Export Strategy: Re-thinking the Basket of Exports Premachandra Athukorala Arndt-Corden Department of Economics Craw

1. Export Strategy: Re-thinking the Basket of Exports PremachandraAthukorala Arndt-Corden Department of Economics Crawford School of Public Policy Australian National University Prema-chandra.athukorala@anu.edu.au

2. Structure 1. Analytical framework: Determinants of export performance and the case for product specific policy focus 2. Recent export performance: a comparative overview • Potential basket of exports: lessons from the East Asian experience

3. 1. Analytical framework (a) Determinants of export performance • World demand versus domestic-supply factors • Consensus view based on the export experiences of developing countries during the post-World War era: World demand is, of course, an important determinant of exports in the short-run, but in the medium to long-term, supply-related factors play the dominant role in determining a country’s relative export performance World demand is not an engine, but simply a handmaiden of export growth of a given country

4. Supply side factors (a) Macroeconomic policy Determine international competitiveness (profitability) of production of exports (and import-competing goods) Key variables: exchange inflation, wages, and interest rates (each adjusted for inflation differential between the given country and its trading partners) (b) Investment climate: stable enabling environment for the operation of the private sector ‘Good institutions’: law and order, property-right protection, political stability, policy certainty, openness to trade etc. Particularly important for attracting export-oriented foreign direct investment, which plays a pivotal role in the expansion of manufacturing exports (discuss below)

5. Institutions ‘Institutions are the humanly devised constraints that structure human interaction. They are made up of formal constraints (e.g. rules, laws, constitutions), informal constraints (e.g. norms of behaviour, conventions, self-imposed codes of conduct), and their enforcement characteristics. Together they define the incentive structure of societies and specifically economies’ Douglass C. North (1994), ‘Economic Performance Through Time’, American Economic Review, 84(3), 359-368.

6. (b) Product-specific policy focus (Microeconomic policies/ incentive policies) Not a must, private entrepreneurs know better than policy makers. New export lines can emerge de novo if the macro-economic house and the domestic investment environment are in good shape. (Examples from Sri Lanka)

7. (Continued from the previous slide) but can play an important supportive role , if • The supply-side prerequisites (discussed above) are met and • Policies are designed by taking into account the country's comparative advantage in international production and changing patterns of international production and trade (Discuss examples from Singapore, Malaysia and Thailand)

8. 2. Recent export performance • A dramatic slow down of export growth (Figure 1), • Precipitous fall in Sri Lanka’s share in exports from developing countries Sri Lanka has failed to share inthe ‘the great transformation of world trade’ (Krugman2008): the dramatic shift in manufacturing exports from developed to developing countries • So, Sri Lanka’s export problem is fundamentally ‘home grown’.

9. Figure 1: Sri Lanka: Exports and Imports as a percentage of GDP, 1990-2012

10. Figure 2: Sri Lanka’s share in exports from developing countries, 1990-2011

11. What are the possible reasons? • Real exchange rate appreciation (Figure 3) - Mirrors the growing domestic macroeconomic imbalances • Deterioration in the investment climate - ‘Doing Business’ (World Bank) ranking has slightly improved, but this capture solely the perception of existing enterprises. - Other indicators (eg Enabling Trade Index of World Trade Forum, Country Risk Guide Index) , which are widely used by investors in assessing country risk, have significantly deteriorated - Export oriented FDI inflows have declined and a large number of export-oriented foreign projects are no longer in operation

12. Figure 3: Sri Lanka: Real exchange rate and its components, 2004Q1 – 2012Q4

13. Has Sri Lanka run out of surplus labour? Unemployment rate has decline: from 15.2% to 4.0% in 2012. But, this is a deceptive indicator of labour market tightening, for two reasons: • Massive increase in public sector employment: from 900 thousand in 2005 to 1279 thousand (14% of the total labour force!) in 2012 • Rapid increase in overseas employment Total number of contract workers leaving the country increased from 1078 thousand during 2003-07 to 1307 during 2008-2012. The current stock of overseas migrant workers amounts to over 14% of the total working age population .

14. 3. Identification of the export basket: lessons from the East Asian experience Sri Lankan has performed relatively poorly in most (if not all major product categories; so first we need to think about how to regain growth dynamism of existing products (Table 1). As regards expanding the export basket, the East Asia experience suggests two vital addition: (a) Fitting into ‘global production sharing’ within vertically integrated global industries (mostly in machinery and transport equipment) (b) Processed food

15. Table 1: Sri Lanka’s export composition (%)

16. Global production sharing Tables 2 and Figure 3 Machinery and transport equipment (SITC 7) figure prominently in world exports, and exports from East Asian countries. The expansion of machinery and transport exports has been driven by ‘global production sharing’

17. Table 2: Sri Lanka’s export composition in global context, 2010-11 (%)

18. Global production sharing: ‘The break-up of the production process into geographically separated stages’ It opens up opportunities for countries to specialise in different slices (tasks) of the production process in line with their relative cost advantage. Alternative terms: International production fragmentation; vertical specialization, Slicing the value chain , Offshoring (international outsourcing

19. Example: Apple iPhone The entire world iPhone exports is recorded as exports from China and iPhone imports to any country show up its trade data as imports from China but in reality, iPhone is ‘assembled’ in China: it is a global, rather than a Chinese, product

20. China’s direct value added 3.6% The bulk of parts and components come from: Japan 35.1% Korea 13.3% Germany 17.5% USA 6.3% Other countries 24.2%

21. Three phases in the global spread of production networks (1) two-way exchange between home and host country: parts and component assembly/testing in the host country to be incorporated in final assembly in the home country (2) component assembly networks encompassing many host countries (R&D, final assembly and head-quarter functions still in the home country) (3) Full-fledged production networks involving component production/assembly/tenting and final assembly encompassing host countries ( R&D and head-quarter functions are still predominantly in the home country

22. Product Coverage First in electronics and then, spread into many other industries: consumer electronics electrical goods machine tool automobile cameras and watches pharmaceuticals, bio-medical equipment sola panels light emitting diodes

23. Products within the category of machinery and transport equipment are generally capital and technology intensive (‘high-tech’ products) But, under global production sharing, a given country specialises in a slice (task) of the production value chain that suits its relative cost advantages. In a labour abundant economy, assembly activities within global production networks tend to be relatively more labour intensive (and hence ‘pro poor’) compared to conventional manufacturing (that is, production of a good from start to finish in just one country). The statisticians (economist!) who compile the export sophistication data used in World Bank and IMF reports have missed this important point (This error comes from the Harvard's Kennedy School)

24. Global production sharing has been the prime mover of the ‘great transformation in world trade’ (mentioned before) (Figure 3) • ‘Network products’ (parts and components, and final assembly figure prominently in the export strictures of East Asian countries (Table 3).

25. Figure 3: Developing countries’ share in world manufacturing exports

26. Table 3: Share of network products in manufacturing exports, 2009-10 (%)

27. Global production sharing and export-led industrialization Global production sharing opens up new opportunities for countries participation in a finer international division of labour, to specialize in different slices (tasks) of the production process. It defeats the fallacy of composition argument against export-led industrialisation. But, a country’s success in joining global production networks and industrial advancement does not depend on the availability of labour at relatively low wages alone. (As already discussed, only a handful of developing countries have gained significantly from global production sharing)

28. To complement labour cost advantage, countries need to focus on: • Availability of middle-level (supervisory) technical manpower • Lowering the cost of ‘service links’ Service link cost: cost involved in coordinating production blocks located in various countries

29. Lowering the cost of ‘service links’ Service link cost in a given country depends on a whole range of factors impacting on the overall investment environment: (i) Infrastructure and trade-related logistic In addition to improved land connectivity, facilities for speedy air transportation is vital for electronics and other ‘high value-to-weight’ products) (ii) political stability and policy certainty

30. (iii) Property right protection, including enforcement of contracts (particularly important for entry into producer-drive production networks) (iv) Concurrent liberalisation of trade and investment policy regimes MNEs are the key players in global production sharing (discussed) -- the bulk of global production sharing takes place through intra-firm linkages rather than in an arms-length manner. FDI and trade polices are co-determinants of the location choice of MNEs within production networks.

31. Penang Case Study Penang (Malaysia), a classic example of achieving export success trough ‘plugging into’ global production networks Athukorala, P. (2011), Growing by Global Production Sharing: The Tale of Penang Export Hub, Geneva: International Trade Centre/World Trade Organization. http://crawford.anu.edu.au/acde/publications/publish/papers/wp2011/wp_econ_2011_13.pdf]

32. Evolution of the export hub • 1971-1975 The arrival of ‘Eight Samurai’ (National Semiconductor (NS), Intel, AMD, Osrum, Hewlett Packard, Bosch, Hitachi, Clarion) to set up plants for component assembly • Emergence of ancillary (supporting) industries - initially foreign vendors (mostly from Taiwan and Singapore) - Then, local vendors (Box 4: Eng Teknologi, Box 5: LKT Industries (Athukorala 2011) By the mid-1980s, an export cluster with a sizeable number of branch plants of electronics and electrical MNEs and a network of supporting firms was well established (‘silicon Island’)

33. From the late 1980s: Production base diversified with the entry of MNEs in consumer electronics and consumer peripheral industries • From about the mid-1990s: Further diversification of product composition and structural changes in the last decade or so - some contraction of final assembly of consumer electronics and electrical goods in face of competitive pressure from China - relocation in other low-cost countries of relatively more labour intensive segments in hard disk drive, and electronics parts and components production/assembly industries

34. a number of large electronics MNEs has shifted regional head-quarter functions and some R&D activities to Penang. • MNEs in a number of new electronics–related dynamic product lines have set up production/assembly plants in Penang: medical services and equipment light emitting diodes (LED) photovoltaic design and development

35. Outcomes Penang now accounts for nearly 40% of total manufactured goods exported from Malaysia Export growth in recent years have largely been driven by price increases rather than volume expansion (Figure 4)

36. Figure 4: Manufactured Exports from Penang: Vale (US$ million) (left scale) and share in Malaysian exports

37. Faster economic growth in Penang compared to the other states : • Penang per capital income compared to the national average: 10% lower in the early 1970s • 57% higher in 2010 Unemployment rate and Poverty rate have been much lower than the national average over the past three decades

38. What explains Penang success? • Focused investment promotion • Effective personal involvement from the top level of government • Post-investment care (FDI promotion did not end at the point of binging the investor into the country) • Infrastructure development (an innovative ‘land bank) • Vocational training and skill development (Penang Skill Development centre) • Fostering MNE-local firm links

39. Processed Food Importance of processed food as a dynamic export product line for developing countries Share of Processed Food in Total Food Exports

40. Powerful forces on both demand and supply sides have underpinned this development ( it is a structural change): - ‘internationalisation’ of food habits - advances in food technology, transport and refrigeration facilities

41. Share of processed food (2010-11) In Total food Total non-oil exports merchandise export Thailand 75% 23% Vietnam 45% 27% Sri Lanka 17% 5%

42. The new export opportunities are important for growth and poverty implications of agricultural trade in agricultural resource-rich and labour abundant developing countries Why?  (1) Terms of trade gains (high price and income elasticity of demand) • Employment generation (greater labour intensity of production compared to other resource-based manufacturing) • Balance of payments impact, or net addition to national income (GNP) (high domestic input content) (4) Spread effects on the rural economy

43. Export success depends crucially on the ability to meet sanitary and phyto-sanitary standards (SPS) standards. • Foreign direct investment is vital for forging market links and in meeting SPS standards