When one thing leads to nothing: Cultivating industrial ecosystems in an era of GVCs

In the late 1970s, during the rising tide of neoliberal globalisation, many countries in the Global South opened up their economies to foreign capital and began linking up to Global Value Chains (GVCs). 

The ethos that drove such reforms may be divided into two camps: In China, pragmatism prevailed, with Chairman Deng Xiaoping stating, “To cross the river, feel for the stones.”

In Sri Lanka, there was an ideological faith in markets and foreign capital, with then President J.R. Jayawardena stating, “Let the robber barons come.”

Today, one of these countries has defaulted on its external debt and is undergoing its 17^th IMF program. The other is the world’s factory, contributing to over 35% of global manufacturing value-added and expected to lead the next technological cycle.

Fragmentation and centralization

The economist Albert Hirschman famously described development as “the record of how one thing leads to another.” In his theory of general linkages, Hirschman explained how certain economic activities can lead to upstream and downstream spillovers. These linkages can then develop to create a self-expanding local industrial ecosystem. 

But what does this mean and look like in an era of global value chains (GVCs)?

Since the 1970s, the Fordist ideal of a large, centralised factory bound to a national supply chain has disintegrated. 

The acceleration of globalisation through improvements in transport and communication technology, and the reduction of tariffs and capital controls, has led to the fragmentation of factories and national economies. 

Today, capital chases geographies where factor costs are cheapest, establishing resource extraction in one locality, labour-intensive processing in another, and so on. For example, it takes 43 countries across six continents to make an iPhone. But concomitant with this fragmentation of production is the continued centralisation of capital. 

According to UNCTAD, 80% of global trade is concentrated within GVCs, particularly through the intra-firm trade of a handful of transnational companies (TNCs). It is estimated that over 50% of the market share in many global industries are dominated by TNCs. In many cases, these TNCs have larger GDPs than some countries in the Global South.

This dialectic of production fragmentation and capital centralisation poses unique new challenges for industrialisation and industrial policy in the Global South.

Success and failure

Only a few countries have managed to leverage GVCs to move from one thing to another. China was for many years considered the example par excellence of a labour-intensive, export-processing economy. Indeed, studies had shown how little value in the final sale of electronic goods accrued to Chinese firms.

But recent years have seen a gradual expansion in domestic value-added of Chinese exports. When the iPhone 3G began production in 2008, Chinese firms captured just 3.6% of its final sale value, but by the release of the iPhone X in 2017, Chinese firms were able to capture 25.4% of the product’s value. 

China is an exceptional example of a country that linked up to GVCs, linked back to a local industrial ecosystem, and kept pace with global technological change. Today, China is capable of producing technology and brands that outcompete incumbent TNCs, as evidenced by the fact that exports are increasingly driven by domestic firms rather than foreign-invested ones. 

Many countries in the Global South have not been able to emulate this success. In Sri Lanka, labour-intensive, export-oriented manufacturing linked to GVCs produced an initial sugar rush of employment and profits. 

While this sector has been a mainstay of the economy, it has failed to produce a virtuous cycle of reinvestment of into expanded productive capabilities and new technological frontiers.

In Sri Lanka, 83% of industrial exports are by companies registered with the Board of Investment, most of which are foreign invested-enterprises (FIEs). Domestic value-added remains fairly low, due to the lack of a local supply chain. Meanwhile, the export basket is extremely undiversified, with textiles and clothing comprising 35-45% of the total for the last three decades.

For many middle-income countries like Sri Lanka, one thing has not led to another. On the contrary, the country has become a prime example of premature deindustrialisation.

Navigating value hierarchies

GVCs may be better understood as global value hierarchies, with each link of the chain representing a certain set of productive capabilities as well as a claim on value. In a closed economy, these links would add up to a local industrial ecosystem. But in an open economy, countries risk being locked into a monoculture of productive capabilities at the bottom of the hierarchy.

To avoid this trap, many of the lessons of developmentalist industrial policy can still apply in the era of GVCs. FIEs are unlikely to take the initiative to set up domestic linkages unless compelled to do so. China’s success in GVCs lies in its strategic use of industrial policies to facilitate transfer of foreign technology and boost its own domestic supply chain. As a result, Tesla’s Gigafactory in Shanghai procures 95% of components from within China.

The success of export-orientation and linking up to GVCs is often strongly conditioned by the geopolitical conjuncture and the global demand regime in place at the time of opening up. 

Sri Lanka serves as an interesting comparator to China, because, despite differences in size and history, it opened up to foreign capital at around the same time as China in the late 1970s. 

Deng Xiaoping even sent a delegation to Sri Lanka to study its Special Economic Zones.

Yet Sri Lanka’s process of opening up was radically different from China. A shock therapy style approach to trade liberalisation killed off infant industries. This combined with fire sale privatizations neutered, rather than nurtured, the country’s productive capabilities. Policymakers may have hoped that TNCs would bring with them market access, advanced technology, and better managerial skills, but the process of linking up to GVCs ultimately caused a harmful disarticulation of the local industrial ecosystem.

Meanwhile, China’s approach to opening up was arguably more mission-oriented, with a strong emphasis on industrial policy. China’s home market was well-protected by a state monopoly on foreign currency and imports until the 1990s. Even during the peak of SOE reforms in the 1990s, the goal was to consolidate control over the commanding heights of the economy, enabling the provision of foundational infrastructure and heavy industries required for export competitiveness. Meanwhile, openness to China’s foreign-investment has always been selective and conditional on transfer of productivity-enhancing technology.

Engagement with GVCs can therefore produce two outcomes. The first, in which a “natural path” of development is allowed to proceed, leads to a stagnant monoculture, which inhibits the development of productive capabilities, and leads to premature deindustrialization. The second, in which pragmatic and proactive industrial policies are deployed, can potentially lead to the cultivation of a local industrial ecosystem.

Industrial policy, or the art of getting from one thing to another

GVCs are a reality of modern, globalised production systems. Countries in the Global South have little option but to work with or around them. The task for industrial policymakers in these countries is to push forward domestic firms, not as mere subcontractors in GVCs but as active, learning agents, and future competitors. 

The specific industrial policy strategies that can be used to capitalise on the opportunities and overcome the challenges of GVCs are context-specific. Larger economies like China and India may be able to leverage access to their home market to force technology transfers. Others, like Vietnam or Mexico, may be able to capitalise on the relocation of production caused by trade wars. Resource-rich countries, like Indonesia, Angola, or Bolivia, may be able to leverage their market share of critical minerals to induce investment in downstream processing activities.

Finding what works for a particular country is a matter of “feeling for the stones”. What doesn’t work, is to “let the robber barons come” and expect them to develop your productive capabilities for you. 

It is up to local actors to prioritise the adoption of new technologies, and to develop a local productive ecosystem that can generate its own technologies and national champions.

Ultimately, getting from one thing to another in an era of GVCs is not a passive outcome of market-led growth, but a conscious effort of national industrial policy.

Header Image Credit: Rio Lecatompessy via Unsplash.