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Participation of small economies in global value chains: Evidence and policy issues

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Participation of small economies in global value chains: Evidence and policy issues

Participation of small economies in global value chains: Evidence and policy issues
Photo credit: The Commonwealth

Small economies face both challenges and opportunities when trying to integrate into global value chains (GVCs). By specialising in specific tasks or stages within a value chain, small economies can, to a certain extent, mitigate their lack of economies of scale. Furthermore, small economies can use GVCs to help with export diversification, employment creation and technology as well as knowledge transfers.

Such integration, however, comes with its own set of challenges: small size and remoteness are two natural challenges that small economies have to address; others, include difficulties related to accessing finance, inadequate transport infrastructure, complying with safety and health standards, upgrading labour skills, ensuring sound legal institutions and improving the national business environment.

This issue of Commonwealth Trade Hot Topics focuses on the integration of small economies in value chains in the agrifood, seafood, and textiles and apparel sectors in the case of goods, and in tourism as well as IT and business process outsourcing in the case of services. The paper also highlights small economies' trade policy options related to foreign direct investment (FDI), small and medium-sized enterprises (SMEs), regional integration, transport infrastructure, logistics and trade facilitation.

This article is based on a more detailed analysis undertaken in WTO (2015) and covers selected 32 small economies. The distinguishing characteristics of these countries are that many have a small market size, narrow resource base and small or restrictive economies of scale; many too are islands and are situated in remote locations. Moreover, many of these countries are also highly vulnerable to natural disasters.

Small economies are less integrated in goods value chains

Integration into GVCs is often analysed using data on trade in intermediate goods. In 2013 non-fuel, intermediate goods constituted 34 per cent and 40 per cent of small economies' exports and imports, respectively. Such trade is relatively more important at the world level, where it accounted for 46 per cent of total trade in 2013. This lower share of intermediate exports and imports reflects the relatively lower integration of small economies into GVCs and their product and sector specialisation.

This paper provides evidence of the integration of small economies in selected goods and services value chains, which are of significant importance for small economies in terms of export receipts and also in terms of comparative advantage.

Policy issues

The increasing fragmentation of production has opened up new opportunities for small economies at the level of production stages, services and sectors. Policy-makers in small economies have a number of trade policies at hand that can facilitate the integration of their firms into value chains.

First, the entry or upgrading in GVCs is often linked to FDI. Besides direct employment effects, FDI can bring dynamic benefits linked to technology transfer or knowledge spillovers. Therefore, policy-makers should engage on policies aimed at both promoting FDI and strengthening the linkages of FDI with the domestic economy.

Firms in small economies with at least 10 per cent of foreign ownership tend to be more integrated in GVCs than domestically-owned firms. On average, 84 per cent of manufacturing firms with foreign participation source 54 per cent of inputs from abroad for their production. Such backward linkages are lower for purely domestically-owned firms, with 68 per cent of firms using foreign inputs in their production with the average share of foreign inputs being 38 per cent. Firms with foreign ownership participation are also more likely to export and tend to export a higher share of their sales compared to entirely domestically-owned firms.

A 2014 study by the United Nations Conference on Trade and Development (UNCTAD) showed that most FDI inflows to small island developing states (SIDS) go to the mineral extraction sector and related processing activities. Smaller inflows go to the business, finance and tourism sectors. Since many small economies tend to be remote from major markets and of small size, they are less attractive for market seeking FDI. On the other hand, in several services industries such as tourism as well as IT and BPO, small size and remote location are less of a disadvantage.

After FDI, a second policy area of major importance to small economies is support to small and mediumsized enterprises. SMEs in small economies are less able to participate in international trade and GVCs compared to larger firms. Particular challenges that SMEs face when trying to participate in GVCs include access to finance, workforce skills, market information and a restricted market size that prevents them from growing.

A way around this is for small economies to join other small economies through regional integration agreements such as CARICOM or the Pacific Island Countries Trade Agreement (PICTA). This could also attract larger companies or lead firms to organise production networks inside a region.

Another option is for small economies to increase their participation in GVCs by reducing their timerelated trade costs. Efforts here require a focus on improving trade infrastructure and logistics services as well as on the implementation of the WTO's Trade Facilitation Agreement.

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