Read the following case carefully and answer the questions given at the end.

Case # 1. Benefit From Export Competitiveness

Improving export competitiveness is important and challenging but it is not an end in itself. It is
only a means to an end: the promotion of development. This raises the question of the benefits
resulting from TNC associated trade, beginning with improving the trade balance, and continuing
with upgrading export operations and sustaining them over time. In each case, the issue is how
host developing countries can most benefit from the assets that TNCs command. Much depends
on the strategies pursued by TNCs within their international production systems, on the one
hand, and local infrastructure and technological, institutional and supplier capabilities as well as
the policies purchased by Governments on the other.

A first approximation for assessing benefits and costs although not the most important one ---
involves the trade balance. Even though export-oriented FDI helps to increase exports, foreign
affiliates also import, and imports may increase significantly along with exports. In such cases,
net foreign exchange earnings may be negligible. Moreover, high export values may co-exist
with low levels of local value added. This is typically the case, for example, when foreign
affiliates mainly assemble imported components, reflecting and relatively unimportant role
assigned to them in production systems. Measuring the trade balance of export-oriented foreign
affiliates as well as their value added, is fraught with difficulties. The data typically lump
together export-oriented FDI and domestically-oriented FDI, making it difficult to determine the
trade balance of export-oriented foreign affiliates separately. (Personably, the trade balance of
domestic market-oriented FDI would be negative.) Furthermore, no systematic data exist on the
composition of imports by foreign affiliates, which is relevant for understanding the implications
for host economies. Scattered information suggests that the imports of parts and components
were high in certain industries, such as telecommunications, electric machinery and vehicles
especially in countries that hosted labor-intensive activities of international production systems.
Furthermore, in developing countries, one would expect that newly established affiliates (or
affiliates that intend to extend their capacities) would typically need to import capital goods (just
as many domestic firms do) in order to expand local productive nature more likely to be
indispensable for the production of the goods or services in question to take place--- than imports

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of components for assembly or other inputs (for which domestic alternatives may be available or
capable of being developed), yet both types of imports would be counted simply as affiliate
imports.

Moreover, imports would be particularly high when production facilities are being set up and
reliance on home-country or other foreign suppliers of inputs tends to be high, and then
personably decline (partly as a result of the growth of local linkages). The imports of foreign
affiliates China are an instructive example (although one that cannot necessarily be generalized
in this respect), in that the data show that a sustained part of imports by foreign affiliates consists
of capital goods. Although the trade balance effects of foreign affiliates consists of capital goods.
Although the trade balance effects of foreign affiliates activities remain the same when the
composition of imports is taken into account, the overall economic implications for China are
different as imports of capital goods add significantly to the capital stock and productive capacity
of the country.

In any event, as far as the impact on a country's balance of payments position --- often a major
underlying concern for developing countries (although somewhat diminished in importance as
countries' exchange rate policies have become more flexible) --- is concerned, focusing on the
trade balance captures only a part of the impact of TNC activities. Additional factors that need to
be taken into account are capital inflows, the repatriation of earnings and capital, and other long-
term impacts on the foreign exchange earnings affiliates and associated local companies. Such an
analysis of the balance of-payments impact, which would also have to be weighed against their
other (structural) effects on a country's development and welfare, falls outside the scope of the
present export.

The question of upgrading exports relates to the extent to which FDI involves higher
technological content and domestic value added in host country export production and a
restructuring of exports from those based on static comparative advantage to those based on
dynamic comparative advantage. The starting point is that specialization in different segments of
international production systems may imply different benefits and competitive prospects. There
is therefore some concern that specialization in labor-intensive segments, even of high-
technology exports, may in some ways be undesirable as it may provide few benefits in training

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or technology and meagre spillovers to the local economy. Besides the competitive edge of low-
cost labor may disappear as wages rise. Still, labor intensive exports are economically beneficial
as long as local value added is positive at world prices, even if it does not rise at the same pace as
the total value of exports. In fact, where surplus labor is unlikely to be used in more
remunerative or economically desirable activities, it is in the interest of the countries concerned
that it be used in production for export. Any theory of comparative advantage would suggest that
such countries should specialize in simple labor-intensive processes at the beginning of their
export drive; the question is whether they can subsequently upgrade and sustain their exports.

TNCs can contribute to the upgrading of a country's competitiveness by either investing in

higher-value added activities in industries in which they have not invested before or by shifting
within an industry from low-productivity, low technology, labor intensive activities to high-
productivity, high-technology, knowledge-based ones. The first of these processes is illustrated
by a number of the winners discussed in this Part, especially those that experienced a notable
shift --- as a result of substantial new FDI inflows and new roles in supplier networks --- from
low to medium -- to high technology industries and sectors. Also rising significance is the
growth of FDI associated service exports from developing countries. Intra-industry upgrading
occurs in several ways. There is, first of all, the situation in which TNCs locate production
facilities aimed at serving highly competitive national regional and global markets in a
developing country, many of the dynamic products identified in chapter VI fall into this
category. TNCs need to upgrade these production facilities continually just to survive, let alone
capture higher-value products within the same industry. The success of countries such as China,
Ireland, Malaysia, the Philippines and Singapore in upgrading the export competitiveness of their
electronic industries in a case in point. Thus for example, Motorola, in its own interest
substantially upgraded its facilities in China (box-VI.9); Ireland convinced Intel to upgrade
beyond assembling and testing to water fabrication; and Malaysia established long-term
relationships with Matsushita Electric and Sony working with them to upgrade their export
operations for color televisions into regional manufacturing operations. But even where strong
corporate self-interest is involved government policy (often in close cooperation with TNCs) can
play a role in encouraging upgrading in particular by ensuring that the production environment

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allows such upgrading and that it extends to more value-added functions such as R&D. The case
of Motorola in China, is case in point.

Sometimes similar tends to take place in the case of foreign affiliates hitherto protected by
import barriers. Under pressure from trade liberalization and competition, many TNCs
restructure --- in their own interest --- import substitution activities into export-oriented
operations, at least in countries in which a competitive base exists, or can be created. Some
outstanding examples are the automotive industry in Maxico and the color television industry in
Malaysia and Thailand. Here, policies played an important role, In Mexico, it was the launch of
the maquiladora scheme, combined with the need of the automobile industry to find low-cost
production sites and the further liberalization of NAFTA with its rules of origin for the
automobile industry that had a profound effect on the country's export competitiveness. The rules
of origin were initially established to help United States automobile TNCs to complete better in
their home market against Asian, specifically Japanese, TNCs. This worked very much in
Mexico's favor as Ford, General Motors and Chrysler (now Daimler Chrysler) and their suppliers
set up world-class plants there to export to the United Stated market. Then, Volkswagen, a
German automobile TNC, established an export in Mexico and was obliged to bring its global
suppliers into Mexico to meet the NAFTA rules of origin. The overall result was a complete
restructuring of the Mexican automobile industry from a protected and inefficient import
substitution activity to highly competitive export platform.

These are examples from some of the most dynamic export products of how the self-interest of
TNCs combined with appropriate government policy, can produce major improvements in the
export competitiveness of fast countries. In other situations, however, considerably stronger
government efforts are required to capitalize the assets of TNCs and what, in the absence of such
efforts, may only be temporary advantages. The garment industry exemplifies why simply
attracting export-oriented activities in and itself might not be enough to move up the value -
added ladder and increase national benefits.

Branded manufacturers of garments like Sara Lee and Fruit of the Loom made use of the United
States' production sharing mechanism to gain competitive advantage vis-à-vis Asian producers
by establishing assembly operations in the Caribbean basin. In the context of the Multifibre

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Arrangement quotas, this mechanism allowed these assemblers to remain competitive in the
United States market in spite of the fact that wage levels in the Caribbean basin were higher than
many other garment production sites. Contrary to the experience of Mexico in respect of the
rules of origin of NAFTA, this mechanism did not allow host countries to progress by increasing
local content, raising value added or upgrading the industry. This is because the tariffs applied to
value added outside the United Stated discourage the use of local inputs For that reason, Costa
Rica, for example, chose to focus on electronics and other industries. With the impending
implementation of the WTO Clothing and Textile Agreement, many host countries specializing
in garment exports will have great difficulties in facing competition from Asia, especially from
China. In anticipation of this, some of these branded manufacturers are cutting back on their
international production systems and relying more on full-package suppliers and contract
manufacturers. The nature of the production-sharing mechanism that restricted the upgrading of
the local operations beyond low-wage assembly has left these export platforms in difficult
circumstances. Corrective national policy action is urgent in cases like this.

This underlines the importance of ensuring the sustainability of export-oriented foreign affiliates.
For such affiliates not to be ephemeral, they need not only to upgrade, but to be progressively
embedded in host economies through strong backward linkages. This requires policies aimed at
fastening local capabilities, and, in particular technological capabilities, human resources and a
competitive domestic enterprise sector. Where these policies are successful, they are likely not
only to make the export involved more sustainable and beneficial for the host countries involved,
but also to increase the competitiveness, but also to increase the competitiveness of the domestic
enterprise sector, the bedrock of economic development. In the end, some of these domestic
enterprises may become TNCs in their own right and contribute to the development of their
home countries through their own global activities. The success of a number of (mainly Asian)
countries in attracting export-oriented TNC activities as part of a broader national
industrialization strategy offers a model for others.

TNCs play an important role in the exports of many developing countries and economies in
transition. Indeed for the most dynamic products in world trade. TNCs are central for enabling
these countries to reach world markets, and they provide some of the 'missing elements'' that
developing countries need to upgrade their competitiveness in export markets. The potential

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benefits in TNCs export activity are still far from fully exploited and they are growing.
Technologies are changing. Processes and functions are increasingly divisible, and the
boundaries of what is internal and external to firms are shifting. The 'death' of distance -or its
diminishing cost --- is stretching location maps. New activities are likely to join the globalization
surge, including many from developing economies. The challenge for countries that would like
to improve their export competitiveness in association with TNCs is how to link up with the
international production systems of these firms and how to benefit from them.

The spread of TNC activity offers host countries opportunities to expand and move into higher
value-added activities. Capitalizing fully on static benefits and transforming them into dynamic
and sustainable advantages requires pro-active government support. To benefit most from TNC
associated export competitiveness developing countries must make continuous efforts to root
TNC activities in host economies raise the level of local content, increase the value added by
these activities, upgrade them into more sophisticated areas and make them sustainable. TNCs, in
a number of circumstances, will take initiatives of their own, in their own self-interest. But
national policy efforts and the policy pace to pursue them ---- are critical for both attracting
export oriented FDI and ensuring its sustainability in order to advance development.

Questions:

(a) What are the areas of concern for low exports from developing countries?

(b) Do you agree that the flow of FDI to developing countries can augment their export
potential? How?

(c) What is the role of transnational corporations in upgrading a country's competitiveness?

(d) Suggest measures to increase the competitiveness of the domestic enterprise sector in a
developing country.

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