Off the mark: Backward linkages and high value products

Much importance is attached to the concept of 'backward linkage' in development literature. Commonly it is understood to refer to an industry that produces an output that is used as an input in the production of another output (it could also refer to positive externalities). For example, steel production is a backward linkage industry for a number of commodities such as corrugated iron sheet, machinery, cutlery etc. The term is simply a description of the place of the industry in the production chain. However, in Bangladesh it is frequently asserted that having domestic backward linkage industries is essential or desirable for rapid industrialisation. The deduction is false as a general proposition.

The preoccupation with backward linkage industries is perhaps a throwback from the defunct economics of a bygone era of the command economy. The economic planners of that era had to worry about backward linkages since the whole production process could grind to a halt if any input were not locally produced. This was due to the fact that the country did not trade much with the rest of the world either because the rest of the world imposed restrictions on trade with the country (as in the case of the early Soviet Union) or the country shut itself out from the rest of the world with a policy of import substitution industrialization (such as early China and India).

When trading opportunities are available inputs can be accessed in the world market. Indeed, globalisation has completely negated the logic of backward linkage industries. No country should attempt to produce all the inputs needed for the production of any particular good unless it can do so competitively.

If one looks at the emerging industrial structure and the trade patterns of the developed countries, this becomes very evident. Intra-industry trade (essentially trade in inputs) is becoming increasingly important relative to inter-industry trade or trade in final goods.

The USA, the original home of the computer industry, now hardly manufactures much computer hardware. US companies have shifted their hardware production offshore. Even much of the work of software engineering has also been outsourced or shifted to such countries as India.

Many apparel companies in developed countries have either closed down altogether or shifted their operations offshore to developing countries where costs of production are lower. Interestingly some of these countries have actually increased their textile output at the same time they were closing down their downstream (forward linkage) apparel industry. Much of the textile output is now exported to the emerging clothing producers in the developing world.

Car manufacturers do not fabricate all car parts; whatever can be imported at a lower cost they simply buy from the international market. The very logic of globalisation requires that a country does not try to produce everything it needs; it concentrates in producing only those commodities in which it has a comparative advantage while importing the rest.

Therefore, the creation of backward linkages for any industry must not become an obsession. Level playing field should be ensured for the development of all industries by exploiting their comparative advantage regardless of whether they are backward linkage activities or not.

Another idea that has percolated into economic policy discourse and seems to have considerable sway relates to high value products. It is often suggested, even by the highest policy makers, that the entrepreneurs should graduate to higher value products that presumably contain higher value addition. This is conceptually problematic.

High value and higher value addition may not always go together. For example, if an entrepreneur sets up a facility to produce cars (or plasma TV) by assembling mostly imported parts, he will produce a very high value product, but it would not have very high value addition. On the other hand, some very low value products, such as jute sacks or knit T-shirts, have very high value addition.

Requiring entrepreneurs to produce high value products with high value addition would therefore restrict them to only a small subset of the available production processes; and this cannot possibly be an optimal policy. More importantly there may be no economic advantage in producing high value products. In such case, advising entrepreneurs to shift to high value products is tantamount to asking them to commit business hara-kiri.

The most profitable business opportunities are usually available in mass, and hence cheap, products. Those who have succeeded in the mass market will not, and of course should not, abandon the market until they have lost competitiveness. The richest and most successful business enterprises are usually found to cater to the mass market.

The software giant Microsoft essentially produces a very low value product viz, a word processor. But this software has an enormously large market as it is useful to anyone who uses a computer, whether in an office, home or school. This makes it an extremely profitable product that has catapulted Microsoft owner Bill Gates to the status of the richest man of the world in a very short period. He will not be amused if he is advised to shift his talent to some extremely high value software such as those used for designing flight paths of satellites or spacecraft.

The retail giant Walmart serves the lower end of the market. Despite its tremendous success in retail business it has not moved upmarket by setting up very expensive and exclusive boutiques. Obviously it has not seen much profit in such a venture.

Toyota and Ford have very successfully produced cheap cars for the mass market for a long time. While they have small sections devoted to the luxury car market, their main concentration is the mass market. It will be a folly to advise them to try and produce cars to compete with the very high value cars such as Rolls-Royce or Ferrari. Incidentally, none of the latter carmakers is as profitable as the former.

In advocating for high value products what is lost sight of is the prime motivation for running a business, which is earning profits. Entrepreneurs will always choose the most profitable activity; and this is precisely what they should do if they wish to survive or excel in the marketplace.

A high value product does not necessarily guarantee high profits. Entrepreneurs should not switch to high value products unless they expect to earn higher profits. Most importantly, they should not abandon a profitable product regardless of whether it is of high value or not. Economists (vide Nobel laureates Arrow and Debreau) proved more than half a century ago Adam Smith's proposition that when entrepreneurs in a competitive market produce the most profitable products their contribution to the output of the nation is at a maximum.

M. A. Taslim, Professor of Economics of University of Dhaka, is currently the CEO of Bangladesh Foreign Trade Institute.