Global commerce has been changing since the late 20th century. Rather than trade finished products, such as cars, countries now exchange parts and components that, together, produce a finished commodity.
Facilitated by lower transportation and communication costs, the inputs of production can be sourced from the most economical place. Every country that participates in world trade today has its place in this global value chain.
For emerging nations, engaging in global value chains is key to their economic development. According to the United Nations, there appears to be a positive correlation between participation in this system and GDP per capita growth rates.
India gets involved
India, with its low labour costs and huge workforce, knows this well. Since the mid-1990s, it has made efforts to increase both trade volume and value-chain engagement.
Indias participation in global value chains has risen from 57th place in 1995 to 45th place in 2009, according to the the OECD Trade in Value Added (TiVA) Statistics.
Tracking the specific value chains for a country across the globe paints a revelatory picture of its economic integration by sector. In manufacturing, for instance, India is more closely linked to Asia and the southeast Asian region, especially for electrical and optical equipment. Services, on the other hand, show more integration with western countries such as the United States, the United Kingdom, a few European nations and Hong Kong.
A few sectors are standouts, including the manufacturing not elsewhere classified and recycling sector, which includes gems and jewellery, where India ranks second.
Computer, software support and other information technology-related services that have been the engine of Indias growth over the last 15 years also compete well globally. In business and other services, India ranks sixth and 13th in the OCEDs report.
Textiles, an employment-intensive sector where Indian exports have traditionally flourished, continues to perform strongly, placing the country at number 13 in textile value-chain participation. India has also seen gains in the electrical and optical equipment and transport equipment sectors, with its trade participation ranking jumping from 50th to 31st and 33rd, respectively.
All this growth is good news, as expanding manufacturing is at the core of Indias efforts to create jobs for large volumes of low-skilled workers. But there is room for improvement.
Upping the free trade ante
To keep it up, India, like other countries, has been negotiating several free trade agreements through the last two decades like the ones with ASEAN, Singapore, Japan and South Korea. These facilitate international commerce by reducing trade barriers. There are several other free trade agreements (FTAs) under negotiation like the ones with Australia, Canada, Thailand and Israel.
But the utilisation rate of these deals ranges from 5% to 15%, meaning that it is doing relatively low commerce for goods eligible for free-trade benefits.
Rules of origin refer to the exporting countrys value-added share of a final product. Normally, an FTA benefit is given to an import from an FTA partner only if that country is responsible for adding a certain percentage of the products total final value. Most of Indias FTAs put this requirement at 35% to 40%
In theory, this rule protects India by preventing other countries from gaining free trade benefits by exporting to it through an Indian FTA partner.
But in a world of increasingly fragmented production processes, conditioning preferential access to India on higher single-country value additions is limiting. Instead, rules of origin customs designed with a more regional or sector-specific approach would improve Indias integration with international value chains.
A related issue is local content requirement, which countries impose when they seek to grow local industries (as India does with manufacturing).
India requires foreign investors who want to source inputs from other countries for efficient production to buy Indian instead, which goes against the design of improved production through value chains and makes the country a less appealing investment destination for international manufacturing.
The country would do well to consider these issues as it takes part in ongoing negotiations of the Regional Comprehensive Economic Partnership (RCEP), a proposed trade agreement between the ten ASEAN nations and six other regional partners, including India, China and Australia.
Given Indias increasing integration within Asia, the agreement holds real potential for further inserting its transport, electrical and optical equipment sectors into global value chains. But doing so effectively will require a careful re-examination at rules of origin and local content requirements.
Domestic reforms for greater global integration
Unravelling Indias potential to become an Asian manufacturing hub will be no easy feat.
To go bigger, Indian industry needs improved transportation infrastructure and quicker customs clearances, easing the movement of goods between ports and factories.
Compared to China, with its high-speed transit to and from ports, India lags well behind. Even compared to other Asian countries, Indias tranport time is high.
Laws, too, have historically inhibited growth of Indian manufacturing. Expansion and retraction are both subject to numerous government-approval processes, which reduces flexibility.
Some of the concerns have been addressed by the present Indian government which has initiated reforms to facilitate investment through the Make in India initiative and otherwise. This is expected to spur manufacturing activity. But the government has made little effort to improve or rationalise labour laws to better align with its national development interests.
Finally, global value chains are most beneficial for countries that contribute in the higher value-added segments of a production chain: its more lucrative to make the computer that controls the automated vehicle than its wheels.
This requires a skilled labour force, something that India despite its many improvements in production and trade has yet to achieve.