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COLUMN

Maximising value addition

MATasum
Several misconceptions mnr economic research in Bangladesh. These arise due primarily to a reliance on the simplicity and the superficial plausibility of the proffered explanations, which do not tax the intellectual capacity of the audience and are favourable to influential groups. Consequently, they gain wide acceptance over explanations that are more com-plexor unpleasant.
It is difficult to establish an alternative (correct) explanation when such misconceptions are entrenched. As long as a majority of the people held the comfortable view that dirigisme was the right economic policy, the case for free market did not attract much support. Similarly, if a large number of people hold the view that the pursuit of maximisation of value addition in every line of production is a desirable policy, economists will be hard-pressed to convince them otherwise. The situation is very damaging to the economy when policy makers are also taken by such facile explanations.
Value addition is an important term in national income accounting. It is defined to be the creation of new value, or what amounts to tire same thing, income earned in the process of production of a particular commodity. In general, value addition in the production of a commodity is equal to its sale price less the value of all purchased material inputs from other industries.
The definition is fairly unambiguous and there is little scope for misinterpretation. However, in non-professional (and occasionally even in professional) economics discourse, the term is often endowed with an added implication that it does not have. Economics and business commentators and policy makers frequently suggest that a higher value addition in the production of a commodity is in some sense better or more desirable than lower value addition.
While this may be the case for certain industries depending on the market conditions, the deduction is in general not correct. The maximisation of value addition was a very persuasive argument in favour of import substitution industrialisation policy, which did significant damage to economic
growth of many developing countries that adopted it as a development strategy during the postWorld War Il decades.
Several production processes may be required to support the production of a single commodity. Consider the most important export product of Bangladesh --the ready-made garments. The cutting and making (CM) operations are the last stage of the conversion process of some raw materials into garments and perhaps the simplest and least expensive stage. The stage prior to CM is fabric production and the one before that is spinning. Both these stages are much more complex, capital-intensive and expensive. The earliest production stage in this chain is of course the production of cotton, which is an agricultural operation.
If the economy wishes to have close to hundred percent value addition in the production of garments, then it must engage in cotton cultivation, spin yarn from the home-grown cotton, manufacture fabric from the yarn and finally cut and make garments from the fabric. Each of these stages or processes has unique requirements, uses very different technology, requires very different skills and produces different outputs. There is no guarantee that a nation can attain economic effi-
ciency in the production of all these goods.
Indeed, there are few countries in the world that can efficiently produce all these goods. Of the top ten textile exporters of the world, only four -- USA, China, India and Pakistan -- are also major cotton producers (China is also the largest importer of cotton).
Of the top ten textile exporters of the world, Hong Kong, Korea and Taipei had their clothing exports severely reduced in recent years while Japan has ceased to be a significant exporter. The EU and USA, two of the top textile exporters, are also likely to have problems with their clothing industry in the near future. On the other hand, some developing countries that are not noted for their textile industries have emerged as successful garment exporters. These include Bangladesh, Cambodia, Sri Lanka, andVietnam.
The availability of primary inputs locally certainly gives an advantage to the domestic production of a good, such as garments. Lead-time can be cut significantly and transport and import transaction costs can also be reduced substantially.
However, these advantages may not be enough to give a competitive edge to domestic production if the country does not in the first place have a comparative
advantage in the production of these inputs. Higher production costs will outweigh the benefits of availability of the inputs locally.
Similarly, if the country does not have a comparative advantage in the production of the final good, the local availability of the cheap inputs will not suffice to make the manufacturing of the output profitable. This is precisely the reason why despite being some of the most efficient producers of textiles (an essential input for apparels), countries such as Japan. Hong Kong and Korea have been forced to cede their apparel market share to the emerging developing countries such as China, India, Bangladesh andVietnam.
These facts should suggest that it is incorrect to assume that a country must maximise value addition in the production of a single commodity or produce all the necessary inputs to excel in the export of that commodity. Each stage of production, being a different operation from the rest, has its own business rationale. It must survive on its own merit and not on the largesse of other operations. It is bad economics to tie up the fortunes of one stage of production with another it may stunt the growth of both and reduce the potential output of the economy.
The development of any sector (such as garments) provides a
powerful boost to the growth of backward and forward linkage industries (such as textiles and accessories). If the economy has, or build up, a comparative advantage in any of these industries, they will flourish. The unassisted rapid growth of the accessories industries in Bangladesh is evidence of this fact. The government may wish to support the growth of the backward and forward linkage industries through its various industry support programmes, but these must not hobble the primary industry lest its comparative advantage is reduced or lost. The goose should not be killed to retrieve the golden eggs!
The maximisation of value addition in the production of a single commodity cannot possibly be either a business objective or a national economic goal. The overriding motive for running a business is to make money or profit; this is true of both garments and textile manufacturers as of any other business.
Note that each stage of production is a separate business run by separate entities. The profits earned at any stage have no definable correlation with the profits at any other stage. Hence, maximising value addition in the production of a commodity has no bearing on the profit calculus of the business entities at each stage and imposing such a requirement serves no useful purpose. Indeed, it can be harmful to all as all industries may suffer from stunted growth or decline.
The national economic goal in just about all countries of the world is the maximisation of national welfare. This is usually taken to mean the maximisation of national income (distributional issues aside). The maximisation of value addition in each industry does not necessarily guarantee the maximisation of national income; indeed income could be reduced because of such a misguided attempt. If all stages of production are not economically efficient, which is likely, maximising value addition will actually reduce potential national output by diverting scarce resources into less efficient activities. Simplistic views about national welfare do not always translate into rational economic policies.
The writer is the CEO of Bangladesh Foreign Trade Institute.