Enabling SMEs to penetrate global value chains of TNCs: Need to strengthen regional innovation systems

By Arjun Kumar, Ritika Gupta

MSMEs are key drivers of innovation, economic growth, and new employment generation, making them a key demographic constituent to measure the economic health of countries globally. And w Globalization of industries happening at a fast pace it will be critical for the growth of MSMEs to look into aspects of accessing the market potential offered by the global integration.

In the joint talk organized by Centre for Work and Welfare (CWW), Impact Policy and Research Institute, New Delhi, Counterview and Working People’s Charter, Prof Dev Nathan said that a lot of trade is nowadays organized in the form of global value chains, and it’s important to know one’s role, and potential to upgrade within the global value chains. It is a critical issue for developing countries as they move from being Least Developed Countries (LDCs) to become Moderately Developed Countries (MDCs) further moving along the middle-income trajectory.

Exploiting the potential of SMEs

Prof M H Bala Subramanya, Department of Management Studies, Indian Institute of Science(IISc), Bangalore highlighted the need to exploit the potential of SMEs (small and medium enterprises) to account for a major share of the total number of enterprises. They occupy a state of strategic importance in almost every economy in the global space because of their immense contribution to national economies. These contributions have multiple facets on four broad areas of employment, innovation, income, and exports.

India occupies a unique position because of its long-standing policy for the protection and promotion of small and medium enterprises. This promotion and protection have multiple objectives, the foremost being employment generation. How to generate employment for the large and growing labor force has been a challenge persistently faced by Indian policymakers.

SMEs have been adopted as one of the policy instruments to overcome the challenge of employment generation”, says Prof Subrahmanya

Talking about international trade he commented that as far as International Trade is concerned it is increasingly dominated by the global value chains (GVCs) of transnational corporations (TNCs). Estimates say that GVCs account for 2/3rd to 4/5th of the global trade. Predominantly the TNCs belonged to the developed world. However, newly industrialized economies and emerging economies like China, Malaysia, Thailand have got well – entrenched in the GVCs of TNCs, leading to their dramatic advances in living standards and economic growth. These developments have implications in the form of challenges as well as opportunities for the Indian economy, particularly its small and medium enterprises.

For adequately exploiting the potential of the SME sector on an increasing scale in the future there is a need to target the international market on a much larger scale than what is being done currently”, says Prof Subrahmanya

Impact of COVID-19 on the global economy

Further dwelling upon the impact COVID-19 had on the global economy, he pointed that it is adding a new dimension to the whole issue. Thus, the three dimensions include:

  • The severely disrupted GVCs of TNCs globally.
  • Adverse effect on demand and supply to Indian SMEs, nationally and regionally.
  • Prompting GVC led investments of TNCs for relocation, to countries like India.

Complex Integration Strategy for the GVC of a TNC

He further stated that the overall rationale behind the adoption of a complex integration strategy for the GVC of a TNC is enhancing efficiency through cost reduction. As a part of the complex integration strategy, a TNC may locate any part of its value chain globally in any country where it can be carried out most effectively or cost-effectively. Breaking the production process of transnational corporations offers new opportunities for integration for both developed and developing economies, with potential benefits for each. Another significant feature of GVCs is that each part of it would indulge with local forms in the domestic market or regional markets, as and when necessary and advantageous.

GVCs of TNCs: Implications for SMEs

He further pointed out that entering into GVCs of TNCs underlines the imperativeness of innovation, efficiency, and productivity on the part of firms. Given this participation in global or regional value chains can be beneficial in fostering a firm’s growth and internationalization, irrespective of its scale and size. Internationalization provides the right conditions for SMEs to enhance productivity, while also enabling the spill-over of technological and managerial know-how and facilitating accelerate innovation. By penetrating or linking with GVCs, SMEs can take up a first step ladder, which through spillovers and knowledge transfers can often lead them to fetch higher value-added assignments, through product innovations and working knowledge.

Talking about developed countries Prof Bala stated that their SMEs are in a better position in the global economy today as they are better integrated with the GVCs of TNCs.The share of developed economies in value of exports on average stood at 34% and their contributions were as high as 78% at the beginning of the previous decade. More than 3/4th of the total number of SMEs in the developed world is linked to the international market which ultimately leads them to GVCs. Not all SMEs would be able to take the advantage of the opportunities that would be emerging from the rapidly expanding GVCs through linkages. SMEs in general both in the developed and in the developing world are known for their internal constraints due to their smaller scale, lower levels of sophistication, prone to market failures leading to limited access to finance. SMEs often face greater difficulties in internationalizing their activities than their counterparts.

According to World Bank statistics, export SMEs in developing countries account for 8% of the manufacturing sales. SMEs with fewer employees take a longer time to access the international markets than the larger forms. The kind of benefits that SMEs would be able to derive if they succeed would depend upon the entry point, the position in the global production network, and the links developed by them within the networks.

For emerging economies like India, if one has to make a mark on the global production network similar to other emerging economies, it is necessary to enable domestic forms viewing SMEs to penetrate and link with the GVCs on an increasing scale.” Says Prof Subrahmanya

Are small and Medium Scale Enterprises integrated well with the GVCs?

If SMEs have to internationalize and integrate themselves with the GVCs on a considerable scale, they have to be competitive, efficient, and productive which requires them to be innovative. However, innovation is widely absent in the SME sector, implying a low innovation capacity of Indian SMEs which is reflected in India’s very low ranking in the global innovation index (81 out of 141 countries).

He further dwelled upon the requirement of external support for SME innovation and said that innovation does not occur in Silos. If innovation among SMEs has to thrive, they need to be networked in the local/regional markets because there is a positive association between innovation and networking. The networks can be in the form of vertical linkages with customers and suppliers or horizontal linkages with academic/research institutions, industry associations, other SMEs in the same cluster. Lack of collaboration with other firms in the same industry and with universities and research and development was identified as one of the external barriers for SME innovation by a nation-wide study on innovative SMEs.

Thus, Indian SMEs have a limited presence in the GVCs of TNCs due to their weak internationalization, which in turn is due to their weak innovative base, owing to their weak networks, which is particularly due to weak firm linkages. This in turn could be attributed to the weak internal strength of SMEs or weak or no external support availability locally or regionally.

Efforts must be made to strengthen SME sector locally to enable their penetration and reach globally”, says Prof Subrahmanya

Significance of Regional Innovation Systems for Firm-level Innovations

Throwing light on the significance of Regional Innovation Systems he stated that the ability and potential of SMEs to network and innovate depends upon the internal strength and vibrancy of the regions in which they operate. This is because firms succeed if they benefit from the specific advantage of their environment comprising diverse supportive elements. A regional cluster is a concentration of interdependent firms within the same or adjacent industrial sectors in a small geographical region such as a town or a city. A regional information system on the other hand is much beyond a regional cluster of firms and has a more planned and systematic character.

As of now, there are 388 SME clusters in India, out of which 112 clusters are located in eight metropolitan cities. Even the remaining ones are located in major 26 cities of different states across the country. While the former eight metropolitan cities are most likely to comprise RISs of varying strengths, the latter 26 cities may just comprise RCs with a potential to develop into a RIS.

We need to focus on these regional Clusters (RCs) which have the potential to develop into regional Information systems (RIS)”, says Prof Subrahmanya

The strategy and experience of Bangalore RIS-based SME can be a lesson to emulate elsewhere in the country. Support to SMEs should be provided not just at the start-up phase but in subsequent stages of its life cycle as well, including the internationalization stage. A strong and vibrant RIS would result in increased regional networks resulting in more radical product/process innovations giving rise to increased internationalization thereby ending up in increased penetration of GVCs of TNCs.

The network and innovation support system extended through an R&N public service platform should be created in each of the RCs in India, to enable the networking of SMEs for innovation to penetrate the international markets to join the GVCs of TNCs”, says Prof Subrahmanya

Prof Bala concluded by saying that providing network and innovation policy support to offset the internal deficiencies of SMEs by providing “accessible and productive innovation infrastructure” for firms at different stages of their life cycle would largely enable the emergence of an “innovation flourishing environment” for the benefit of SMEs to steadily penetrate the GVCs of TNCs through internationalization.

Ketan Reddy, Research Scholar, Department of Humanities and Social Sciences, Indian Institute of Technology Madras acknowledged the importance of Innovation to help MSMEs transform as participants in GVCs which would help India achieve the target of a 5 trillion economy. Since only 0.2% of MSMEs in India participate in GVCs, the picture becomes even gloomier as these firms are not directly participating with GVCs and are rather integrating with large domestic firms which are therefore integrated with transnational corporations and thereby forming the global value chain.

The last World development report 2020 focuses solely on global value chains highlights that in 2017 around 65% of the trade that is happening in the present day is in products that never existed before 1992. The report tells the amount of innovation that has been happening and gives scope for every developing economy and the firms from which they try to innovate as a channel of leapfrogging their status from low developing countries to a low middle income to higher middle income.

Another aspect of regional clusters where the agglomeration effects could be seen and they could help SMEs be more productive. Productivity is an important factor that drives GVCs participation in the firm and it is important if one could get regional clusters running and more catering to MSMEs.Trying to come up with policies that promote joint ventures with MSMEs can help them technologically which could then further increase their gains in GVC participation.

Lack of demand for innovation and knowledge services

Prof Dev Nathan, an Eminent Professor commented that so far the discussion was largely on the supply of knowledge and innovation services. The question of the demand for innovation and knowledge services and the existence of insufficient demand for knowledge services needs to be looked upon. Many schemes are not utilized particularly in the northern part of the country in the clusters. There are schemes for certain common services but they don’t come up due to lack of enough demand.

We have to go to the firm strategy, as the firms do not have a strategy that requires a demand for innovation, and under what conditions can we develop or nudge firms to move in the direction of requiring innovation in their practices. We should think for certain quality requirements which will allow exports but not themselves to be directly related to exports. This will enhance demand for certain kinds of knowledge and innovations to meet those standards.

Government Assistance and Schemes to enable MSMEs

Dr. Radhika, Fellow-I, NIPFP pointed out the kind of government assistance that has been provided, is a dedicated scheme for a cluster development program for MSME which focuses on two special aspects, provides common facility centers, and infrastructure development. There are quite a large number of schemes but in terms of performance, they are geographically lopsided.

There is a kind of mismatch between utilization of schemes by MSMEs in the regional clusters, and what prevents them from utilizing these schemes is very critical which requires overview and critical appraisal of the scheme”, says Dr. Radhika Pandey

In order to promote the role of innovations and the role of promotion of entrepreneurial skill, there exists a scheme that aims to develop incubators. The problem is that the scheme is tied and most of the incubators in the southern region.

“There needs for a relevant up-to-date database on the performance of these schemes and how MSMEs who have taken up the scheme has started performing”, says Dr.Radhika Pandey

Reflections by Prof M H Bala Subrahmanya

On the idea of promoting and encouraging TNCs to go for joint ventures with local SMEs, he responded by saying that such kind of encouragement may not yield dividends. We need to consciously promote industry-institute interaction, enable SMEs to know which is the first stage of networking with institutions. Industry Institute interaction will enable SMEs to improve the quality of their products, quality of innovations, and developing more links with TNCs in the regional market. The best strategy is to bring the SMEs closer to institutes consciously which will also get them virtually costless benefits.

If hundreds of students go and identify an industry problem, it will be to the advantage of locally clustered firms for their innovations leading them to enter in the international market”, says Prof Bala Subrahmanya

Many SMEs only start with incremental innovation in response to the direction or the demands of the customers. No SME gets into radical innovation directly. For the government industry, the kind of innovation scope may be limited as compared to the engineering industry where innovation scope is much more. Those SMEs who are confident of their radical product innovations obtain patents.

The challenge is how to convert a large number of incremental innovators into radical innovators.” Says Prof Bala Subrahmanya

Informal Nature of Micro Enterprises

Dr. Akhilesh Sharma said the low utilization of government schemes and the lack of innovation in MSMEs are the most pertinent issues which need to be addressed. In India, 99.5% of enterprises are micro-enterprises with one or two employees. The micro-enterprises are the owners of the workers of their firm. The focus of micro-enterprises is local and regional demand and not exports. The other important issue is low registration where only around 30% of MSMEs are registered. With this low registration, MSMEs are not able to avail the benefit of the government schemes or any other initiatives either in terms of at the incubation centers or technology centers.

High level of informality in the MSME sector is affecting the performance of the small and medium enterprises”, says Dr. Akhilesh Sharma

There is a need for a multi-stakeholder discussion between industry, government officials, and academicians to design a policy that can add value for MSMEs. There is also a need to increase formality in the sector and increase the registration process for enabling people to get timely information about the market and government schemes.

Way forward

There is scope for greater collaboration between SMEs and academia, at the same time, there is scope for review of schemes presently existing for the benefit of SMEs. There is a need for critical appraisal of those schemes so they can be made more beneficial. There is also a need to think of what needs to be done to incentivize micro-enterprises to scale up so that they become small and medium enterprises. A large number of compliance requirements that disincentivizes these enterprises to scale up needs to be looked upon. Also, more awareness at the local and state level should be incorporated for enhancing the registration system of MSMEs.

District industrial centers can play a key role in improving the registration process, also giving training to small and medium enterprises and hence one should focus on improving its performance. The institution plays a key role in primary sector lending where all the government schemes are routed through district industrial centers. Also, there is a need to increase the formalization of industries. There is an urgent need to strengthen and promote the SME sector for the sake of the country’s economic growth. The best way forward is to promote Industry institute interaction to promote their innovation and internationalization.

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