Economics, Governance and public sector management, Industry and trade, Private sector development

SMEs in global value chains: Catalysts for dynamic and inclusive economic growth

SMEs in global value chains: Catalysts for dynamic and inclusive economic growth

The world has been witnessing the active construction of global value chains (GVCs) by multinational corporations (MNCs) in recent decades. According to the World Bank (2020), the share of GVC trade in world trade increased rapidly from approximately 40% in 1990 to over 50% in 2007 before declining somewhat after the global financial crisis in 2007–2008. MNCs fragment production processes into various stages and locate them in various countries and places where the particular stages can be conducted most efficiently, or at least cost, in order to achieve an efficient production system. GVCs are actively formed in sectors that require several production stages, such as machinery or textiles and apparel. GVCs take various forms and can involve both MNC-affiliated and non-affiliated firms. The active construction of GVCs has been made possible by sharp declines in transportation and communication costs, which in turn are attributable to not only technological progress in transportation and communication services but also liberalization in trade and investment policies and deregulation in these sectors.

GVCs have come to attract the attention of firm managers and policy makers as participation in GVCs can bring benefits for firms and countries. For firms, involvement in GVCs expands business opportunities in foreign countries in the form of new import sources and export destinations, enabling those firms involved to increase efficiency and productivity. Moreover, these firms can acquire technology and management know-how through business interactions inside the value chains. For countries, the greater the involvement in GVCs by their firms, the greater the potential for economic growth. Because of these multiple benefits, firms and countries are eager to find ways to become involved in GVCs.

In light of these developments, our study uses enterprise surveys conducted by the World Bank to attempt to identify the factors related to firm and country characteristics that determine the probability and level of GVC participation by firms. We pay particular attention to small and medium-sized enterprises (SMEs), mainly for three reasons. First is the importance of SMEs in economic activities. In many countries, SMEs account for more than 95% of the total number of firms and comprise more than 70% and 50% in terms of employment and value added, respectively. Nurturing competitive SMEs will contribute to the realization of sustainable and inclusive economic growth. Another reason is the important role of SMEs in supplying parts and components to large assembling firms in GVCs. Value chains involving various stages of production provide SMEs—whose scope of operation is limited because of their small size—with business opportunities to exploit their competitive advantage. The third reason is their dynamism. Although their number may be small, there are SMEs with creativity and competence that could contribute to economic development and growth. These SMEs could successfully realize their significant potential by becoming involved in GVCs.

Our study extends earlier studies, such as those by Harvie et al. (2010) and Wignaraja (2013), in terms of country coverage as well as issue coverage. Unlike earlier studies, which analyzed firm characteristics, we cover country characteristics as well. The examination of country characteristics for the determination of firms’ GVC participation is useful for drawing policy recommendations.

Our sample consists of 38,966 firms, covering 111 countries for the 2009–2018 period. In the sample, 17,743 firms (45.5%) are not engaged in foreign trade. 24.4% are engaged in imports but not exports, while 9.5% are engaged in exports (both direct and indirect exports) but not imports. 20.7% are engaged in both imports and exports, and we call these firms “GVC firms.” This share goes down to 13% if we exclude indirect exports, indicating the importance of indirect exports. The proportion of GVC firms in the total number of firms (GVC firm ratio) is found to increase with firm size: firms with fewer than 4 employees (5.8%), 5–19 employees (9.0%), 20–99 employees (18.9%), 100–199 employees (33.7%), and more than 200 employees (47.5%). These findings indicate that SMEs, here defined as those with fewer than 199 employees, are likely to face greater obstacles to participating in GVCs.

For the firm characteristics that determine GVC participation, our analysis shows the importance of high labor productivity, large firm size, foreign ownership, long operational period, high technological capability, and financial access for firms to participate and increase their level of engagement in GVCs. High technological capability is particularly important for SMEs. Concerning the country-level attributes, a high level of openness to trade and foreign direct investment (FDI), an abundance of educated people, well-developed infrastructure, efficient logistics, and good governance are found to facilitate firms’ participation in GVCs and increase levels of GVC participation. These attributes are particularly important for SMEs.

Based on these findings, we provide several recommendations for firms and governments to allow firms to participate in GVCs and increase their GVC participation. For firms, developing and improving technological capability is very important, particularly for SMEs. Closely related to this point, increasing labor productivity contributes significantly to achieving these objectives. Attracting foreign investment is also useful, as it brings not only technology but also overseas procurement and sales networks.

For governments, we strongly recommend that they provide and improve education, and build and improve the quality of infrastructure, logistics, and governance. These policies are especially crucial for SMEs. We should also note the importance of providing technical assistance to firms, especially SMEs, and the importance of achieving and maintaining an open trade and FDI environment for firms to participate in GVCs and increase their level of GVC participation. Unilateral trade and FDI liberalization, as well as joining bilateral and multilateral free trade agreements, would be very effective for achieving these objectives.

In order for governments to promote firms’ participation in GVCs, they need to formulate appropriate policies, which in many cases include difficult reforms, and implement them with strong political leadership and determination as well as appropriate international cooperation with international organizations and foreign donors.

Read the working paper here.
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References:

Harvie, C., D. Narjoko, and S. Oum. 2010. Firm Characteristic Determinants of SME Participation in Production Networks. ERIA Discussion Paper Series, ERIA-DP-2010-11.
Wignaraja, G. 2013. Can SMEs Participate in Global Production Networks? Evidence from ASEAN Firms. In Global Value Chains in a Changing World, edited by D. K. Elms and P. Low. World Trade Organization Publications.
World Bank. 2020. Trading For Development in the Age of Global Value Chains. World Development Report. Washington, D.C: World Bank.

Shujiro Urata

About the Author

Shujiro Urata is a visiting fellow at ADBI, Tokyo, and senior research advisor to the president of the Economic Research Institute for ASEAN and East Asia, Jakarta.

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