Moving towards regional value chains

The principal measure of cross-border investment activities on multinational enterprises (MNEs) is foreign direct investment flows (FDI).

The three key dimensions of technology policy trends in recent times are — the degree of fragmentation and the length of value chains, the geographical spread of value-adds, and the governance choices of MNEs that determine the prevalence of arm’s -length trade versus FDI.

Given the declining trend of global value chains and arm’s-length trade a successful firm may have a strong regional bias impacting the survival of globally competitive firms.

The neighbourhood concept

Studies have looked at FDI inflows through the lens of neighbourhood and extended neighbourhood concepts. These concepts are applicable in the China and India context. Indeed, while a substantial fraction of FDI inflows may be explained by select economic variables, country-specific factors and the idiosyncratic component account for more of the investment inflows in Europe, China, and India with special reference to the post-Covid 19 period.

How to define a neighbourhood?The gravity model, as social scientists refer to the modified law of gravitation, considers the population size of two places and the distance between them.

Since larger places attract people, ideas, and commodities more than smaller ones, and places closer have a greater attraction, the gravity model incorporates these two features. Hence, the gravitational attraction between two continents, countries, or regions with similar cultures and roots may define the neighbourhood approach. Such attraction can explain investment, market access, and trade flows.

It seems possible to explain the trend in production and technology in light of the “extended neighbourhood” approach. In the post-Covid period, the trend may favour one of four approaches.

One, reshoring will lead to shorter, less fragmented value chains and a higher geographical concentration of value-adds. This will affect higher-technology global value chain (GVC) intensive industries.

The will lead to increased divestment and a shrinking pool of efficiency-seeking FDI. For some economies, it implies the need to re-industrialise. The others will have to face premature de-industrialisation. Many developing economies will face trouble accessing and upgrading along with the GVC development ladder in the short run.

Two, diversification will lead to a wider distribution of economic activities affecting services and GVC-intensive manufacturing industries. This will increase opportunities for new entrants (economies and firms) to participate in GVCs. Besides, its reliance on supply chain digitalisation will cause GVCs to be more loosely governed, platform-based and asset-light, and values capture in host countries will become more difficult. Three, regionalisation (for example China’s extended neighbourhood and India’s neighbourhood) may reduce the physical distance and may also reduce the supply chain. Consequently, the geographical distribution of value-addition will rise, affecting regional processing industries and even the primary sector.

Four, the firms may ignore global efficiency-seeking criteria and look for regional markets. There are possibilities to create broader industrial bases and clusters. In the process of regional economic cooperation, industrial policy and investment promotion will become indispensable to build regional value chains.

India’s trade with China despite the pandemic and political turmoil soared 70.1 per cent in dollar terms in the first five months of this year.

Chinese exports to India grew 64.1 per cent year-on-year from January to May, while imports surged 90.2 per cent. Currently, India’s manufacturing has been influenced by raw materials, OEMs, and components exported by China to India. Any disruption of this trend will escalate cost and hit welfare. The extended neighbourhood in the context of China and India and their implications in business are useful lessons for us to understand the disruption of GVCs with regional bias.

India’s manufacturing prospects with a hugely unemployed population will live on this trend. Policy-wise, thinking alternative to this shift will create pain and misery.

Though, dependency on China is not going away anytime soon, there is also need to look for alternatives, especially in like in Automobile, Pharmaceuticals, Precision Manufacturing, Chemicals.

So the need of the hour is to move up the value chain and alternative value chains with faster turnaround time. For this, R&D must focus on developing indigenous technology and look for alternative Value Chain, something akin to RVCs (Regional Value Chain). The shift from GVCs to RVCs will help define better production related bases to work on and eventually be able to mitigate risk. Perhaps, the seed of Atmanirbharta lie here.

The authors are professors at International Management Institute, New Delhi

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