Labor productivity in developing Asia has been slowing down since the Global Financial Crisis. Declining global capital flows will gradually reduce capital accumulation in developing Asia, and as more Asian countries see an end to their population bonus, labor force accumulation will eventually diminish. Enhancing labor productivity is thus crucial to sustain growth in Asia.

Small and medium-sized enterprises (SMEs) are expected to reverse the deceleration trend of labor productivity in Asia. They are the key drivers of Asia’s economies, accounting for 96 percent of all enterprises and 62 percent of the national labor force in the region, but their contribution to national GDPs is still less than half.

Labor Productivity and Global Value Chains

Global value chains (GVCs) will play a pivotal role in unlocking business opportunities for SMEs, and SME participation in GVCs will in turn boost national productivity.

Trade liberalization and investment brought by economic integration initiatives, such as the ASEAN Economic Community, encourage structural changes in the SME business model from being domestically focused to becoming globally competitive, and require policymakers to consider how to create and support an enabling environment for domestic SMEs to enter the GVC.

SMEs can expect benefits from participating in GVCs, as they increase SME competitiveness through business linkages, enhance product quality due to technology transfer, and facilitate SME expansion to overseas marketplaces with job creation.

On the other hand, labor market rigidity, cross-country regulations, non-tariff barriers, inability to meet the quality and standards for certain products, managerial constraints and lack of access to credit make SMEs hesitant to step forward. All of these constraints can be eased by policy support and regulatory coordination.

Global discussions in GVCs often focus on vertical business linkages, where a large multinational firm leads the overall production network and is mainly responsible for final assembly of products, marketing, sales, logistics, and/or exports and imports of products with partner large firms. SMEs are incorporated in the production network as end-tier or lower-tier suppliers such as raw material suppliers or first-tier suppliers of parts and components. A value chain mechanism that more SMEs can tap will need to be developed further, focusing on horizontal firm linkages.

Global value chains will play a pivotal role in unlocking business opportunities for small and medium enterprises.

Horizontal Linkages in Asia

Horizontal firm linkages are a critical model of GVCs in developing Asia, especially in the export-oriented agri-business, food processing, and handicraft industries, where SMEs are involved throughout the production chain as suppliers from the end-tier to the first-tier, the lead firm or producer, packaging and storage firms, marketing agents, wholesalers and retailers, and/or exporters and importers of products. They often make up a business cluster, but not all clusters are successful due to a lack of cluster managers coordinating the production process and logistics among participating SMEs.

Participation in GVCs enables SMEs to access a large customer base, glean learning opportunities from large enterprises, and boost their productivity and job creation. Strengthening competitiveness and connectivity is required for SMEs in GVCs. In particular, business cluster development is key for horizontal firm linkage models. SMEs need a product quality control, skilled labor, and the owner’s education for successful participation in GVCs. To this end, they need to develop business networking, acquire support from business development services, and secure access to finance. These are critical policy support areas, but also areas requiring private sector support.

The Role of Finance in Integrating SMEs into GVCs

Asian Development Bank surveys conducted in Kazakhstan, Papua New Guinea, the Philippines and Sri Lanka noted greater access to trade finance and growth capital through innovative financing models as one of the policy priorities for integrating SMEs into GVCs. An increasingly globalized economy will bring more SME internationalization, particularly in the supporting industry, and new financing needs from SMEs, such as funding in offshore currencies. Liberalized trade and investment have increased demand for supply chain finance and trade finance among SME exporters and importers.

The currency-swap trade settlement between the People’s Republic of China and the Republic of Korea is an example of an innovative approach to trade finance facilitation for SMEs, and can be replicated in other Asian countries. This system enables the importer (buyer) in each country to borrow in the exporter’s currency, to pay for trade bills in that currency. Digital finance, represented by mobile banking, internet banking and crowdfunding, is also a promising tool to bring more opportunities for international SMEs to access low-cost financing for global business development.

A cross-border policy and regulatory coordination is necessary to support SME participation in GVCs. The implementation of global regulatory standards at the national level—such as Basel capital accords and anti-money laundering regulations—often prevents international SMEs from raising timely growth capital from financial institutions, suggesting the necessity of regulatory adjustment among stakeholder countries.

The development of horizontal firm linkages across the border or export-oriented business clusters needs policy coordination among countries concerned in labor mobilization and trade facilitation. Developing a business development services ecosystem is critical to enhance SME participation in GVCs, which requires public and private sector collaboration. National policymakers need to use broader and coordinated policy approaches for integrating SMEs into GVCs and supporting innovative financing models accessible for these enterprises.

This piece first appeared on the Asian Development Blog.