Over last 20 years, important changes have taken place in international trade dynamics. Specialisation in trade is no longer based on the comparative advantage of countries in producing final goods, but in the comparative advantage of “tasks” that these countries complete at a specific step among the global value chain (World Trade Organization, 2011, p. 4). This paper illustrates and analyses the role of multinationals and foreign investment in Colombia as a mechanism to engage with Global Value Chains (GVC). A cross-section dataset for 2010 is used to show that there is a strong correlation between the percentage of imported inputs and the percentage of the firm owned by foreign private investors. Moreover, the results confirm that there is a correlation between having a higher share of imported inputs with exporting, indicating that the firms owned by foreign investors are more involved in the GVC dynamic. Policies focused on attracting multinationals and foreign direct investment, accompanied by policies that reduce administrative costs of trade, are therefore desirable.
Background on the issue and data
The current global context of production, characterised by the dispersion of different stages of production processes in different countries (to gain efficiency and reduce production costs), has emphasised the importance of adhering to the so-called GVC as a strategy to accelerate the economic growth of Countries and regions. As the OECD (2013) states, GVCs allow firms and economies to do the part of the process that they are best at, which involves using intermediate goods and services from elsewhere without having to develop a whole industry, while generating employment and benefitting from capital inflows that have positive impact in economic growth. This suggests that conventional industrial strategies aimed at strengthening specific sectors are outdated, and that developing countries should focus their efforts on attracting large multinational companies that allow the country to exploit the benefits of these new production schemes and take advantage of opportunities that may arise as a result of increasing operating costs in regions that have traditionally received Foreign Direct Investment, such as China and other Asian countries.
Given this framework, recognising the role of multinationals as a linkage between local production and international markets is imperative to understanding how developing countries become active players in GVC. As Nicita, Ognivtsev and Shirotori (2013) argue “[…] having a strong relational linkage with the lead firm in a supply chain could enhance a transfer of knowledge, technology and even financial capital into the suppliers’ country” (p. 16). Furthermore, establishing a broad network of enterprises, suppliers and affiliates all around the world results in a pattern of trade in which goods exported for final consumption include a large amount of inputs that have been provided by other countries (OECD, 2013).
I looked at the role of multinationals as a mechanism for getting involved in the GVC by using data collected on Colombia by the World Bank Enterprise Survey in 2010. The main purpose is to identify if there is any relationship between foreign investment, measured in terms of percentage of firms that is owned by a foreign investor and the level of engagement with GVC. Since countries import inputs and add value to export them when they are part of a GVC, the percentage of imported inputs in production was used as a proxy for measuring the degree of insertion in GVC. However, it could be the case that firms import inputs and produce goods exclusively for the local market, thus I also looked at the relationship between the percentage of imported inputs and exports.
The dataset I used contains information from 942 firms from 29 different industries. In about half of the sample, the percentage of imported inputs for production represents more than 20% of total inputs; 8.9% of the firms reported that 10% or more of their shares are owned by a private foreign investor; and 38.2% of the studied enterprises are exporters.
At a glance the data shows that companies that have some foreign investment participation use a greater amount of imported inputs and are more likely to export. On average, 47% of the inputs used by companies with foreign owners are imported. When owners are nationals, the rate is 32%. In addition, on average 92% of the sales of local companies are sold in the local market, while for enterprises with foreign investment the local market represents 79%.
I used a simple linear regression model to test my hypothesis. The results suggest that there is, in fact, a strong correlation between the indicators used. Firms with higher participation of foreign investors import on average 18% more inputs that firms with local owners. This correlation remains significant at the 1% level when controlling by the size of firm and the obstacles derived from customs and trade regulations as shown in Table 1. However, the correlation is smaller when the administrative costs of importing are included in the model (14%, column 3) These costs, measured by a categorical ordinal variable, take higher values when the administrative costs associated with importing are higher. This indicates that a higher consumption of imported inputs used in production is not only explained by foreign investment. There is an entrance “barrier” to imported inputs market that keeps both, local and foreign firms, from using them in their production. Once firms get over these obstacles, they use more imported inputs in their production process (i.e. they participated in costly bureaucratic process to obtain a license to import from a particular supplier since the know that afterwards they will be rewarded with lower production costs, so they are going to import more).
A dummy for each industry was used to identify possible differences across them. In twelve of the 29 industries this difference was different from zero with a confidence interval of 99%. Finally, a variable to account for firm’s final destination market was added. To avoid multicollinearity, the percentage of sales sold in the national market was used. Nevertheless, the coefficient obtained for this variable was not statistically significant from zero, and the correlation of interest, between imports and foreign investment, became significant only at 10%.
The latter finding suggests than a different approach is needed to have a better understanding of the relationship between using imported inputs with exporting, as expected in a GVC. Hence, a second linear model was analysed, the results of which are shown in Table 2. Firstly, the percentage of imported inputs was regress against the participation of foreign investment and a dummy that indicates if firms export or not (Column 1). Secondly, the dummy was replaced with the exports value (Column 2). Then, controls for industry and custom and trade regulations were added (Column 3). This regression reveals a positive and significant relationship between being an exporter and having imported inputs given any level of foreign investment participation in the firms. Apart from that, the results obtained are very consistent with the ones obtained in the first model.
Based on the results, it is possible to conclude that there is a very significant correlation that confirms that companies with higher participation of foreign investment, in this case multinationals, tend to use more imported inputs as part of their production process in Colombia. The value of exports for both, foreign and local enterprises, is higher when they use these imported inputs. Even though, further research is needed for a deep understanding of the role that multinationals have played as a platform to insert the country in GVC, as it cannot be said that there is a causal effect.
Policy implications and data limitations
Is important to highlight some limitations regarding the data used to avoid misleading conclusions regarding the GVC in Colombia. The percentage of materials inputs from foreign origin continues to be a weak indicator of the degree of insertion in GVC. This indicator, however, is the most accessible as is difficult to find information at a firm level that properly describe the amount and origin of value added from other countries contained in Colombian exports. The OECD, jointly with UNCTAD, has created a dataset (TiVA) that uses input-output matrices to decompose the aggregated value of each export by origin. Further study using this information will give a broader overview of Colombia’s degree of integration on this trade dynamic. The fact that the data is aggregated by industry makes analysis of the role of multinational s complicated.
Two important policy recommendation can be drawn based on the obtained results. On one hand, the correlation found support the hypothesis that multinationals are more closely linked to GVC than local firms. Policies aiming at attracting more foreign investment to the country may therefore contribute to improvements in the performance of Colombia in the GVC spectrum, as well as generating economic growth. It is necessary to consider the differences across industries, however, as the capability of each one to engage with this dynamic varies. On the other hand, firms by themselves cannot not easily engage with the GVC. They need a favorable business environment with low administrative barriers that allow easy access to international market to import inputs and to market their goods and services abroad. More flexible regulations and policies focused on the elimination of non-tariff barriers will encourage both local and foreign firms to import inputs to export, as the OECD (2013) and WTO (2011) argue.
Nicita, A., Ognivtsev, V., & Shirotori, M. (2013). Global Supply Chains: Trade and Economica Policies for Developing Countries. United Nations. Geneva: UNCTAD.
OECD. (2013). Interconected Economies: Benefiting from Global Value Chains. OECD Publishing.
World Trade Organization. (2011). Trade Patterns and Global Value Chains in East Asia: From trade in Goods to Trade in Tasks. (WTO, & IDE-JETRO, Eds.) Geneva.