THE GLOBAL VALUE CHAINS OF MNCs AND INDIAN SMEs: WHY …

HOW TO ENABLE NDIAN SMEs TO PENETRATE THE GLOBAL VALUE CHAINS OF TNCs?

The need to strengthen Regional Innovation Systems

M H BALA SUBRAHMANYAPROFESSOR

DEPARTMENT OF MANAGEMENT STUDIESINDIAN INSTITUTE OF SCIENCE

BANGALORE-560012

12th March 2021 1IMPRI Webinar

INTRODUCTION• Of late, international trade is increasingly dominated by Global Value Chains (GVCs) of TNCs:

Estimates say GVCs account for anywhere between 2/3 to 4/5 of the global trade (Dollar, 2019;West, 2018).

• NICs and emerging economies like China, Malaysia, Thailand and even Indonesia and Vietnam havegot well-entrenched in the GVCs of TNCs, leading to their dramatic advances in living standards andeconomic growth (Dollar, 2019).

• These developments have implications in the form of challenges as well as opportunities to Indianeconomy, particularly its SMEs.

• The all-pervading Covid-19, and its consequent impact on the global economy is adding a newdimension to the whole issue.• It has severely disrupted GVCs of TNCs, globally,• It has adversely affected demand as well as supply of Indian SMEs, nationally and regionally,• It is prompting GVC led investments of TNCs for a relocation, to countries like India.

• SMEs in India are highly diversified, and they are at the forefront of India’s internationalization: theyaccounted for almost one-half of the total exports in 2018/19.

• But hardly 0.20% of the total 63.39 million Indian SMEs have entered the international market, as ofnow. This leads to two questions:

1. Why have Indian SMEs not been able to seize the opportunities from the ever-growing GVCs of TNCs?2. How to enable more and more Indian SMEs to access and exploit the GVCs of TNCs?

12th March 2021 IMPRI Webinar 2

GVCs of TNCs


Country 1

TNC Headquarters

•Administration

•Management•Strategy

•Finance

Country 7

•Services

Local Subcontractors/Vendors

Country 4

•Production affiliate


Country 5

•Production affiliate


Country 3

•Design affiliate


Country 2

•R&D affiliate


Country 6

•Marketing and distribution


GVCs of TNCs

• The overall rationale behind the adoption of complex integration strategy for the GVC of an TNC is enhancing efficiency through cost reduction.

• A component of a value chain will be located in that country where it can be carried out most efficiently or cost effectively.

• Overall, firms make components in the most cost-effective location and value is added at every step along the way, resulting in a finished product that is assembled with inputs from multiple countries (Daria and Deborah, 2016).

• In fact, breaking up the production process offers new opportunities for integration of both developed and developing economies, with potential benefits for each, but with adequate homework as well (Dollar, 2019).

• Another significant feature of GVCs is that each part of it would indulge in trade with local firms in the domestic market or regional markets, as and when necessary and advantageous.


GVCs of TNCs: Implications for SMEs• In general, firms that are part of global or regional value chains tend to display high levels of

innovation, greater efficiency and increased productivity.

• This underlines the imperativeness of innovation, efficiency and productivity on the part of firms intend to integrate themselves with GVCs.

• Given this, participation in global or regional value chains can be beneficial in fostering a firm’s growth and internationalization, irrespective of its scale and size (European Parliament, 2019).

• This has particular relevance to SMEs. By penetrating or linking with the GVCs, SMEs can take a first step ladder, which through spill-overs and knowledge transfers can often lead them to fetch higher value added assignments, through product innovations and market knowledge.

• Internationalization provides the right conditions for SMEs to enhance productivity, while also enabling the spill-over of technological and managerial know-how and facilitating accelerate innovation (Zachariadis, 2019).

• Precisely for this reason, a majority of the SMEs in the developed world contribute to exports: while their share in the value of exports, on average, stood at 34%, their contribution (in terms of number of exporting units in total number of SMEs) was as high as 78%, at the beginning of the previous decade (The World Bank, 2016).


GVCs of TNCs: Implications for SMEs• But not all SMEs will be able to take advantage of the opportunities that emerge from the rapidly growing

GVCs through linkages (as they will not have even a threshold level of competence to get linked to GVCs).

• Due to internal as well as external barriers emerging from not only smaller scale and lower levels ofsophistication but also market failures, leading to limited access to finance, SMEs often face greaterdifficulties in internationalizing their activities than do their larger counterparts.

• This holds good to developing countries as most of their SMEs has low levels of integration in GVCs, withfew backward and forward linkages in production.

• Trade participation of SMEs in developing countries is low, with exports accounting for 7.6% ofmanufacturing sales and, SMEs with fewer employees take longer to access international markets thanlarger firms (The World Bank, 2016).

• Further, for those that do manage to penetrate and integrate into the GVCs, the magnitude and nature ofbenefits will critically depend on the SMEs’ entry point and position in the global production networksand the links that they can develop within those networks (Zachariadis, 2019).

• All these have implications for Indian economy, particularly its SMEs. If an emerging economy like Indiahas to make a visible mark on the global production networks similar to China and other emergingeconomies, it is imperative to enable domestic firms to penetrate and link with the GVCs.

• In India, SMEs being at the forefront of internationalization, though in a limited way, it is essential toexamine and explore the promotion of SME internationalization through GVC linkages, steadily andconsistently. This assumes significance as it is one of the objectives of Strategy Action Plan unveiled bythe Ministry of MSMEs (2018) recently.


SMEs in IndiaSME Achievements in India (for the recent period)

Enterprises Employment Share in Industrial Production

Share in GDP

Share in Exports

63.39 million 111 million 45% 30% 48.10%

SME Structure

Micro enterprises Small enterprises Medium enterprises

Share in Total MSME enterprises

99.47% 0.52% 0.01%

Employment per enterprise

1.71 persons 9.65 persons 35 persons

Note: A substantial chunk of Indian SMEs is sub-optimal by scale.12th March 2021 IMPRI Webinar 7

Are Small Scale and Medium Scale Enterprises integrated well with the GVCs?

• As indicated earlier, empirical data reveal that only a minor fraction of Indian SMEs (in the registeredsector) is internationalized.

• If SMEs have to internationalize and integrate themselves with the GVCs on a considerable scale, theyhave to be competitive, efficient and productive which require them to be innovative because one of theprincipal determinants of SMEs’ competitiveness is innovation (Pachouri and Sharma, 2016).

• However, innovation (which needs to be radical in nature) is widely absent in the SME sector, implying alow innovation capacity of Indian SMEs, and this is reflected in India’s very low ranking in the globalinnovation index (81 out of 141 countries) (Pachouri and Sharma, 2016).

• A recent nation-wide study, covering 9001 SMEs out of a total of 2,08,415 firms (of all sizes) across 26states and 5 Union Territories of India based on the Annual Survey of Industries (ASI) 2009-10 database,revealed that 35.37% of them were engaged in innovative activities (Nath, et.al., 2014).

• But these innovations were mostly in the form of introducing new machines, followed by improvement ofthe quality of existing products, process and product innovations.

• Those who claimed to have undertaken product innovations accounted for 32% of the innovative firms,which amounted to about 11% of the total surveyed firms. Predominant types of innovation are ‘new tothe firm’ category (Nath. et.al., 2014).

• This substantiates that radical innovation is largely absent in Indian SMEs.


SME INNOVATION REQUIRES EXTERNAL SUPPORT

• Innovation does not occur in silos, and therefore, SMEs operating in silos are unlikely to innovate.

• If innovation among SMEs has to thrive, they need to be networked in the local/regional markets. Innovation emerges with close interaction between a firm that wants to pursue innovation and the support systems that assist the firm in securing the required resources for innovation (Pachouri and Sharma, 2016). There is a positive association between networking and innovation (Rogers, 2004).

• Networks can be in the form of vertical linkages with customers and suppliers or horizontal linkages with academic/research institutions, government led SME promotion agencies, industry associations, other SMEs in the same sector/cluster, etc. (NKC, 2007).

• Inter-firm networking in the form of ancillarisation of SMEs accounted for a meagre 0.52% in 1987/88 which improved by almost 10 times to reach 5.08% by 2001/02 in the registered SME sector (DCSSI, 1992; DCSSI, 2002).

• In fact, lack of collaboration with other firms in the same industry and with universities and R&D labs was identified as one of the external barriers for SME innovation, by a nation-wide study on innovative SMEs (NKC, 2007).


INDIAN SMEs HAVE A WEAK PRESENCE IN THE GVCs OF TNCs

• Indian SMEs have a limited presence in the GVCs of TNCs due to theirweak internationalization, which in turn is due to their weakinnovation base, owing to their weak networks, particularly due toweak inter-firm linkages.

• This, in turn, could be attributed to weak internal strength of SMEs atlarge, and/or weak or no external support availability,locally/regionally.

• This brings out that to exploit SME sector’s potential, and transformthem, efforts must be made to strengthen them locally to enabletheir penetration and reach globally.


Indian SMEs in the GVCs of TNCs: Status and Causal Chain


Indian SMEs:

Weak internal strength

Weak external support

Weak networks including

weak inter-firm linkages

Weak innovation baseWeak internationalization

Limited presence in the GVCs of TNCs

Significance of RIS for Firm level Innovations• The ability and potential of SMEs to network and innovate would depend on internal

strength and/or on the strength and vibrancy of the region/s in which they operate.

• This is because firms succeed if they benefit from the specific advantage of theirenvironment comprising diverse supportive elements (Cook, 2003).

• However, not all regions need to comprise clusters and not all regional clusters needto encourage innovations.

• A regional cluster (RC) is a concentration of ‘interdependent’ firms within the same oradjacent industrial sectors in a small geographical region such as a town or a city(Isaksen, 2001).

• A regional innovation system (RIS), on other hand, is much beyond a regional cluster offirms. It has a more planned and systemic character (Isaksen, 2001).

• A RIS usually consists of firms of varying sizes (in diverse industries) and universitiesinteracting with each other for knowledge generation and technology transfer,supported by a regional government and conducive culture, within an institutionalframework.


REGIONAL INNOVATION SYSTEM

Local innovation assets e.g. clusters

Learning

Dissemination

Businesses (Knowledge utilization sub-system)

Universities (Knowledge generation sub-system)

Regional culture

Exports

Regional Investment

Technology transfer activity

Demand for technological knowledge

Global production networks

External decision makers

Global Research Networks

Regional governance sub-system


RISs and RCs in India• As of now, there are 388 SME clusters in India, of which 112 (about 29%) clusters

are located in eight metropolitan cities such as National Capital Region (comprisingDelhi, Faridabad, Gurgaon, Noida and Ghaziabad), Ahmedabad, Mumbai, Pune,Bangalore, Hyderabad, Chennai and Kolkata.

• Even the remaining ones are located in major (26) cities of different states acrossthe country such as Agra, Aligarh, Amritsar, Aurangabad, Belgaum, Bhavnagar,Coimbatore, Cuttack, Ernakulum, Hubli, Indore, Jaipur, Jalandhar, Kanpur, Kolhapur,Ludhiana, Madurai, Mangalore, Mysore, Nagpur, Patiala, Rajkot, Salem, Surat,Vadodara and Varanasi which together accounted for 100 SME clusters (about 26%of the total) (DCMSME, 2020).

• While the former (eight metropolitan cities) are most likely to comprise RISs ofvarying strengths, the latter (26) cities may just comprise RCs but have the potentialto develop into a RIS.

• The pertinent question is - what kind of a RIS we have in our metro cities? Is thereanything to learn?


Regional Innovation System for SMEs in Bangalore


• Academic Research Institutes

• Engineering Institutes

• Management Institutions

• Science, Art and Commerce Colleges

• TNC R&D affiliates

• Public Sector R&D Institutes

• Domestic Private company R&D Labs

• TNCs

• PSUs• Private companies

• Industry associations

• Angel/VC/PE/Private sector banks

• Directorate of I and C

• SSIDC/SIMC

• TRC/KCTU

• SIDBI/SFC

• Exclusive SSI branches of Public Sector Banks Regional

GovernmentIndustry

AcademiaR&D Centers

SMEs (located in industrial estates across the city)Imports

FDI inflow

FDI outflow

Exports

What Needs to be done?

• The strategy and experience of Bangalore RIS based SMEs can be a lesson to emulate elsewhere inthe country.

• However, emulating Bangalore RIS, even remotely, if possible, can only be a long term strategy.

• In fact, support to SMEs has to be provided not just at the start-up phase but in subsequent stagesof its life cycle as well, including the internationalization stage.

• In most industrialized countries, governments increasingly provide support from incorporation tointernationalization. For instance, in the UK, the main goal of innovation policy is to help more andmore new firms emerge, survive, and enable them to identify and successfully exploitopportunities in foreign markets (World Bank, 2010).

• Among the emerging economies, the network and innovation support extended through a R&Dpublic service platform by Shanghai Municipality Science and Technology Commission in Chinaappears noteworthy.

• It aims to provide a wide variety of support services to SMEs, similar to those found in developedcountries.

• Such a support system must be created in each of the RCs in India, to enable the networking ofSMEs for innovation to penetrate the international markets to join the GVCs of TNCs.


Shanghai R&D Public Service Platform

Business innovation services

Equipment sharing

Resource security

Testing base cooperation

Professional technology

Industry testing

Technology transfer

Entrepreneurship

Management decision making support

Science and technology literature

Scientific figure

sharing


RISs to enable SMEs to penetrate GVCs of TNCs


A strong and vibrant RISIncreased regional

networks

Vertical linkages with customers and

suppliers

Horizontal linkages with higher education institutes, R&D

organizations, industry associations and other

SMEs

More radical/incremental

product/process innovations

Increased internationalization

Increased penetration of GVCs of TNCs

CONCLUSIONS• To conclude, network and innovation policy support to offset the internal

deficiencies of SMEs by providing “accessible and productive innovationinfrastructure” for firms at different stages of their life-cycle locally wouldlargely enable the emergence of “innovation flourishing environment” forthe benefit of SMEs to steadily penetrate the GVCs of TNCs throughinternationalization.

• If appropriate measures are not taken at the earliest, by the policymakersinvolving the key stakeholders of the economy (government, industry andacademia), the current status of Indian SMEs in the global economy wouldonly continue.

• Any amount of “tinkering with the system” in the form of moreconcessions, incentives, and benefits (which is the current policy pattern)would hardly alter the status-quo.


•THANK YOU


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THE GLOBAL VALUE CHAINS OF MNCs AND INDIAN SMEs: WHY …