Economics, Regional cooperation and integration

Learning from firms in East Asian production networks

Learning from Firms in East Asian Production Networks

Slowing growth in the Peoples Republic of China (PRC) – the world’s second largest economy – is grabbing the headlines with some suggesting a third wave of the 2008 global financial crisis. While this topic deserves attention because of its global economic implications, there is insufficient analysis of firms in global production networks (GPNs), which were at the forefront of the economic transformation in PRC and the rest of East Asia, and lessons for latecomers to GPNs.

GPNs entail a type of sophisticated industrial organization which is different from a textbook idea of a single large vertically integrated factory situated in a country. It involves the location of different production stages (e.g. design, assembly and marketing) across different countries, linked by a complex web of trade in intermediate inputs and final goods. For example, the Toyota Prius – a hybrid electric mid-size hatchback car – for the US market was designed in Japan and is presently assembled there. But some parts and components for the Prius are made in Thailand, other ASEAN economies, and the PRC.

The extent of East Asia’s participation in GPNs is significantly greater than elsewhere and has spurred the region’s global rise to the coveted “Factory Asia” league with rapid growth and rising per capita incomes over several decades. East Asia’s share of world production networks exports rose from 38% to 48% between 2001-2004 and 2009-2013. The PRC is the leading player within East Asia with its share rising from 13% to 25%. Korea’s share rose from 4% to 5% and the share of the 10 ASEAN economies remained at about 9%. Japan’s share fell from 11% to 8% but this figure seems understated as Japanese firms are present in GPNs in other East Asian economies. The 2009-2013 figure for East Asia compares with 28% for the European Union, 7% for the US, 6% for Latin America, less than 1% for India and less than 1% for Africa.

GPNs in East Asia originated in the 1980s in the clothing and electronics industries and have since penetrated many industries including consumer goods, food processing, automotives, aircraft, and machinery. The role of services in GPNs in East Asia is increasingly important but has been underestimated due to serious data problems.

The role of firms in GPNs in East Asia is a new frontier in economics. While there are insightful case studies of the organizational aspects of individual firms in GPNs in East Asia, little research attempts to generalize the findings of case studies to multiple firms though econometric analysis. The recent availability of microdata from enterprise surveys has enabled identification of the benefits of joining GPNs in East Asia and the characteristics of firms in GPNs.

Evidence from Malaysia and Thailand suggests that joining GPNs brings tangible benefits such as raised profits and value added at firm-level. Furthermore, these benefits arise when firms actively invest in building technological capabilities focusing on assimilating and using imported technologies rather than formal Research and Development (R&D) by specialized engineers. Strikingly, firms in the PRC generally have higher levels of technological capabilities than those in ASEAN economies, which partly explains the PRC’s impressive record in GPNs. The gap in technological capabilities between PRC and ASEAN firms is associated with higher levels of foreign ownership, skills, managers’ education and capital.

It is observed that more developed East Asian economies like Japan and Korea have a deep base of industrial suppliers to large firms in GPNs including small and medium enterprises (SMEs). SMEs account for most of the jobs in ASEAN economies but have a limited presence as suppliers in GPNs. Evidence from Malaysia suggests that even among SMEs, larger SMEs benefit from economies of scale and set lower prices than smaller SMEs when joining GPNs. However, size is not the whole story. Licensing foreign technology, building technological capabilities and actively using preferences in free trade agreements (FTAs) also facilitates SMEs joining GPNs. Access to credit from commercial banks is another crucial factor for SMEs to participate in GPNs as indicated by the PRC and ASEAN economies. Financial access for SMEs in these East Asian economies is in turn influenced by managerial experience, availability of collateral and financial audits.

GPNs in East Asia are interwoven with forces associated increasing globalization and regionalization. They are underpinned by strategies of multinational firms, technological advances (e.g., information, communications, and transport technologies), improvements in logistics and trade facilitation, and tumbling barriers to trade and investment. At the national-level, outward-oriented market-friendly strategies supported the participation of East Asian firms in GPNs. While there are subtle differences in the strategies pursued, East Asian economies commonly emphasized attracting export-oriented foreign direct investment (FDI) into export processing zones (EPZs); investing in ports, roads from EPZ to ports and airports; streamlining business regulations; notable spending on education and training; and developing banking systems.

An important implication of the PRC’s growth slowdown and rising wage costs is the increased opportunities to attract FDI and participate in GPNs especially in labor-intensive activities. East Asia’s rich GPN experience offers valuable lessons for industrial latecomers in the developing world. First, participating in GPNs offers a fast track means to achieve higher levels of economic development. Second, it is crucial to focus on the role of firms in GPNs, particularly the process of building technological capabilities and accessing finance. Third, continuity with deep policy reforms provides a supportive business environment for joining GPNs. Fourth, mainstreaming GPNs into policy dialogues with aid donors and multilateral development banks will help to generate development finance for policy reforms and infrastructure development.

Useful links:

Production Networks and Enterprises in East Asia – Industry and Firm-level Analysis
Donor Support for Connecting Firms in Asia to Value Chains, William Hynes and Frans Lammersen, OECD, in Ganeshan Wignaraja (Ed.), Production Networks and Enterprises in East Asia: Industry and Firm-level Analysis: Springer, 2016
OECD work on global value chains
Getting globalization right: the East Asian Tigers Dani Rodrik on the Insights blog

This article was first published by OECD Insights.

Ganeshan Wignaraja

About the Author

Ganeshan Wignaraja is Advisor in the Economic Research and Regional Cooperation Department at the Asian Development Bank, and prior to that was Director of Research at Asian Development Bank Institute.
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