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.