater participation of developing countries in international trade in manufactures, such trade is concentrated in a handful of countries which achieved considerable success before the WTO was born. Post-WTO, the new entrants are simply selling cheap labour, and the talk of developing countries selling high-tech goods is quite misleading, says Yilmaz Akyüz, director of the UNCTAD division that wrote the secretariat report.

“Making sense of a system in which many developing countries are vigorously expanding their foreign trade but are not rewarded by comparable rise in income requires some hard thinking,” says the report. “A first step is to break with a casual style of empiricism - which takes the classification of manufactured goods at face value.”

Little value added

Generally speaking, developing countries participating in high-technology sectors are not involved in the skill- and technology-intensive parts of the production process. “Their contribution to value added is determined by the cost of the least scarce and weakest factor, namely unskilled labour, whereas the rewards to scarce but internationally mobile factors such as capital, management and know-how are reaped by their foreign owners.

“It is thus the labour itself, rather than the products of labour, that is exported.”

“Indeed even in countries such as China and Malaysia, which have been highly successful in raising their shares in world manufacturing exports and value added through participation in international production chains, an important part of domestic value added is captured by profits earned on FDI.”

The report points out that the increased import content of exports has heightened the importance of rules applied to determine the origin of traded goods - an area where the WTO commitment to complete, within three years, the  harmonization of rules for non-preferential trade has been delayed, and is now facing further problems over US demands that the commitment should not force changes in its own anti-dumping, countervailing duty and other trade instruments.

Analyzing the various concepts around origin rules and the criteria for judging substantial transformation - value-added measure, tariff heading criterion, and the technical test (on a case-by-case basis) of specific production activities conferring origin status - TDR 2002 points out that “given that there are no internationally agreed standards, there is considerable room for interpretation and direction by customs authorities in setting rules of origin. As a result, importing countries can vary rules of origin according to its trading partners and products.”

And international production sharing has been associated with preferential market access, particularly on textiles and clothing quotas, use of special tariff provisions by the US to encourage the use of its products in foreign assembly operations, and the outward processing trade between the EC and its trading partners, particularly concentrated in labour-intensive sectors.

Participation in the labour-intensive segments of international production networks can yield benefits for countries in the early stages of industrialization and with a great deal of surplus labour, the report agrees. The increased employment of low-skilled labour in activities linked to international production networks - whether organized by large TNCs producing a standardized set of goods in several locations or through groups of smaller enterprises in different countries that are linked through international sub-contracting - has certainly widened the possible range of sectors where industrialization can begin, and the basic techniques and organizational skills, a prerequisite for more broad-based growth, can be acquired.

“However, that does not constitute a leap into a new pattern of rapid and sustained industrial growth,” the report argues.

With the exception of a small group of countries including the East Asian newly industrializing economies, exports of developing countries are concentrated on resource-based, labour-intensive products. Market growth is slow for many of these products, which are protected in industrial countries.

While expansion in these sectors can allow countries at the lower end of the development scale to improve employment and income, they offer little for the more advanced developing countries since their productivity potential is limited compared to that of skill- and technology-intensive products. A simultaneous drive by a large number of developing countries, especially those with large economies, to expand such exports, and increased competition among them to attract FDI for labour-intensive segments of vertically integrated production networks, could be self-defeating.

For many countries, rapidly upgrading into market- and supply-dynamic products, combined with greater reliance on domestic markets, appears to be a more viable strategy for expansion of industrial activity than extending the existing patterns of production and trade.

In this process, technological upgrading can play a crucial role not only by enhancing the gains from trade but also by expanding the domestic market through increases in productivity and wages. In countries located in low-wage, labour-intensive segments of international production networks, further progress in capacity-building and industrialization calls for a strategy designed to replace imported skill- and technology-intensive parts and components with domestically produced ones in order to raise the domestic value-added content of exports.

“In most countries, this would require a different approach to FDI and TNCs than has hitherto been pursued,” adds TDR 2002.

The production networks, the report says, allow TNCs a good deal more flexibility in and control over their choice of investment locations; their productive assets such as know-how, design and technology can be locked more tightly inside the firm, thanks to barriers of entry resulting from the high costs of managing and coordinating such complex units.

“The packaged nature of FDI can, in these circumstances, be the cause of a highly skewed distribution of the gains from trade and investment unless local bargaining power can bring a more balanced outcome, as it did for the first-tier East Asians. However, replicating the success of those countries is all the more difficult where such investment is highly mobile: locational advantages are easily won and lost through small cost changes or emergence of alternative sites, giving rise to the danger of enclave economies where there is a persistently high dependence on imported inputs such as capital and intermediate goods.”

These problems, warns the report, “can be particularly serious for middle-income countries which have been successful in early stages of industrialization, but which now need rapid upgrading and productivity growth in order to advance further along the development path.”

Exports vs. value added

Analyzing in some detail the trade statistics from 1980 to 1996 in terms of North-South trends, UNCTAD finds that:

   *   manufacturing value added has consistently exceeded the value of manufacturing trade in the industrialized countries, but the opposite is true for developing countries;

   *  the ratio of manufacturing value added to manufactured exports fell in the developed countries from 225% to 180%, but the drop was sharper in developing countries, from 75 to 55 percent;

   *  manufacturing imports have outpaced exports in developing countries, but not in developed countries; and

   *  the ratio of manufacturing value added and exports to GDP remained broadly unchanged in the developed world, while the export ratio rose steeply in developing countries but without a similar upward trend in the value-added ratio.

This pattern, UNCTAD says, is particularly pronounced for some “super-traders”, such as Hong Kong China and, more recently, Mexico.

In a table (Table 3.5 on page 81), the TDR  brings out that the industrialized countries as a group registered a fall in share of world manufactured exports over 1980-1997, from 82.3% to 70.9%, while increasing the share of manufacturing value added (MVA) from 64.5 to 73.3 percent.

As a group, over the same period, developing countries increased their share in world manufactured exports from 10.6% to 26.5%, but their share in world MVA only rose from 16.6 to 23.8 percent.

Singapore saw a threefold increase in manufactured exports from 0.9 to 2.6%, while its MVA rose four times from 0.1 to 0.4 percent. Korea’s share in manufactured exports rose from 1.4 to 2.9%, while its MVA share rose from 0.7 to 2.3%; and Taiwan Province of China increased its share of manufactured exports from 1.6 to 2.8%, while its MVA share rose from 0.6 to 1.6%.

Malaysia increased its manufactured export share from 0.2 to 1.5%, while its MVA share rose from 0.2 to 0.5%; and Thailand increased its manufacturing export share from 0.2 to 1.0%, while increasing its MVA share from 0.3 to 0.8 percent.

China’s share in manufactured exports rose from 1.1 to 3.8%, while its MVA rose from 3.3 to 5.8%;  India’s manufactured export share rose from 0.4 to 0.6%, while its MVA share stayed the same at 1.1 percent.

Among the others, Indonesia increased its export share from 0.1 to 0.6%, while its MVA rose from 0.4 to 1.0%; Turkey increased its export share from 0.1 to 0.5%, while its MVA rose from 0.4 to 0.5%; Chile increased its manufactured export share from 0.0% to 0.1%, while MVA share remained the same at 0.2 percent.

At the other end, Mexico increased its share in manufactured exports from 0.2 to 2.2%, but its share in MVA dropped from 1.9 to 1.2%; Hong Kong China raised its share of manufactured exports from 0.2 to 0.6%, while its MVA share fell from 0.3 to 0.2%; Brazil kept its share of world manufactured exports at 0.7% over the period, but its MVA was reduced from 2.9 to 2.7 percent.

“With the exception of a few East Asian first-tier newly industrializing economies (NIEs), with a significant industrial base already closely integrated into the world trading system, developing-country exports are still concentrated on products derived essentially from the exploitation of natural resources and the use of unskilled labour which have limited prospects for productivity growth and lack dynamism in world markets.”

“The statistics showing a considerable expansion of technology-intensive, supply-dynamic, high-value-added exports from developing countries are misleading,” observes UNCTAD.

“Such products indeed appear to be exported by developing countries, but in reality those countries are often involved in the low-skill assembly stages of international production chains organized by the TNCs. Most of the technology and skills are embedded in imported parts and components, and much of the value added accrues to producers in more advanced countries where these parts and components are produced, and to the TNCs which organize such production networks.”

Fallacy of composition

“Certainly,” adds the TDR, “few of the countries which pursued rapid liberalization of trade and investment and experienced a rapid growth in manufacturing exports over the past two decades achieved a significant increase in their share in world manufacturing income.

“Clearly, for many developing countries, getting the most out of the international trading system is no longer just a matter of shifting away from commodity exports. At the same time, many of the same forces that adversely affected price and productivity dynamics in the primary sector, including the competitive structure of markets, income elasticities and technological weaknesses, need to be re-examined in the light of recent trends associated with the increased participation of developing countries in the international trading system.”

The report brings out the fallacy of composition (once an ill afflicting commodity-exporting countries and the export trade in commodities) as a result of excessive competition among developing countries.

“They are in fact competing on the basis of price and wages of labour,” said Akyüz. “Labour markets are more flexible in the South and this has effects on greater competition and results in instability of markets in manufactures exported by developing countries. In fact, the brunt of adjustment falls on the labour in the South.”

The report argues that national trade strategies are more important in making trade serve development, and that the one-size-fits-all approach incorporated in the current trade negotiations will adversely affect the interests of developing countries.

The analysis of the experience of the developing countries brings out that theories of free trade based on comparative advantage are not the factors shaping international trade, that the differences in the speed of liberalization of markets have played a significant role, and the commercial policies of many industrialized countries have limited the access to their markets.

Even more decisive in influencing the product dynamism have been the strategies of TNCs. The three product groups with the fastest growth rates over the last two decades - components and parts for electrical and electronic goods, labour-intensive products such as clothing, and goods with a high R&D content - have been most affected by the globalization of production processes through international production-sharing arrangements.

The increased mobility of capital and the continued restrictions over labour movements have extended the reach of international production networks, thus accelerating the growth of trade in a number of sectors where production chains can be split up and located in different countries. Commercial policies in industrial countries granting preferential market access to goods produced by the foreign assembly operations of their TNCs, as well as to goods containing inputs originating in their own countries, have helped this process.

[The trade rules (Article III of GATT 1994 and the WTO Agreement on Trade-Related Investment Measures (TRIMs)), however, prohibit importing developing countries from using tariff or fiscal arrangements to encourage the use of local content by foreign investors.]

Favourable tariff provisions, often through regional arrangements, and fiscal and other incentives have encouraged this process, promoting a new pattern of trade whereby goods are processed in several locations before reaching final consumers and the total value of trade recorded in such products exceeds the value added by a considerable margin. Trade based on specialization within such networks is estimated to account for up to 30% of the world’s exports.

The evidence analyzed and presented in the TDR shows that the benefits of integration and expansion of international trade depend on the modalities of a country’s participation in the trading system and on how trade is linked  to domestic economic activity. The evolution of a country’s share in world trade is not always mirrored by changes in its share in world income.

From TWE No. 279 (16-30 April 2002)