EBRD Transition Report 2014 – Box 3.2. Global value chains: drivers of innovation?

Box 3.2. Global value chains: drivers of innovation?

Over the past two decades, the increased prominence of global value chains (GVCs) has transformed the world economy. The declining cost of communication and international shipping has caused production processes to be broken down into ever smaller parts and spread across vast geographical areas. As a result, international commerce is now dominated by trade in intermediate – rather than final – goods and services. This box looks at how GVCs stimulate innovation among manufacturing firms in the transition region.26

There are several reasons why participation in GVCs can help firms in emerging economies to learn and innovate. First, being part of a GVC means that a firm has to satisfy the chain’s requirements in terms of the quality of products and the efficiency of processes.27 To do so, managers may need to adapt their production methods or acquire technology via licensing arrangements. Second, serving foreign clients may require improved logistical solutions or delivery methods, as delivery at the appropriate time is essential for a smooth supply chain. Third, importing intermediate goods can itself be a channel for the diffusion of technology where firms import state-of-the-art technology that has not previously been available in the domestic market. Importing new technologies can also enhance the technical skills of the workforce if this necessitates further training. These increases in human capital may, in turn, enable companies to introduce innovative products of their own.

However, in certain circumstances GVCs can also hamper innovation within participating firms. This is most likely to occur where firms in developing countries are involved solely in the assembly of foreign intermediate goods. As this is the least skill-intensive stage of the value chain, the potential for technological spillovers is minimal and it is unlikely that participation in the GVC will encourage these firms to introduce new products of their own.

Chart 3.2.1 shows the percentage of innovative BEEPS V firms that are part of a GVC. GVC firms are defined as those that both import at least 10 per cent of their intermediate goods and export at least 10 per cent of their output.28

We can see that GVC firms tend to be more innovative than other firms across all five measures of innovation. In particular, 44 per cent of GVC firms responding to BEEPS V have introduced a new product in the last three years, compared with only 31 per cent of firms that do not participate in an international supply network. Equally striking is the fact that there is a 15 percentage point difference between the two when it comes to the percentage of firms that spend money on R&D or use technology via a licensing arrangement.

In order to check that these substantial differences are not driven by other factors, such as firms’ ownership structures or their access to finance, Table 3.2.1 presents the results of a multivariate regression analysis. It shows that these differences in R&D, the licensing of technology, product innovation and process innovation continue to be observed when other firm-level characteristics are controlled for.

This analysis also determines the precise source of the positive impact that GVCs have on innovation. All measures of innovation – with the exception of the acquisition of external knowledge – are positively and significantly correlated with the importing of at least 10 per cent of total intermediate goods. However, only product innovation is positively and significantly associated with the exporting of at least 10 per cent of total output.

These results suggest that GVCs help firms to expand their product ranges and upgrade technology primarily by giving them access to better quality inputs, rather than by expanding the size of their markets.

The detailed innovation module in BEEPS V can help to shed more light on the mechanisms that are at work here. Firms that reported the introduction of a product or process innovation or the acquisition of external knowledge were asked whether they were able to do so as a result of working with domestic or foreign partners (such as clients or suppliers). Chart 3.2.2 shows that 22 per cent of GVC firms reported working with foreign partners on innovation, compared with only 10 per cent of non-GVC firms. This suggests that the higher levels of innovative activity among GVC firms can indeed be attributed to their easier access to foreign technology and knowledge. An important policy implication is that firms in emerging markets cannot hope to become more innovative simply by importing physical inputs. Instead, they need to invest in longer-term relationships with foreign suppliers and clients in order to allow a continuous flow of knowledge and know-how.

Chart 3.2.3 shows the impact that participation in GVCs has on the probability of firms innovating. Here, firms are grouped together on the basis of the relative skill endowments of the countries where they operate (measured as the percentage of the workforce that has completed secondary education). This chart suggests that the marginal probability of innovating on account of participation in a GVC increases with the quality of the workforce that is at the firm’s disposal. Firms in countries with higher skill levels are given – via GVCs – more skill-intensive tasks with greater scope and need for technological spillovers.

However, caution is warranted when it comes to the type of involvement that firms have in GVCs. As mentioned above, participation in GVCs may hinder innovative activity and prevent positive spillovers if it only involves the assembly of components.

All in all, the analysis in this box shows that where participation in GVCs goes beyond simple assembly, it may allow firms to reap substantial productivity benefits through international spillovers of technology and know-how. A good example of this is the automotive industry in central and eastern Europe.29 In CEB countries where this sector has seen high levels of foreign direct investment and local car producers are well integrated into GVCs – such as Hungary and the Slovak Republic – labour productivity in the automotive sector is substantially higher than the average for the manufacturing industry as a whole. By contrast, in countries where foreign investors play no meaningful role in the car industry (such as Bulgaria), the opposite is true.

The challenge, then, remains unchanged: not only replicating, but also improving on this paradigm across a variety of industries in the region, in order to help countries move up the value chain.

TABLE 3.2.1

Global value chains and innovation

	(1) Product innovation	(2) Process innovation	(3) R&D	(4) Acquisition of external knowledge	(5) Licensing of technology
Import at least 10% of intermediate goods	0.513***	0.367***	0.487***	0.107	0.437***
Import at least 10% of intermediate goods	(0.063)	(0.067)	(0.089)	(0.097)	(0.074)
Export at least 10% of output	0.256**	0.191*	0.089	0.188	0.210*
Export at least 10% of output	(0.089)	(0.095)	(0.120)	(0.125)	(0.098)
Both import and export 10%	0.421***	0.359***	0.531***	0.218*	0.551***
Both import and export 10%	(0.075)	(0.079)	(0.096)	(0.106)	(0.084)
Foreign-owned firm	0.038	-0.007	0.048	-0.007	0.435***
Foreign-owned firm	(0.079)	(0.083)	(0.093)	(0.102)	(0.081)
Staff training	0.371***	0.434***	0.480***	0.451***	0.156**
Staff training	(0.052)	(0.054)	(0.065)	(0.070)	(0.059)
Quality certificate	0.184***	0.189**	0.263***	0.220**	0.455***
Quality certificate	(0.056)	(0.059)	(0.069)	(0.077)	(0.061)
External audit	0.108*	0.109	0.066	0.268***	0.102
External audit	(0.055)	(0.057)	(0.069)	(0.076)	(0.060)
Managerial experience	0.005*	0.004	0.006*	0.002	-0.002
Managerial experience	(0.002)	(0.003)	(0.003)	(0.003)	(0.003)
Age of firm	0.002	0.003	0.001	0.004	-0.002
Age of firm	(0.002)	(0.002)	(0.002)	(0.002)	(0.002)
OECD country	0.269	-0.403	0.575*	0.071	-0.096
OECD country	(0.203)	(0.238)	(0.238)	(0.283)	(0.269)
Size of firm, where baseline case is small firm (fewer than 20 employees)
Medium size	-0.022	0.075	0.041	-0.209*	0.128*
Medium size	(0.056)	(0.059)	(0.072)	(0.085)	(0.063)
Large size	0.071	0.182*	0.269**	-0.170	0.260**
Large size	(0.077)	(0.081)	(0.094)	(0.107)	(0.083)
Whether access to credit is an obstacle to current operations, where baseline case is no obstacle
Small obstacle	0.081	0.022	-0.048	0.118	-0.023
Small obstacle	(0.054)	(0.057)	(0.069)	(0.076)	(0.061)
Large obstacle	0.171**	0.192**	-0.021	-0.052	0.115
Large obstacle	(0.065)	(0.069)	(0.083)	(0.094)	(0.073)
Constant	-1.067***	-1.501***	-2.093***	-1.843***	-1.956***
Constant	(0.163)	(0.177)	(0.215)	(0.241)	(0.213)
N	3628	3617	3511	2277	3601

Source: BEEPS V and authors’ calculations.
Note: Standard errors are reported in parentheses below the coefficients. ***, ** and * denote statistical significance at the 1, 5 and 10 per cent levels respectively.

CHART 3.2.1 CHART 3.2.2 CHART 3.2.3