Are Global Value Chains Good News for Africa’s Industrialisation?
International trade is changing. Modern communication technologies and falling transport costs have led to the emergence of global value chains (GVCs). These are production networks in which components are traded several times, spanning many countries, often the entire globe. They are driven by firms that seek to optimise their sourcing strategies through geographic re-organisation and the separation of production stages. Today 80% of global trade is linked to multinational corporations(1), 60% of global trade in goods takes place in the form of intermediate products(2) and on average foreign value added makes up 25% of the total value added included in a country’s exports.(3) What does this new pattern hold for Africa’s industrialisation agenda? In their forthcoming, joint African Economic Outlook 2014, the African Development Bank (AfDB), the Organisation for Economic Co-operation and Development (OECD) and the United Nations Development Programme (UNDP) provide new evidence.(4)
GVCs: what’s in it for Africa’s industrialisation?
A value chain identifies the various steps that firms take to bring a product or a service from its conception to its end use by final consumers (Figure 1). At each step–design, production, marketing and distribution - value is added in some form or another.
Driven by offshoring and mounting interconnectedness, those activities have become increasingly fragmented across the globe and between firms. The various tasks along the production chain can be carried out in distant locations, depending on their respective comparative advantages. These are referred to as global value chains or international production networks.(5)
Each stage carries, to varying degrees, opportunities for new local activities, jobs and corporate profits, as well as the associated technology diffusion and opportunities to generate public revenues. "Successful integration into a value chain allows a country to seize a bigger share of those benefits and potentially accelerate its industrialisation".
Figure 1 - Stages in a generic value chain: From conception to production to final sales
Global value chains offer new opportunities for structural transformation in Africa: instead of industrialising bottom up and building up all the sectors required to compete in global markets, developing countries can integrate into global value chains at a specific stage by catering specific skills or products. This opens up new and quicker routes for development.
Measuring Africa’s integration in global value chains
To avoid double counting and provide an accurate picture of a country’s global position, its trade with the rest of the world needs to be measured in value added rather in gross terms. The OECD/WTO Trade in value added (TiVA) and the UNCTAD-Eora projects measure trade in value added and participation in global value chains. They distinguish between:
- Backward integration, measured by the share of foreign value added embedded in a country's exports. It looks back from the perspective of a country’s exports across foreign inputs into local production. For example: country A imports engines and frames from country B; local workers assemble them into motor vehicles, thereby adding value; then the final product, cars in this case, are exported to country C. The value of the engines and frames imported from country B relative to the total value of country A’s exports of cars is a measure of backward integration.
- Forward integration, measured by the share of a country's exported value added that is further exported by the importing country. It looks forward from the country’s perspective at the flow of its exports around the world; specifically those other countries use to produce their own exports. For example: metals are extracted by country A from its soil – which is a form of value addition - and sold to country B, which uses them as components of mobile phones it assembles and exports to country C. The value of country A’s exports of such metals relative to the total value of country A’s exports is a measure of forward integration. Like in the case of backward integration, it assesses the degree of integration of country A in the value chain, but this time its contribution takes place earlier in the chain.
GVC integration is the extent to which a given country contributes to the global processing of goods and services and can be measured by cumulating the degrees of backward and forward integration. The AEO 2014 expanded the work of OECD/WTO and UNCTAD for African economies. The results are presented in Figure 2: relative to the size of its own exports, Africa’s participation in global value chains is fairly high, especially compared to many other regions. However, a lot of Africa’s GVC integration is of the forward kind, i.e. Africa is a source of raw materials for many global value chains. In terms of backward integration, i.e. the use of foreign intermediate products in its exports, Africa shows a similar profile to other regions.
Figure 2 - Integration of world regions into global value chains, 2011
Upgrading through GVCs: Africa’s productivity has benefitted, but wider linkages remain a challenge
Although GVCs offer new pathways to development they are no panacea. Turning the opportunities offered by GVC integration into longer term developmental benefits requires both economic and social upgrading.
- Economic upgrading refers to productivity gains, structural transformation and growing domestic value added embedded in a country’s exports. Its drivers are knowledge transfers, product differentiation and the addition of adjacent stages of the value chain. For example: Blue Skies, a firm in Ghana, adds domestic value by cutting fresh fruit locally and shipping it to European supermarkets by air, instead of exporting simple fruits and leaving all processing and trading up to external firms.
- Social upgrading refers to the expansion of employment and improvement in employment conditions.
Most African countries have been able to combine GVC participation with economic upgrading. Figure 3 shows that African countries with a higher share of foreign value added in exports (backward integration) on average experienced higher productivity growth and positive structural change: greater specialisation on specific segments of value chains seems to pay off. By contrast, however, forward integration shows negative links with measures of structural change and diversification, reflecting the negative impact of dependency on natural resources.
As for social upgrading, employment gains seem to follow the economic gains, but the relationship is not straightforward, and is difficult to measure. Ethiopia managed to attract a significant number of producers in the global apparel value chain linked to big brands such as H&M creating 60,000 jobs. Conversely, however, macroeconomic data in South Africa and Egypt suggests that although both countries are more integrated into global value chains and export more today than a decade ago, they do so with the same or even a smaller number of workers employed.
Figure 3 - Productivity Growth and Backward GVC Participation are correlated in Africa
Source: AfDB, OEC and UNDP (forthcoming), African Economic Outlook 2014; based on UNCTAD-EORA GVC database (2014) and productivity data from McMillan and Rodrik (2011) and AEO 2013
Reaping economy-wide gains from a few firms integrating into global value chains thus remains a challenge. Often activities linked to GVCs are isolated from the rest of the economy and few linkages develop. Tunisia, for example, has thriving export sectors in textiles and apparel and electrical machinery that are well connected to European production networks and markets. However, due to strict regulations separating the offshore and onshore sectors, most of these activities operate in isolation from the broader local economy, limiting the potential for further upgrading and employment creation. Cabo Verde has been able to boost its integration into global tourism value chains, increasing this sector’s share of in GDP to 20%. However, linkages are yet to develop from the resort style hotels and the local economy.
Besides, integrating into global value chains may bring about risks, such as making jobs and livelihoods vulnerable to shocks happening far away. Proper consideration must therefore be given to social protection and other means of managing these risks.
The pathways to upgrading are specific to each value chain and depend on the balance of power
The balance of power between lead firms and suppliers determines the scope for economic and social upgrading. Understanding those power structures is a prerequisite for identifying opportunities and devising adequate upgrading policies at sector- or even product-level:
- The more concentrated, producer-driven chains - cocoa or coffee in agriculture, automobiles and microchips in manufacturing, or extractive industries - offer fewer opportunities for upgrading into higher value-adding stages of the chain, as most processing steps are tightly controlled. Opportunities tend to lie in acquiring upstream capabilities - such as research, supplier services and component manufacturing - or in expanding into higher quality varieties of the base product such as organic or fair trade types of cocoa and coffee. South Africa for example became a global supplier of components in the global automotive chain after it had attracted investments by lead firms into local production.
- Buyer-driven chains, such as apparel and horticulture, allow for closer links between producers and consumers, by cutting out middlemen and providing unique value-added required by consumers. A good example is the growing share of direct supplies of flowers from Kenya to retailers, bypassing the traditional auction houses. However, quality standards play a crucial role in buyer-driven chains and can be a steep barrier to entry, especially for smaller producers such as farmers or SMEs in services and manufacturing.
Africa’s opportunities lie in regional value chains and openness; quality, cost and skills remain challenges
The lack of ability to meet such quality standards, as well as high costs of transport and energy, and poorly trained workforce are among the top reasons cited by international firms for not investing more in GVC relationships with African suppliers. The lack of a strong service sector is another hindrance: while on average 30% of the value of manufactured products exported globally is added in the form of services, such as design, development, marketing, warranties and after-sales care, Africa’s share of global service exports has been decreasing. The inadequate provision of public and private business services and extension services particularly penalises smaller firms, which need them to focus on innovation and value addition in their core field. The accelerating spread of global value chains amplifies these challenges, as they put African countries at a disadvantage in the competition for GVC investments, especially in manufacturing.
African countries’ advantages lie in their natural resource endowments, low labour costs and growing consumer markets. Experts interviewed for the forthcoming African Economic Outlook 2014 also see African markets as relatively open. Openness to trade, especially to imports of intermediate products is particularly important for countries to remain competitive in international supply chains.
Although a small share of African exports is currently destined to regional markets, the ongoing retail revolution and growing consumer potential present important opportunities for stronger regional value chains. In addition to higher proximity and first mover advantages, regional markets often require lower standards and thus present lower barriers to entry. Fast growing African markets will remain a primary driver of growth in the years to come; governments should strive to make it easier for African entrepreneurs to tap them. They need better roads, more reliable energy supply, but also greater freedom of moving across countries. Currently Southern and East Africa are the African regions whose exports incorporate the highest share of imports from other African countries. In other words, they are ahead in terms of their level of regional value chain integration (Figure 4).
Figure 4 – Sources of foreign value added in African exports
Industrialising with global value chains requires tailor-made policies that boost Africa’s capacity to integrate and upgrade.
The challenges and opportunities that GVCs present for structural transformation differ widely by sector and, within sectors, by product. "The challenge for policy makers is to maximise economy-wide opportunities while at the same time create the optimal environment for the value chains with the biggest potential". This means that governments will be confronted with trade-off in several areas.
In the area of trade policy, for instance, trade barriers and local content regulations must be balanced against attractiveness to GVC investors, who want to link African production to a global flow of intermediate goods and services. One essential ingredient of South Africa’s successful motor industry development plan was the scrapping of onerous import tariffs and local content requirements for investors. Instead, policy makers made a bet on longer term gains through local learning and development of component manufacturing. However, this implies having in place the capacity to benefit from learning and technology upgrading – in other instances, local content requirements may be productive.
Fiscal policy is another case in point: African governments often lose large sums in unnecessary incentives for international investors that would come anyway, attracted by natural resources or a fledgling consumer market and. Conversely, investing in workforce development and infrastructure is more important for longer term attractiveness to GVC-driven investors and could benefit from the financial resources lost in tax incentives. Moreover, such investments determine a country’s capacity for upgrading. Where such capacity is not created, countries risk competing with each other for GVC investments with low social and environmental standards and with the generosity of their tax incentives. Such low road strategies tend to deliver limited gains for a few, while the price is paid by many.
Figure 5 - Typology of Skills Development Policies for Global Value Chain Upgrading
Finally, entrepreneurship and public-private collaboration is crucial for using GVCs for development. Entrepreneurs play a critical role in identifying value chain opportunities with high potential, and accepting the risks involved in trying to seize them. Using GVCs for development requires public institutions to help build and support the country’s entrepreneurial base. This includes entrepreneurial training and access to finance, as well as partnering with local firms when formulating global value chain strategies. Domestic business associations are essential for this process. Their role is to identify the needs of firms in a given value chain and communicate them effectively to government. They also work as partners in capacity building and training for firms and can be interlocutors for international investors. The Ethiopian textile and garment manufacturers association, for example has become a critical partner for government and for international lead firms such as H&M. The association has helped shape the government’s set of policies supporting the sector and been a partner to H&M in building capacity for meeting quality standards among local firms. The Kenyan Flower Council plays a similar role in Kenya’s horticultural sector. Actively supporting the creation of such associations must be among the first steps towards using global value chains for development.
In summary, the heralding of global value chains as the new paradigm of global trade does open new opportunities for African firms, but it requires a shift in the way economic policies are designed and implemented: rather than national or sectoral strategies, successful integration and upgrading in value chains call for openness and product-specific, sometimes firm-specific strategies.
Pedro Conceiçao is Chief Economist and Head of Strategic Advisory Unit of the United Nations Development Programme, Jan Rieländer is Economist at the Europe, Middle East and Africa Desk at the OECD Development Centre, Abebe Shimeles is Manager of Development Research Division, African Development Bank, and Henri-Bernard Solignac-Lecomte is Head of Unit, Europe, Middle East & Africa, OECD Development Centre.
 UNCTAD, 2013.
 UN Comtrade.
 OECD TiVA.