CROSS-BORDER ENGAGEMENT: AN INTEGRATED ANALYTICAL FRAMEWORK l 61
Value chain positioning matters. Structural transformation of economies is not always accompanied by higher productivity (Rodrik, McMillan, and Sepúlveda 2016). Thus, improving livelihoods may not necessarily be about moving to different value chains but instead to different segments of the value chain with higher value added or higher profit margins, as represented in Stan Shih’s “smile curve” (World Bank and World Trade Organization 2019). For example, in the apparel sector, the profit margins are much higher in retail than in manufacturing, which is typically the activity developing economies dominate. The framework given in figure 2.1 facilitates better understanding of the complex interfirm and intrafirm relationships that prevail in global value chains. Box 2.1 provides a simple illustration of different types of trade (including trade in services) and investment strategies that can be used to serve home and foreign markets. These strategies include exporting, traditional horizontal investment, vertical investment, export
BOX 2.1 Internationalization Strategy Options for Serving Consumer Markets at Home and Abroad The various avenues for serving the home and foreign markets, using the framework given in figure 2.1, are illustrated and discussed here. Global firms have a variety of options for setting up their value chains to serve a particular market, and the ultimate strategy reflects the outcome of comparing relative profits. Increasingly complex firm strategies have made traditional classifications of investment type more difficult and less useful. The relationship between trade and investment flows across different multinational enterprise (MNE) strategies addressing the substitutability and complementarity of exporting and foreign direct investment (FDI) is schematically represented in figure B2.1.1. Assume there are three countries, and that the goal is to serve the home and one foreign market (F2). The services trade flows from headquarters are omitted to avoid clutter. Exporting. A simple classic exporter scenario involves intermediates production and assembly at home. Products are sent to a foreign market (F2) distributor (square distribution activity), incurring a trade cost. This involves no FDI. Traditional horizontal FDI. The firm chooses to save on trade costs by replicating the production process in the foreign consumer market (F2), rather than by exporting from home. A firm faces the proximity-concentration trade-off, that is, a firm weighs the net savings in trade costs (incorporating additional production costs abroad) from FDI against the net gains of scale economies from single-location production at home (and having to pay export trade costs). This type of FDI is sometimes associated with “market-seeking FDI,” as in the case of tariff-jumping FDI, and would result in FDI replacing export flows and being a substitute for trade. Traditional vertical FDI. A firm minimizes costs by production fragmentation, setting up different stages of production in different countries according to comparative advantage. To invest in vertical FDI, the cost advantage in producing intermediates abroad would have to be greater than the sum of new trade costs of importing intermediates and the coordination costs of multinational production ƛ associated with dealing with a fragmented production process. This is the efficiency-seeking FDI or resource-seeking (Box continues next page)
