Export diversification - a key policy objective of LDCs

Enterprises in GVCs (global value chains) add value by providing labour and tangible inputs (e.g., raw materials and semi-finished goods) or intangible inputs (e.g., technologies, knowledge and skills) to the final commercial goods or service.  As commercial entities, they seek growth in market share, turnover, profit and size, among others.  To achieve this, they typically make their corporate decisions or manage GVCs based on three broadly defined factors: (1) resource endowment; (2) efficiency maximisation; and (3) market access (Figure 5).  Given the growing role that GVCs play with respect to income generation and job creation in LDCs, the literature has largely discussed GVCs based on these three factors and developed theories such as "comparative advantage", "economies of scale", "export-led development" and "FDI promotion" (cf., UNCTAD, 2013; WTO, 2013).  
Enterprises, by nature, seek access to key resources such as low-cost labour, natural resources, scarce materials, well-developed infrastructure and advanced technologies, both within their country and across the world.  Location advantages derived from availability of labour, materials and infrastructure (e.g., multi-modal logistics services) can reduce costs of production and distribution for an enterprise, due to decreased distance and improved controllability (Kimura and Ando, 2005).  Such comparative or competitive advantages are either natural or can be developed.  LDCs usually have abundant low-cost but unskilled labour and untouched natural resources such as land and minerals, while they generally lack advanced technologies and well-developed infrastructure.  In this case, enterprises which mainly depend on access to resources, such as those in labour-intensive or extractive industries, may be attracted to operate in LDCs.  In the meantime, advanced competitive advantages such as skills, infrastructure, value-added industries, etc. can and should be developed.
The purpose of efficiency maximisation is primarily to reduce costs within an enterprise or the overall value chain, i.e., to achieve higher productivity at lower cost (Christopher, 2011).  In theory, economies of scale are believed to help a firm achieve high productivity; thus, larger enterprises are expected to be more productive and to have higher competitiveness than their smaller-scale competitors, which may focus on smaller but less competitive markets to stay alive and grow.  Production agglomeration (e.g., industrial or SME clusters) and consolidated operations (e.g., supplier or logistics consolidation) can also enhance efficient value chains through achieving low transaction costs.  Utilising advanced technologies, including information and communication technologies (ICT), firms are able to improve production systems and facilities to achieve high productivity and quality at lower cost.  Concepts of value chain management, such as zero inventory, just-in-time movement of goods, and outsourcing and offshoring have indeed been applied to reduce total costs within GVCs, enhancing overall efficiency.  As LDCs generally lack advanced technologies and skilled labour, attracting foreign direct investment (FDI) from TNCs could provide opportunities to improve national productivity rapidly through transfer of technology and know-how, while TNCs develop and expand their GVCs in LDCs.  In this regard, participation of LDC enterprises in GVCs is important as an effective strategy to achieve a higher level of efficiency in their operations over time.
Firms are generally motivated to enter into new markets to seek growth opportunities.  In many economies with limited domestic demand in certain sectors, the diversification and modification of a firm's products, brands and operations in order to satisfy demand in a new market through exports or overseas FDI play a crucial role in achieving growth (Czinkota and Ronkainen, 2010; Kotlar and Keller, 2011).  Key success factors for market access include, but are not limited to, an enabling business environment and low entry barriers in the new market, and the availability of adequate market information, solid distribution channels and reliable logistics systems.  Firms supplying competitive products with greater backward and forward linkages, such as automobiles and ICT equipment, have led to the development of GVCs.  Within this context, market access can generally be of two types: trade and investment.  LDCs, which have a relatively large market, or participate in regional free trade agreements which facilitate market access to other countries' markets, are seen as a potential trade and investment destination at both local and international levels.
In the case of Bangladesh, GVCs have been developed in the labour-intensive light manufacturing sector, i.e., apparel and garment industry, which is required to access abundant and cheap labour to maintain its competitiveness in the global markets.  One evidence of this resource endowment GVC strategy is the data of greenfield investments to Bangladesh (fDiMarkets, 2014).  The data indicates that nearly half of new jobs created by FDIs to Bangladesh are those in the apparel and garment industry (Figure 6).
Export diversification should be a key policy objective for LDCs as dependence on a limited range of agricultural commodities or light manufacturing goods, which is the case observed in Bangladesh, may expose these countries even more to external economic shocks, particularly in terms of demand.  Some developing countries like India, Malaysia and Thailand have already made export diversification a prime focus, and saw their reforms yield high economic returns (ESCAP, 2011).  Export diversification would put LDCs on the path towards long-term sustainable growth and would render their economies more resilient to external shocks.
A crucial, and sometimes, overlooked, aspect of export diversification is the strengthening and diversification of GVCs.  The highly-globalised nature of production in the modern economy where, as previously stated, GVCs are responsible for approximately 80 per cent of global trade serves to underline this fact.
Trade and investment facilitation is a core component of export and GVC diversification.  As exports depend on imports of intermediate goods and materials as well as the inflows of FDI to export manufacturing sectors, achieving progress on trade and investment facilitation and the lowering of entry barriers is necessary for LDCs in order to promote export diversification.  In addition, trade and investment facilitation helps to foster increased competition and, hence, greater innovation and efficiency in exports, and also promotes technology transfer and learning-by-exporting.  Export diversification also requires development of the private sector, in particular small and medium-sized enterprises (SMEs) as they play an important role in export operations as well as supplying intermediate goods and services to TNCs and large enterprises which are main exporting drivers.  
Given the importance of trade and investment facilitation to GVC diversification, it is not surprising that tariffs and non-tariff barriers (NTBs) are two of the major obstacles to successful diversification.  Tariffs on raw materials or intermediate goods impede the competitiveness of businesses seeking to engage in value-added production activities;  these impact FDI decisions.  Non-tariff barriers implemented by trading partner countries, in particular sanitary and phytosanitary (SPS) measures and other types of quality standards, provide major barriers to development and diversification of GVCs.  Many producers in LDCs, especially SMEs, experience difficulty meeting such measures, and as a result are prevented from integrating into GVCs.
Various other barriers may exist within the particular LDC itself.  Underdeveloped transport infrastructure can make it difficult for local producers to supply their goods to foreign companies in a timely or reliable manner.  Lack of access to finance is also a frequently-cited obstacle (ESCAP, 2009; 2011)-a problem that most acutely impacts SMEs.  Also, a lack of skilled labour discourages TNCs and large enterprises from investing in LDCs due to their low readiness on advanced technologies and production.  Those issues can mean that businesses are unable to upgrade their production or products to meet the standards specified by foreign countries' trade regulations or the internal standards of TNCs.
There are a number of ways in which governments, in particular, in LDCs, can better facilitate the development and diversification of GVCs.  Those policies can be broadly categorised into three areas: trade policies, investment policies and business environment.  Some major policy priorities should be:
n Under trade policies:
i. Reducing trade transaction costs;
ii. Concluding bilateral, regional and multilateral trade agreements (including mutual recognition agreements) to help countries diversify exports by improving the access to foreign markets of domestic products (Samen, 2010) and improving access to foreign inputs; and
iii. Implementing other trade facilitation measures that make it faster and less burdensome to export, such as streamlining customs procedures (ESCAP, 2009).
n Under investment policies:
i. Adopting an adequate investment regime;
ii. Investing in advanced infrastructure (both transport and ICT, to improve logistics); and
iii. Instituting fiscal and credit incentives, to trigger business and investment activity within a particular trade sector (though such incentives should be used with care if the government suffers from budget constraints).
n Under business environment:
i. Improving the business enabling environment, in particular an enabling environment for both local companies and foreign investors;
ii. Reducing business transaction costs;
iii. Helping to establish high-quality laboratories that can efficiently certify products, in order to minimize the negative impact of SPS measures (ESCAP, 2011);
iv. Building awareness of GVCs among SMEs, increasing knowledge of how GVCs work and their tremendous potential benefits for SMEs;
v. Improving skills and technology in SMEs, through initiatives such as capacity building, encouraging international partnerships and targeted financial incentives (OECD, 2008); and
vi. Raising awareness among SMEs of intellectual property rights in order to improve innovation and creativity in the sector (ESCAP, 2009).
In addition to various policy mandates at national level, international organisations like ESCAP could conduct more research on GVCs focusing on both quantitative and qualitative analyses that identify the opportunities and challenges for SMEs' effective integration into GVCs, particularly those in LDCs.  Such research would specifically contain an analysis of trade and investment based on production data including a review of input-output tables.  Research could also identify strengths, weaknesses, opportunities and threats (SWOT) for LDCs in Asia and the Pacific to participate in specific GVCs linked to exports, such as food processing, garment/apparel, automobile and electronics in terms of value chain configuration and characteristics.  Research could finally aim to propose practical policy recommendations based on best practices to increase the chances for LDCs to play an important role in emerging GVCs in Asia and the Pacific.
Masato Abe, Ph.D. is Economic Affairs Officer, Business and Development Section, Trade and Investment Division, United Nations Economic and Social Commission for Asia and the Pacific Bangkok, Thailand. E-mail: [email protected]
David Abonyi is Consultant, Business and Development Section, Trade and Investment Division, United Nations Economic and Social Commission for Asia and the Pacific, Bangkok, Thailand.
[email protected]