In the flying geese paradigm, Japanese economist Kaname Akamatsu explains that companies restructure to find the cheapest labor costs by moving low-value activities to nearby less-developed countries. Today that story rings truer than ever before as global value chains (GVCs) reach a critical turning point.

Simply put, GVCs take a broader look at supply chains coordinated by multinational companies, but also encompass economic analyses of the countries involved with the activities.

Last year, for the first time in history, developing economies attracted more foreign direct investment (FDI) — 52 percent — than developed economies, according to the latest FDI report from the United Nations Conference on Trade and Development (UNCTAD) and the World Trade Organization (WTO). The impact of this report on GVCs, say Wharton and industry experts, could be profound.

There is an enormous amount of change going on. The global supply chain is in flux, notes Wharton operations and information management professor Morris A. Cohen. International supply networks have been in place for decades now, but the pace of global trade expansion has skyrocketed past the rate of the world’s GDP growth.

The recession of 2008-2009 has further increased trade with developing economies, adds Anthony Mistri, economics expert at the World Trade Organization.

Nations may have borders, but businesses no longer do.

Changing GVCs

In 1990, developing countries had a 20 percent share in global trade. Today, that figure is more than 40 percent. Moreover, transnational companies coordinate around 80 percent of global trade, according to UNCTAD.

This impact is particularly significant in developing economies, where value-added trade contributes to nearly one-third of a country’s GDP compared to almost one-fifth in developed nations.

The more foreign investments there are in a country, the higher the level of participation in GVCs, thereby resulting in higher domestic value added from trade.

Moreover, developing economies with effective GVC participation can increase GDP per capita growth by 2 percent above average, says Axele Giroud, an expert at UNCTAD who helped author the report. But that kind of change doesn’t happen overnight.

GVCs adapt dynamically, but depending on the sector, supply chains are shifting in different ways. You see the disintegration or fragmentation of value chains in manufacturing, says Wharton management professor Ann Harrison. But in agriculture, you see the opposite going on.

Agribusiness is becoming more and more integrated.

Current technological advancements have made production processes become more fragmented, Mistri adds. Better communications have facilitated operating at a distance, not only for raw materials or components planning, but also in services and management. Participation in GVCs can commence with the smallest of components — and don’t involve building a complete new factory — creating more opportunities to participate.

China has jumped to third place from sixth place as the world’s biggest investor, behind the United States and Japan, Giroud says.

Though China is still officially categorized as a developing economy, Cohen adds, it’s debatable whether the nation is “developing” or “developed.” According to Wharton operations and information management professor Marshall L. Fisher, China is no longer the cheapest place to produce things, and it has accelerated people’s thinking about where to go from here. 

Indeed, while Chinese labor costs are growing 20 percent annually, wage hikes in the US are inching up by 2 percent due to lack of jobs and the recession, Cohen notes, adding that “the labor advantage is eroding, and the tipping point could bring jobs back to the US,” a phenomenon called “re-shoring.”

General Electric recently announced that it is reopening a manufacturing plant in Kentucky, and Apple plans to start assembling Mac Pros in the US, the company said in June. While experts have long accepted Asia as the go-to region for cheap labor, that reality is quickly changing.

Though Africa is one of the least developed continents, it is also the region with possibly the most potential. FDI declined significantly worldwide by 18 percent, whereas inflows to Africa increased by 5 percent. That’s a really positive sign for Africa.

It may not sound high, but it’s significant when everywhere else decreases, notes Giroud.

Challenges, solutions

Even so, while developed economies retain 31 percent of the value added from exports, Africa retains only 14 percent and Asia 27 percent, according to the UNCTAD report. That’s partly because extractive industries contribute to a large part of Africa’s exports, yet the processing end is woefully underdeveloped.

Edwin Keh, a Wharton lecturer and former chief operating officer of Walmart’s global procurement division, calls it “the curse of the abundance of natural resources.” Year after year, oil and minerals were pulled out of the ground. African countries didn’t need to manufacture anything to make ends meet. But what happens when these resources go dry?”  he asks.

For example, Africa is the world’s biggest producer of cashew nuts, but about 90 percent of the crop gets exported raw to countries like India and Vietnam and then sent to the US or Europe for roasting, salting and packaging, says Miriam Gyamfi of the African Cashew Alliance (ACA) in Ghana.

That means that Africa, the biggest producer of cashews, is missing out on the most profitable part of the cashew value chain — the processing of the nut. ACA’s mission is to help African cashew industries by enabling access to finance, providing technical assistance and setting up market linkages to international industries. The organization works with companies like Kraft, Costco and Red River Foods.

In comparison, processing and manufacturing in Asia account for a significant part of export value, thereby retaining more economic benefits regionally.

These disparities mean that developing countries need to plan a more sophisticated approach to maximize their role in GVCs with good infrastructure, education and know-how; market access; the ability to produce at internationally recognized standards; security of finances, and geopolitical stability, to only list a few, says Mistri.

Basically, the more entrepreneurial risks a country can mitigate, the higher the chances are it can attract multinational firms.

As GVCs reach more complex levels worldwide, transnational companies and developing countries need to find ways to mutually benefit. “We need to think more dynamically and to synthesize trade and investment policies. We can build domestic capacity to support global firms so they give attention to social and environmental factors,” says Giroud.

At the end of the day, Keh adds, global supply chains are all about total supply chain, upstream and downstream, from raw materials to final assembly. The developing world is disappearing.

Adapted from China Knowledge@Wharton,http://www.knowledgeatwharton.com.cn. To read the original, please visit: http://knowledge.wharton.upenn.edu/article/developing-economies-grow-global-value-chains-reach-turning-point/