Sri Lanka should enable global production sharing, not ‘high value added’ exports: economist
ECONOMYNEXT – Sri Lanka should lift barriers to engage in global production sharing instead of chasing ‘high value added’ exports, a misguided concept developed by ‘import substitution’ promoters, a top economist said.
Starting from around 1960s firms started to internationalize or off-shore manufacturing where several countries participated in different stages of a product which was then finally assembled in another country.
Initially staring in developed nations, over time billions of dollars production and trade has shifted to developing countries with low or zero import duties,and final assembly is taking place in countries with large labour pools, such as China and Vietnam.
Now large global production networks (GPN) have developed with interrelated firms and GPN trade accounted for over half of global trade in manufactures, Premachandra Athukorale, a professor at Australian National University said in Colombo.
By 2013, 55 percent of manufactured exports involved GPN trade with 32.5 percent in components and 23.2 percent in final goods.
Pursuing strategies to promote ‘high value added’ exports involving taxing intermediate goods and final goods at different rates will keep countries out of global production networks, Athukorale warned.
"Policy interventions aimed at promoting domestic value added can run counter to the objective of employment generation and poverty reduction," he said.
Concepts like promoting ‘high value added’ products in one location were developed by prominent advocates of ‘import substitution’, he said.
Rules aimed at countering transfer pricing can also kill GPN trade, Athukorale said.
Components or parts used in global production were used for specific products and could not be traded in an exchange and had little value outside the network, he said.
Economic philosophers have said that true-capitalist firms constantly innovate and look for ways to reduce costs, improve efficiencies to beat competition changing the way they work in ways that neither bureaucrats nor interventionists can imagine.
They also develop new products, making others obsolete.
Import substitution on the other hand is a way of selling over-priced goods (usually invented by others) to a people in a trapped in a market with the help of a coercive state where import duties are used to eliminate competition and gouge customers in a Mercantilist fashion.
High Volume not high unit value
Instead of adding a high percentage of value to a unit of production, global production sharing adds smaller shares of value at each location to a high volume of goods, generating a large number of jobs and value.
Athukorale said developed and developing countries engaged in global production sharing.
An American Boeing 787 airliner for example is made with 70 percent of the parts coming from a number of countries including the UK, Spain, Japan, Italy, France and Korea. The Boeing 707, the first US made jet airliner was 99 percent made in the USA.
In 2013 about 70 percent of global computer hard drives were made in Thailand with at least 10 countries supplying parts.
There was a strong link between foreign direct investment and global production sharing which is was seen in countries like Vietnam whose exports grew with foreign investments.
Link between investment and trade freedoms
Global production sharing was mostly done by firms with foreign direct investment, though increasingly domestic subcontractors were now getting into the act in Asia, Athukorale said.
Over time, Western companies also shifted research and development into Asian countries – especially outside China – which had stronger protection for intellectual property.
"The expansion of global production sharing has made inputs and capital increasingly mobile across national boundaries and hence he patterns of production has become more sensitive to the overall investment climate of the country," he said.
Athukorale said once a company got established in a location, they would prefer to stay if the investment and economic environment was conducive.
He said bi-lateral preferential trade agreements had limited value in helping GPN trade because they had rules of origin criteria requiring higher levels of ‘domestic value addition’.
But in GPN trade domestic value addition would be small and fell below the criteria needed for bi-lateral FTAs.
Athukorale said some components that went to make complex products were ‘final goods’ in terms of customs criteria.
But multilateral agreements like the WTO’s Information Technology Agreement which gave sweeping trade freedoms making hundreds of electronic items duty free were relied upon by companies operating in East Asia, he said.
Countries that unilaterally gave trade freedoms to citizens like Singapore led the transfer of production sharing to Asia, he said.
In addition to creating an enabling environment he said governments could play a role in promoting industries to come as Penang and Singapore had done.
Sri Lanka did not have a large enough labour pool to become a location for final assembly like Vietnam and China but could play a role in component manufacture, Athukorale said.
There were several Japanese and Sri Lankan firms producing components for export, which showed that it was feasible to do so, he said.
Sri Lanka had missed opportunities in the early 1980s before the civil war intensified.
He said Motorola had set incorporated a domestic subsidiary in 1980 for an assembly plant with 2,600 workers. US-based Harris Corporation even started building a factory which would employ 1850 people but had left the country after a civil war intensified.
Athukorala said about 6.2 percent of Sri Lanka’s manufactured exports were GPN by 2012-2013 and 22.9 percent in India.
South Asia, a high tariff region with many government trade controls, was out of the loop for many years compared to East Asia, despite having cheaper labour.
Analysts say innovative private firms had used opportunities for service trade in India with large volumes of IT and IT-enabled services picking up with the availability of an English-speaking workforce. India is also a key location for producing pharmaceuticals.
India’s manufacturing and the economy in general started to pick up after government ended central planning in 1991 following a severe balance of payments crisis, reformed its central bank ending fiscal dominance of monetary policy, and gave more economic freedoms to citizens and foreign investors.
Saman Kelegama, head of Sri Lanka’s IPS there was increasing ‘servicification’ of manufacturing and exports and governments should give more freedom in the service areas. (Colombo/Feb08/2016)