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Integrating small businesses into cross-border value chains for economic growth Photo © Chris Kirchhoff/ Media Club South Africa
Wednesday, 13 December 2017 12:03

Integrating small businesses into cross-border value chains for economic growth

Written by  Anna Ngarachu

As Argentina takes over the G20 Presidency this month, it is becoming clearer that it will continue the focus on sustainability. Fostering the transformation of the global economy towards sustainability is one of the commitments made by the G20 towards implementing Agenda 2030, a focus of the last two G20 Presidencies. Integrating Global Value Chains (GVCs) are a critical part of achieving sustainability, especially through the incorporation of small and medium enterprises (SMEs).

SMEs are a vital part of any economy and have developmental gains as they can impact the grass-roots level of an economy, allowing individuals and communities to upgrade their livelihoods and incomes, potentially raising them out of poverty.

There are significant barriers that SMEs face when seeking to upgrade in their sectors or when expanding their production opportunities by seeking to access export markets. This is a result of seeking to attain higher outputs than the domestic market can offer at the time. Alternatively, when domestic demand falters, for variety of reasons, firms look outside their markets for expansion possibilities.

A recent GEG Africa Discussion Paper examines SME participation in value chains, focusing on two leading economies: Kenya and South Africa. It seeks to understand how SMEs in these sectors can be better supported in upgrading and accessing markets, despite the numerous barriers they face when it comes to exporting or participating in value chains. An interesting perspective that is currently emerging within discussions in South Africa is why growth, in terms of exports, has been stagnant despite the relatively competitive rand. This leads one to consider the role of SMEs contribution to exports, whether these SMEs export directly or indirectly through regional value chains (RVCs) or global value chains.

Currently, SMEs in South Africa contribute roughly 50% to GDP with around 2,25 million documented SMEs. Some 667 433 operate in the formal sector and 1,5 million in the informal sector. They play a vital role in employment, making up roughly 60% of formal employment and 91% of formalised business. In Kenya, SMEs currently contribute approximately 25% of GDP and employ 6.4 million individuals, which accounted for 82.7% of the total informal work force in 2014. There is a clear case for SME participation in exports as this would accelerate economic growth, enable SMEs to upgrade and employ more people.

SMEs that access markets directly face a number of constraints, particularly due to undergoing a “learning by exporting” phase before reaching success. Such barriers to exporting include high transaction costs due to infrastructure constraints, border procedures, tariffs and trade-related issues, including a lack of adequate trade finance.

The lack of network infrastructure dampens trade “connectivity” in the form of marginal access to ICT, energy and adequate transport. Capacity constraints also arise in the form of standards that must be complied with before access to markets is granted. This can be an overbearing procedure: most South African SMEs export into the rest of sub-Saharan Africa, where market contexts and non-formal barriers can be challenging. These market difficulties would be synonymous with the East African region too, where Kenya acts as the main connector to its neighbouring countries.

There should be an alternative to upgrading possibilities for SMEs and their contribution to export growth. SMEs can leverage Multinational Corporations (MNCs), which have a presence in local economies, and access markets indirectly through RVCs/GVCs. This could resolve some of the transaction and infrastructure constraints mentioned above, including the information asymmetry issues that SMEs face when entering new markets directly. MNCs are at the heart of cross-border distribution within the African region. They are mainly concentrated in environments favourable to doing business, such as in investment and financial hubs. Hence, South Africa and Kenya, which are lead economies in this regard, act as “gateway” economies – connecting the region to the world and the world to the region.

However, access to cross-border value chains via MNCs is difficult for many smaller enterprises which feed various products into their production processes, owing in part to the stringent requirements that MNCs impose on upstream suppliers. A key focus here is standard requirements, particularly voluntary sustainability standards (VSS). VSS emerge from the broader context of sustainability standards that refer specifically to a “set of criteria defining good social and environmental practices in an industry or production process“.

The conversation around standards and VSS has developed so much that there is a notion that VSS are at times too stringent, negativity affecting trade, as opposed to acting as enhancers of sustainable value chains. Therefore, stringent VSS may be considered as non-tariff barriers – a sentiment echoed by participants at the 2017 Trade for Sustainable Development Forum hosted by the International Trade Centre in September. Particular barriers are unpacked in the recent GEG Africa Discussion Paper, from which the majority of these insights are taken.

The main obstacles SMEs face when accessing MNC value chains relating to VSS revolve around:

  • The lack of awareness regarding the necessity of adopting sustainability standards,
  • A lack of technical capacity to understand the elaborate and often complex nature of these standards and how to implement them,
  • Costly implementation and certification of VSS
  • Lack of adequate financing to allow SMEs to upskill and upgrade their operations, including catering for the costs of testing and certification,
  • The uncompetitive nature of market structure and contractual agreements between MNCs and SMEs that do not favour small firms
  • The fragmented VSS landscape, which results in a duplication of VSS requirements, which in turn leads to them becoming even more cumbersome and stringent. The lack of governance structure is often a root cause.

G20 countries have a number of MNCs within the Southern and East Africa regions, and some key recommendations have been made for the grouping”s consideration:

  • A commitment by G20 countries to keep markets open. For countries in Southern and Eastern Africa to participate in international markets via exports and integrate into GVCs, it is vital for international markets to remain open.
  • The G20 should support enhanced investigation of financing options to support SMEs and their uptake of VSS, with special focus on preferential and guarantee financing mechanisms. This should take the form of innovative equity and debt financing, especially for SMEs owned by women, youth and people with disabilities. This could be provided through facilities set up by institutions such as the World Bank. This agenda should continue beyond 2017.
  • The G20 should work with the B20 to support and facilitate business-to-business discussions, particularly at a regional level, and work with regional business associations. This will allow for transparency in the standards implementation process, costs associated with standards certification and implementation, assessment methodology, and dispute resolution. This needs to include further investigation to understand firm linkages between MNCs and SMEs in the form of supplier development programmes. These programmes could help overcome obstacles that small businesses encounter when attempting to access MNC value chains.
  • The G20 could mobilise institutional support for SMEs to engage in standards adoption. It could do this by supporting national standards bodies to establish multi-stakeholder dialogue fora and awareness campaigns, as has been done in India and Brazil. This would assist in eliminating a variety of asymmetrical information gaps that SMEs face. South Africa and Kenya should also consider establishing such multi-stakeholder dialogue platforms.
  • The G20 should ensure that there is an effort to examine the legitimacy of standards, including regulation of VSS to accommodate small entities, and where needed, an effort to harmonise the multitude of standards, especially those that are overly burdensome. An oversight mechanism of groups that establish these VSS should be called for, in conjunction with the approach taken by the WTO technical barriers to trade and sanitary and phytosanitary agreements.
  • There should be an initiative to better understand SMEs and the challenges they face by gathering data on the performance of SMEs, including those in the informal sector. This would assist in driving targeted policy solutions rather than blanket policies. Cooperation mechanisms between companies to drive low-cost and high-uptake ICT tools can enable the creation of digital self-assessment questionnaires for producers. The G20 could support these ICT-driven initiatives through better focussed development assistance initiatives.
  • Lastly, it is important to facilitate the “gateway” economies of Africa. For instance, policies such as the Pan African Investment Code and the ongoing Continental Free Trade Area (CFTA) agreements create favourable regulatory and investment environments for MNCs to locate and expand their operations. In the same light, the G20 should continue to foster the development of policies that support regional integration and contribute to ease of doing business in Africa. This will help develop constructive RVCs that attract foreign players into the market, enhancing the opportunities for African countries to act as gateways.

Sustainable value chains formed a key focus for the 2017 German G20 Presidency and we look ahead as to whether any particular recommendations will emerge from the Argentinian G20 Presidency. These may also materialise on behalf of the institutions that seek to support SMEs; whether it is an improvement in supplier development hosted by MNCs or policies that foster regional integration and development. These keep markets open to allow African economies to act as gateways, creating export opportunities and sustained growth via sustainable value chains.

Anna Ngarachu is a researcher at Tutwa Consulting Group.