Cross-border non-equity modes (NEMs) of international production generated at least $2 trillion in sales globally in 2010 and are growing rapidly, shaping world trade and investment patterns, with important implications for development, the UNCTAD annual report on global investment trends reveals.
The World Investment Report 2011 (WIR11) , released today, is subtitled "Non-equity modes of international production and development."
The study explains that international production is not exclusively about foreign direct investment (FDI) on the one hand and trade on the other. NEMs - which include contract manufacturing, services outsourcing, contract farming, franchising, licensing, and management contracts - allow transnational corporations to coordinate activities in their global value chains and influence the management of host-country firms without owning equity stakes in those firms. Transnational corporations manage the activities of NEM partner firms in their global value chains - for example, a local company in a host country assembling a product or providing information technology (IT) support - through contracts or, equally important, through access to transnational corporations´ technology, skills, business models or internal markets. Transnational corporations seldom take equity stakes in NEM partner firms, although the partner firms are tied to the transnational corporations´ global networks.
Cross-border NEM activity worldwide is significant and particularly important in developing countries. UNCTAD estimates that contract manufacturing and services outsourcing across borders accounted for $1.1trilllion-$1.3 trillion, franchising $330 billion-$350 billion, licensing $340 billion-$360 billion, and management contracts around $100 billion in sales in 2010 (table 1 for selected industries). In most cases, NEMs are growing more rapidly than the industries in which they operate.
In some industries, major non-equity-mode firms - including from developing countries - are transnational corporations in their own right
The nature and origin of NEM players and their geographical dispersion differ by industry. For example, contract manufacturers in electronics and IT-BPO services (information technology and business process outsourcing) are major transnational corporations in their own right, with large-scale operations in a relatively small number of locations worldwide (table 2 for major players). Those in industries, such as garments and footwear, range from bigger multisite players to small outfits in low-cost locations with very wide geographical dispersion.
Developing economies´ firms are major NEM players in some industries, with significant global operations and footprints in other developing countries, thus boosting South-South ties. In electronics, Foxconn, Quanta, Compal, Winstron (all from Taiwan Province of China) and Flextronics (Singapore) are among the top 10 contract manufacturers. Some developing economy transnational corporations such as Li & Fung (Hong Kong, China) play a prime intermediary role between the major brands and contract manufacturers in the garment and footwear value chains. In services outsourcing, for example in IT, firms such as Tata Consultancy Services and Wipro -both from India - are well established; and many from Brazil, the Philippines, and China are emerging. However, in other industries, such as automotive parts, developed-country firms are still the top contract manufacturers.
Non-equity modes hold a large potential for development gains, while some concerns remain
NEMs can yield significant development benefits; indeed value added by NEMs represents up to 15 per cent of gross domestic product in some economies. NEMs employ an estimated 18 to 21 million workers worldwide (figure 1 for selected industries), the lion´s share of whom are in developing economies (table 1). In some industries, such as electronics, garments, footwear and toys, developing countries account for almost all NEM-related employment and exports, compared with their share in global FDI stock of 30 per cent and in world trade (export) of less than 40 per cent in 2010. NEMs in industries such as services outsourcing and franchising also provide large-scale employment in developing countries and boost entrepreneurial and other skills. NEM exports account for 70 to 80 per cent of global exports in several industries (see figure 2 for these industries). Overall, NEMs can support long-term industrial development by building productive capacity, including through technology and skills dissemination and domestic enterprise development, and by helping developing countries gain access to global value chains.
But UNCTAD also cites concerns about the impact of NEMs in host developing economies. For example, working conditions may be poor, particularly in the case of contract manufacturing in labour-intensive activities, since NEM partner firms are under strong competitive pressure to reduce costs. In some instances, NEMs can be used to circumvent social and environmental standards. The report also points to pitfalls for long-term industrial development: Developing countries need to mitigate the risk of remaining locked into low value-added activities and need to avoid overdependence on foreign technologies and inputs.
Policy matters
Policies are instrumental if countries are to maximize the development benefits that can come from the integration of domestic firms into NEM networks of transnational corporations. Good policies also help minimize the associated risks. According to the report, there are four key challenges:
1. Embedding NEM policies in overall development strategies. NEM policies integrated into industrial development strategies will ensure that efforts to attract NEMs are directed at the "right industries" where host countries have a competitive advantage. Low labour costs can be such an advantage, but in the longer run, development strategies need to help local firms move into higher value-added NEM activities within the global value chains of transnational corporations. To avoid a situation where specialization results in dependence on individual foreign partners, there is also a case for NEM diversification aimed at engaging domestic firms in a broad number and variety of activities, the report notes.
2. Building domestic productive capacity. The success of NEM-related policies crucially depends on the availability of attractive domestic firms that qualify for NEM arrangements with transnational corporations. Proactive entrepreneurship policies can strengthen the competitiveness of domestic NEM partners. Such steps may range from fostering start-ups to promoting business networks. Embedding entrepreneurship knowledge into formal education systems, combined with vocational training and the development of specialized NEM-related skills, is also important. Technology policies can improve local absorptive capacities, enhance technological upgrading, and create technology clusters and partnerships. Improving access to finance is important for small and medium-sized enterprises seeking to engage in NEMs, UNCTAD says.
3. Facilitating and promoting NEMs. NEMs are based on contractual relationships between business partners. Clear, stable, and transparent rules governing these contracts are therefore an important means for promoting and facilitating NEMs. Additionally, an UNCTAD survey suggests that there is potential for strengthening the role of investment promotion agencies in encouraging NEMs, in particular through "matchmaking" and "aftercare" services.
4. Addressing negative effects. To address any negative impacts of NEMs, it is important to strengthen the bargaining power of local NEM partners compared with transnational corporations to ensure that contracts are based on a fair sharing of risks and benefits. The development of industry-specific NEM model contracts or negotiation guidelines can contribute to achieving this objective. If transnational corporations engaged in NEMs acquire dominant positions, they may be able to abuse their market power to the detriment of their domestic and foreign competitors and their own trading partners. Therefore, policies to promote NEMs need to go hand in hand with policies to safeguard competition. Other public interest criteria may require attention as well. These include labour and environmental protection and protection of indigenous capacities and traditional activities that may be crowded out by a rapid increase in market shares of successful NEMs.
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