Trade and industrialisation in Africa: SMEs, manufacturing and cluster dynamics

Kaplinsky, Raphael; Morris, Michael L. Article Trade and industrialisation in Africa: SMEs, manufacturing and cluster dynamics Journal of African Trade Provided in Cooperation with: African Export-Import Bank (Afreximbank), Cairo Suggested Citation: Kaplinsky, Raphael; Morris, Michael L. (2019) : Trade and industrialisation in Africa: SMEs, manufacturing and cluster dynamics, Journal of African Trade, ISSN 2214-8523, Atlantis Press, Paris, Vol. 6, Iss. 1/2, pp. 47-59, https://doi.org/10.2991/jat.k.190812.001 This Version is available at: https://hdl.handle.net/10419/267522 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by-nc/4.0/ Journal of African Trade Vol. 6(1-2); December (2019), pp. 47–59 DOI: https://doi.org/10.2991/jat.k.190812.001; ISSN 2214-8515; eISSN 2214-8523 https://www.atlantis-press.com/journals/jat Research Article Trade and Industrialisation in Africa: SMEs, Manufacturing and Cluster Dynamics Raphael Kaplinsky1, Mike Morris2,* 1Institute of Development Studies and Science Policy Research Unit, University of Sussex, Sussex, UK 2School of Economics, University of Cape Town, Rondebosch, South Africa 1. INTRODUCTION The recognition that structural transformation and productivity growth provide the key to enhancing growth is a core component of economic theory and economic policy. These objectives could be met, Adam Smith argued, through the division of labour within and between enterprises. Further, added Smith, the division of labour was a function of the size of the market—the larger the market, the greater the scope for specialisation. Coupled with Ricardo’s argument that specialisation in comparative advantage allows for win–win outcomes through exchange, these core ideas in classical economic theory provide an effective rationale for international trade, especially for small- and medium-sized economies with limited domestic markets. Trade in manufacturing has played an especially prominent role in global economic growth, particularly in recent decades. This is partly because the manufacturing sector has been the major arena for technological change and productivity growth, partly because linkages in manufacturing spread efficiency gains across the manufacturing sector and to other sectors, and partly because manufacturing’s employment intensity has helped to spread the gains from exports and economic growth. However, African manufacturing faces severe challenges in growing manufacturing activities in the face of China and Southeast Asia’s (SE) competitive dominance of global manufactured product markets. This impact occurs in two forms: indirectly blocking African-manufactured exports’ market growth in third-country markets, and directly through African manufacturing producers being undermined by cheaper Asian imports (Edwards and Jenkins, 2015; Kaplinsky, 2008; Morris and Einhorn, 2008). A more recent indirect development is the potentially destructive impact of export of raw materials to China and SE Asia economies which inhibits local production through a reduction in the availability of inputs or an increase in their prices. For example, the export of raw timber from Gabon to China undermines local processing into higher-value added veneer products which had previously been exported to Europe (Kaplinsky et al. 2011). The felling of wild shea trees in Ghana and Burkina Faso and their (mostly illegal) export to SE Asia as timber for furniture production constrains the local Small- and Medium-sized Enterprise (SME)-based shea butter processing industry. Likewise, the export of scrap metal to Asian economies starves domestic metal fabricating SMEs of access to cheap local inputs. ARTICLE INFO Article History Revised 24 May 2019 Accepted 30 July 2019 Keywords African clusters African trade global value chains regional value chains industrial policy manufacturing SMEs ABSTRACT Trade in manufacturing through global and regional value chains has played an especially prominent role in global economic growth in recent decades. However, Africa faces severe challenges in growing manufacturing activities in the face of China and Southeast Asia’s competitive dominance of global manufactured product markets. Traditionally, global trade is heavily concentrated at the corporate level. But this reliance on large firms as a driver of trade is problematic for Africa given its need for a more inclusive synergistic trade and economic growth path that is more employment intensive, more decentralised and which provides scope for enhanced activities by indigenous and small-scale industry. This is not to argue for the exclusion of large firms or foreign direct investment in economic growth, but rather to argue the case for an increased presence of indigenous small-scale firms in the economy and in export trade. There is evidence of dynamism in Africa, both within individual Small- and Medium-sized Enterprises (SMEs) and in clusters of SMEs. In understanding the challenges faced by this sector, and in examining the prospects for their participation in external trade, we review the experience of 25 African clusters using four dimensions: the nature of unintended externalities (e.g., external economies), market orientation and upgrading and growth trajectories, cluster dynamism and joint action for upgrading, external institutional support and upgrading. In terms of policy challenges for SMEs and export trade we discuss four major areas: (i) participation in governed global value chains feeding into high-income markets, (ii) export sales to non-regional low-income markets, (iii) export sales to regional markets and (iv) informal sector cross-border trade to regional economies. We conclude that for Africa, trade and industrialisation are integrally linked and attempts to facilitate regional trade policies cannot ignore the need for developing appropriate industrial policy and adopting an approach of developmental regionalism. This is especially evident with respect to SME development. © 2019 African Export-Import Bank. Publishing services by Atlantis Press International B.V. This is an open access article distributed under the CC BY-NC 4.0 license (http://creativecommons.org/licenses/by-nc/4.0/) *Corresponding author. Email: mike.morr[email protected] Peer review under responsibility of the African Export-Import Bank 48 R. Kaplinsky and M. Morris / Journal of African Trade 6(1-2) 47–59 The observed reality of 300 years of economic progress since the onset of the Industrial Revolution is that economic growth and crossborder trade have gone hand in hand. Global trade is heavily concentrated at the corporate level. It was estimated that at the turn of the millennium the largest 500 global firms controlled 70% of global trade.1 Hence, it is natural to conclude that economic growth in Africa can best be fostered by facilitating a growth in manufacturing exports by large firms. And because there is a dearth of large indigenous firms in many African economies, this will necessarily involve increased foreign investment. Many African economies have concentrated on this route to export growth, including through the promotion of export processing zones. This reliance on large firms as a driver of trade is problematic, not least on the African continent. For one thing, large firms tend to be capital intensive, and unemployment is perhaps one of the greatest challenges facing Africa. Between 2000 and 2008, the rate of employment growth was less than half that of economic growth, and even though the rate of employment speeded up between 2009 and 2014, it still lagged economic growth by an average of 1.4% annually (UNECA, 2017). Slow employment growth disproportionately affects women and youth (Africa’s youth population is anticipated to grow from 226 million in 2015 to 321 million by 2030) and has enormous poverty and political impacts. In recent influential papers, Rodrik has presented evidence to show that manufacturing is unlikely to be a major source of employment growth globally (Rodrik, 2016; Rodrik, 2018a). Further, on the basis of growth trends in Africa involving manufacturing exports by large firms in Global Value Chains (GVCs), he has expressed particular pessimism about the capacity of export trade to make a significant contribution to meeting Africa’s employment challenge (Rodrik, 2018b). Moreover, with the advance of the Fourth Industrial Revolution there is widespread recognition that, globally, employment growth will pose a major challenge to society and economic policy. From the African perspective there is an additional employment challenge to be confronted, and that is the limited capacity of the formal sector to absorb labour. As in other parts of the developing world, a very large proportion of Africa’s labour force earns its incomes in the informal sector. This is particularly the case for Sub-Saharan Africa (SSA), as Table 1 indicates, where more than two-thirds of employment outside of agriculture is in the informal sector, and this proportion has grown. Hence, it is critical to find a route to a synergistic trade and economic growth path which is more inclusive, that is, one that is more employment intensive, more decentralised and which provides scope for enhanced activities by indigenous and small-scale industry. This is not to argue for the exclusion of large firms or Foreign Direct Investment (FDI) in economic growth, but rather to argue the case for an increased presence of indigenous small-scale firms in the economy and in export trade. However, before addressing the evidence in this regard, it is necessary to highlight six related key drivers of global trade which have grown in importance since the mid-1980s. The first of these is the centrality of GVCs in trade. In recent decades value chains have become increasingly fragmented and this follows directly from the division of labour anticipated by Adam Smith. In a highly competitive world, in which the degree of competition has heightened with widespread trade liberalisation, producers have specialised in core competences in which their command over producer and product rents provides barriers to competition. Activities in the chain which are not protected by entry barriers are outsourced. Increasingly this outsourcing has taken a global dimension such that value chains have evolved into GVCs. The definition of GVCs in trade statistics involves the exchange of products involving productive activities in more than two economies. United Nations Conference on Trade and Development and the World Trade Organisation calculate that this trade now accounts for more than two-thirds of total global trade.2 Much of this global trade is in intermediates, rather than in raw materials or finished products. The second relevant development is the extent of governance of trade in GVCs. In many cases, global trade continues to occur on the arms-length basis beloved by economic texts; some of this is within GVCs as it involves more than two economies in the production process. However, the growing complexity of trade in intermediates, particularly in products involving the assembly of imported intermediate inputs, has enhanced the significance of logistics in managing these global production systems. The need for sophisticated logistics controls is heightened by just-in-time production which necessitates delivery reliability and total quality control along the chain. In addition, the fragmenting of final product markets requires careful control over the distinctiveness of intermediate inputs. Consequently, an increasing (although unmeasured) proportion of trade in intermediate products requires detailed control by lead players in GVCs, that is, chain governance. Here, there has been a pervasive growth in the importance of buyers in many sectors (Gereffi, 1999). For example, in the case of final simple consumer goods, retail chains, category buyers and other intermediaries dominate the organisation of global production and Table 1 | The share of informal sector work in non-agricultural employment by region in low- and middle-income economies, 2000–2004 and 2005–2010 (%) 2000–2004 2005–2010 North Africa 47.3 53.0 Sub-Saharan Africa 63.3 70.0 Latin America 55.9 57.7 South and Southeast Asia Not available 69.7 Transition economies 20.7 22.6 Source: drawn from Charmes (2016). 1https://www.sharing.org/information-centre/articles/multinational-corporations-overview. 2An interesting anomaly is the extent of double counting on global trade statistics; for example, the screen in a mobile phone is calculated twice, once as an export from Korea to China, and then subsequently as incorporated in the final value of the mobile phone exported from China to the world. This is estimated to have led to a 28% overestimate of the value added in global trade (UNCTAD, 2013). The trade in value added (TIVA) database developed collaboratively by the WTO and the OECD seeks to decompose global trade into gross and net flows across borders (http://www.oecd.org/sti/ind/measuring-trade-in-value-added.htm). R. Kaplinsky and M. Morris / Journal of African Trade 6(1-2) 47–59 49 exchange along the chain. In more complex durable goods such as automobiles and electronics, the chains are dominated (i.e., governed) by lead firms who control access to supply chains and determine the rules of incorporation. Third, a primary mechanism of governance in GVCs are the standards which suppliers have to meet to be included in the chain (Kaplinsky and Morris, 2018). Typically, at the corporate level, the key standards are Q–C–D. This involves requirements with regard to quality (Q), demands for cost-containment/reduction (C) and reliability and frequency of delivery (D). If suppliers do not conform adequately, they may have to pay a penalty or receive lower prices (or both), or be ejected from the chain. However, corporate standards are not the only set of standards affecting gainful participation in GVCs. In an increasing number of final product markets, civil society organisations set standards affecting the conditions under which production occurs, such as with regard to labour standards and the environmental provenance of production processes. While both corporate and civil society GVC standards involve a trade-off between the degree to which standards are met and the rewards to suppliers, governments and intergovernmental bodies such as the European Union set regulations which determine entry into final markets. These regulatory standards provide no scope for the degree of conformance and are a basic requirement for market entry. Fourth, the extent of governance and the character and importance of standards are critically determined by the nature of the final market. In general, the higher are per capita incomes in the final market, the greater is the degree and complexity of governance and resultant standards in GVC trade. This applies not just as a basic differentiator between the economies to which exports are destined, but also to the niches which are served within different economies. Some markets in low-income countries involve standard-intensive value chains, and similarly, some low-end markets in high-income countries are relatively standards free (Guarín and Knorringa, 2014). Fifth, the relative importance of intraregional trade at a global level is often underestimated. Made in China is in reality often made in East Asia. Formal regional agreements not only facilitate the movement of goods across regional borders, but also of people and capital. Much of this regional integration occurs within the framework of Regional Value Chains (RVCs), through regional economic hubs and decreased transport costs expanding the scale of regional markets and the scope of regionally based FDI and production. When RVCs create backward and forward linkages, this often spills over local borders and extends the scope of regional integration. Hence, regional integration is often integrally intertwined with RVC expansion and linking to global trade through GVCs (UNIDO, 2018). In Asia such economic hubs, coupled with shared norms and institutions which facilitate trust networks and reduced transaction costs, have expanded regional economic integration. These have expanded the scope of RVCs and their integration into export-oriented trade to the extent that “value chains are often organized regionally rather than globally” (UNIDO, 2018; p. xviii). As a consequence, “Southeast Asian economies source over 40% of their foreign value added in exports from Asian partners” (UNIDO, 2018; p. 18). Likewise, in SSA there is evidence that regionally determined rules of origin have facilitated market entry into economic hubs. Regional market entry is governed by large regional retail firms, and the RVCs which arise are driven by large regionally located manufacturing firms, building cross-border supply chains in the process. However, unlike Asia, these have often resulted in an integration between RVCs and GVCs in global export-oriented industries. For example, the large foreign Transnational Corporations (TNCs) which dominate apparel exports to the United States and European Union have not, at least yet, created backward supply chain networks throughout the region (Morris et al., 2016). Finally, and this goes almost without saying, global markets have become increasingly competitive as trade liberalisation has proceeded and as production capabilities have grown globally. Producers who are unable to improve their offerings (in production processes, product character or both) are either excluded from the market or experience extreme pressure on margins. In the worst case, surviving firms and economies are driven into an immiserising growth path in which incomes fall despite an increase in the resources devoted to production and exchange. Hence, the capacity to upgrade, continuously and not just as a single action, is key to gainful participation in global export markets. We now turn to a discussion of the factors which determine the gainful participation of SMEs—including those in the informal sector or the margins of the formal sector—in the growth of global and especially regional exports in African economies. 2. “THE PROBLEM FOR SMEs IS NOT THAT THEY ARE SMALL, BUT THAT THEY ARE LONELY”3 By virtue of their size, SMEs are confronted by a number of challenges which undermine their competitive capacity. These affect their direct costs of production (transforming inputs into outputs), their indirect production costs (product development and design, supply chain management and marketing) and their control over input and output markets. With regard to direct expenditures which affect the variable costs of production, capital goods may have inherent scale economies. For example, the ratio of volume to circumference in spherical containers is 1.6, which provides an important impetus to scale in the chemical and biological process sectors. Even when these scale economies are not technologically determined, the global concentration of Research and Development (R&D) in large firms and high-income economies means that the spectrum of efficient technologies available for purchase is often in reality confined to large-scale and capital-intensive techniques. With regard to indirect costs of production, the capacity to defray investments into R&D, marketing and logistics is a function of scale—spreading these fixed costs over large volumes of sales. The financial muscle of large firms allows them to drive down the price of inputs, to offer financial incentives to obtain market share and to gain from privileged access to low-cost and long-term finance. Finally, the inability to produce in large volumes excludes SMEs from feeding into value chains serving large and often global markets. 3This characterisation of SME cluster dynamics is drawn from Schmitz (1995). 50 R. Kaplinsky and M. Morris / Journal of African Trade 6(1-2) 47–59 By contrast, SMEs benefit from a number of competitive advantages. They are often flexible and agile; not being held back by large corporate bureaucracies allows them to respond rapidly to changing market conditions. SMEs are often particularly adept in developing new products and technologies, and are not weighed down by path-dependent innovation trajectories (Dosi, 1982; Nelson and Winter, 1982). They are often able to escape costly compliance to regulatory regimes, including with respect to minimum wages, health and safety, and child labour. Their bureaucratically thin administrative structures endows them with lower cost structures than their large corporate rivals. Although their incapacity to produce in large volumes constrains their capacity to feed in as suppliers into large-volume value chains, small volume production allows them to serve small-scale and niche markets. While in many cases, such as in the chemical sector, SMEs are disabled by inherent technological constraints, in other cases seemingly insurmountable scale challenges can be surmounted. For example, with regard to the direct costs of production, there are often alternative sources of technology which can produce effectively at low volumes. In East Africa, in the furniture, apparel and farm-mechanisation sectors small producers have rapidly switched their capital goods imports from large-scale equipment sourced from Northern economies to smallerscale and cheaper equipment sourced from China and India (Agyei-Holmes, 2014; Atta-Ankomah, 2014; Botchie, 2015; Hanlin and Kaplinsky, 2016). In recent years, the development of mobile telephony and its rapid expansion in Africa reduces many of the indirect scale barriers, linking individuals into global and regional information sources, and hence, allowing small producers to shop around for alternative suppliers and alternative markets (Aker and Mbiti, 2010). Moreover, indirect costs can be shared with other firms—for example, as will be shown below, SMEs can effectively market their produce under a shared brand name. And in relation to market power, SMEs can join together to purchase collectively and hence to drive down input costs. Globally, there are many examples of vibrant clusters of SMEs who compete effectively in export markets, particularly in the early stages of an industry’s development.4 Perhaps the most widely cited case is that of the Third Italy. During the 1970s and 1980s, Italy was the world’s largest net exporter of furniture, apparel and footwear, yet in each of these sectors the average firm size was <11 employees (Best, 1990). But, clusters of SMEs in industrial districts are not confined to either Italy or high-income economies. Between 1970 and 1990, a cluster of almost 2000 firms in the Sinos Valley in Brazil specialised in the production of women’s shoes and raised its share of world leather footwear exports from 3% to 12%. By 1991 they exported nearly 100 million pairs of shoes annually, valued at $900 million. These firms covered a range of links in the footwear value chain, and created more than 15,000 jobs (Schmitz, 1999). The surgical instrument cluster in Sialkot, Pakistan, produces scissors, forceps, and other precision instruments using stainless steel. In the late 1990s it comprised more than 300 manufacturers, subcontracting work to more than 1500 SMEs, and sourcing inputs from 200 local suppliers and more than 800 service providers. Over 90% of output was exported and the cluster accounted for more than 20% of global trade, making Pakistan the second largest exporter after Germany (Nadvi, 1999). So, what explains the dynamism of clusters and the predominance of small firms within many of them? Industrial districts are not a new phenomenon and their significance in the UK’s industrial development was analysed by both Alfred Marshall and Karl Marx. Marshall’s explanation of clustering, which he referred to as industrial districts, was ascribed to external economies arising from colocation. Examples of external economies are a pool of skilled labour, the agglomeration of suppliers, the pull of buyers to locales where they had a choice of suppliers and the development of specialised support institutions and service providers (Marshall, 1969). More recently a distinction has been drawn between the simple and unintended external economies resulting from colocation observed by Marx and Marshall, and collective efficiency when firms in the cluster engage in purposeful, planned joint action (Schmitz, 1995). This collective action can take a number of forms, including joint purchasing of inputs, joint market intelligence and marketing, product development, skills upgrading and lobbying for support from government. When policy design and delivery are effective, cluster dynamics are greatly aided by appropriate backing from local and national governments (Best, 1990; Van Djik and Sverrisson 2003; Morris and Barnes, 2006; Morris and Robbins, 2007). The most dynamic clusters, particularly in contexts of a challenging external environment, tend to be characterised by joint actions of various forms. Furthermore, critically, particularly in the context of increasingly competitive global markets, cluster dynamics and sustainable and inclusive growth depends on the capacity of individual enterprises and their clustered collectivity to upgrade their offerings (Pietrobelli and Rabellotti, 2011). This requires product development, improvements in process, the adoption of new business strategies, the penetration of new markets and sustained investments in joint action. 3. SMEs, CLUSTERS AND INDUSTRIAL DISTRICTS IN AFRICA Clusters of SMEs are pervasive throughout Africa. Visitors to any city or peri-urban town cannot fail to notice the hive of activity of small enterprises, many of whom are engaged in the same line of business. Characteristically, a large proportion of these are informal, operating in sheds barely protected from the elements and with poor and unreliable access to infrastructure such as power and water. Indeed, as discussed earlier, in SSA the informal sector provides more than two-thirds of employment outside of agriculture. The predominant view is that these SMEs, particularly those in the informal sector, are survivalist, providing meagre incomes and with little capacity to upgrade their operations. The reality, however, is much more complex. True, there are very many SMEs and very many clusters which scrape along the bottom of subsistence production, displaying few signs of dynamism. In the same way, even in high-income economies, there is widespread failure in the SME sector, and routinely, nine out of 10 start-ups fail. Yet, at the same time there is evidence of dynamism in Africa, both within individual SMEs and in clusters of SMEs. In understanding the challenges faced by this sector, and in examining 4See Van Dijk and Sverrisson (2003) for an extended discussion of various types of clusters in developing countries. 5All of these observations are judgements made on the basis of publicly available material on the nature and the performance of these 25 clusters (see Kaplinsky and Morris, 2014) for the detailed sources). It is not possible to subject these clusters to any form of numerical analysis because each of these clusters has been documented in a different form. R. Kaplinsky and M. Morris / Journal of African Trade 6(1-2) 47–59 51 Table 2 | Africa’s experience with 25 clusters Cluster End market Evidence of dynamism External economies Collective action Forms of institutional support Egypt Domiatt furniture (Domestic) Local, national None Labour supply, availability of suppliers, customer attraction, specialised service providers None Cluster/sectoral Domiatt furniture (Export) International Growth, upgrading Labour supply, availability of suppliers, customer attraction, specialised service providers Marketing, learning, logistics External Ethiopia Merkato leather footwear Local, national None Labour supply, availability of suppliers, customer attraction, specialised service providers Logistics Government, cluster/sectoral, external Shiro Meda handloom Local, national None Labour supply, availability of suppliers, customer attraction None External Ghana Suame metalwork Local Upgrading Labour supply, availability of suppliers, customer attraction None Government Suame vehicle repair Local, regional None Availability of suppliers, customer attraction, specialised service providers Learning Government, cluster/sectoral, external Kenya Gikomba furniture Local None Labour supply, availability of suppliers, specialised service providers None None Ngong furniture Local Growth Labour supply, availability of suppliers None None Kibuye furniture Local None Labour supply, availability of suppliers, specialised service providers Logistics Cluster/sectoral Eastland garment Local None Labour supply, availability of suppliers, customer attraction, specialised service providers None None Kamukunji metalwork Local None Availability of suppliers, customer attraction Marketing, learning Government, cluster/sectoral Ziwani vehicle Local Upgrading Availability of suppliers, customer attraction Learning Cluster/sectoral, external Lake Victoria Nile Perch Local, national, international Growth, upgrading Availability of suppliers, customer attraction, specialised service providers Logistics, learning Government, cluster/sectoral, external Lake Naivasha cut flower International Growth, upgrading Labour supply, availability of suppliers, customer attraction, specialised service providers Marketing, learning, logistics Government, cluster/sectoral, external Nigeria Otigba computer hardware National, regional, international Growth, upgrading Labour supply, availability of suppliers, customer attraction, specialised service providers Marketing, learning, logistics Cluster/sectoral Nnewi auto parts National, regional Growth, upgrading Labour supply, availability of suppliers, customer attraction, specialised service providers Logistics Cluster/sectoral, external Mauritius Textile and Clothing International Growth, upgrading Labour supply, availability of suppliers, customer attraction, specialised service providers Marketing, learning, logistics Government, cluster/sectoral, external South Africa Cape clothing and textile National Growth, upgrading Labour supply, availability of suppliers, customer attraction, specialised service providers Logistics, learning Government, cluster/sectoral, external KZN clothing and textile National Growth, upgrading Labour supply, availability of suppliers, customer attraction, specialised service providers Logistics, learning Government, cluster/sectoral, external Durban automotive National, international Growth, upgrading Labour supply, availability of suppliers, customer attraction, specialised service providers Marketing, learning, logistics Government, cluster/sectoral, external South African wine Local, national, international Growth, upgrading Labour supply, availability of suppliers, customer attraction Marketing, learning Government, external Tanzania Mwenge handcrafts Local, national, regional Growth Customer attraction, specialised service providers Learning, marketing Government, cluster/sectoral Gerezani metalworks Local, national None Customer attraction, specialised service providers Learning, marketing Government, cluster/sectoral Keko furniture Local, regional Growth Labour supply, availability of suppliers, customer attraction, specialised service providers Learning, marketing Cluster/sectoral Uganda Fish processing Local, national, international Growth, upgrading Availability of suppliers, customer attraction, specialised service providers Logistics, learning Government, cluster/sectoral, external Source: the sources for these individual studies are cited in Kaplinsky and Morris, 2014. 52 R. Kaplinsky and M. Morris / Journal of African Trade 6(1-2) 47–59 the prospects for their participation in external trade, we review the experience with innovation of 25 African clusters.5 These span nine economies, namely, Egypt, Ethiopia, Ghana, Kenya, Nigeria, Mauritius, South Africa, Tanzania and Uganda (Table 2). They include clusters in the south, east, west and north of the continent, and in both the manufacturing and agricultural sectors. These African cluster experiences are considered in the light of the major determinants of cluster dynamics in other regions of the global economy reviewed earlier. In reviewing the experience of the cluster dynamics, the first consideration is to map the nature of external economies which arise from colocation. These are the spillovers between colocated enterprises which are unplanned, in particular with regard to labour and skills, the proximity of suppliers and customers and the extent of specialisation between firms. The second aspect considered is the nature of the market for the cluster’s output and the relationship, if any, between the locale of the market and the cluster’s upgrading capabilities. Third, beyond unintended external economies lies the possibility of joint action between enterprises, distinguishing in our analysis logistics, marketing and training. Finally, the institutionalisation of assistance to each of the clusters reflects the nature and effectiveness of policy support. This support may be provided by government, by formal associations developed by the private sector and by parties external to the economy, such as lead firms or aid agencies. We assess the significance of innovation in these cluster dynamics by classifying them in terms of their growth performance (sales/employment) and our reading of the case studies with regard to their capacity to innovate and to upgrade their processes, products and business organisation. 3.1. The Nature of Unintended Externalities Each of these clusters, by definition, involves the colocation of SMEs in a similar sector of activity. As we observed earlier, clusters arise as a consequence of spillovers between enterprises. All of the 25 African clusters benefit from at least one of four categories of external economies: (1) labour skills spillovers, (2) proximity of suppliers, (3) proximity of customers, (4) the development of interfirm specialisation and the division of labour. Table 3 summarises the prevalence of individual external economies in these 25 clusters. It shows that 12 of the clusters benefit from all four types of spillover, eight benefit from three types and five benefit from two types of externalities. In none of the clusters did firms benefit from only one type of external economy. 3.2. The Location of Final Markets and Links to Cluster Upgrading As observed earlier, Adam Smith identified the critical importance of the size of the market as a facilitator of productivity growth. However, it is not just the scale of the market which influences productive dynamics—the character of demand also plays an important role. Wider markets beyond the locale of the producer may be more competitive and may embody demand characteristics which force the producers to innovate in order to survive. Indeed, one of the key contributions of the GVC analytical framework has been to evidence how the supply-push productive systems which developed in conditions of scarcity after World War 2 have increasingly had to shift to demand-pulled trajectories (Gereffi, 1999; Kaplinsky and Morris, 2001). Innovation studies also evidence the role which users may play in product and process upgrading (von Hippel, 2005). There is a clear pattern in the relationship between the location of the final market and the dynamism of the clusters (Table 4). Each of the three clusters selling primarily into global markets, the six clusters selling into national markets and the 10 clusters selling into domestic and regional markets, shows signs of both sustained growth and innovation. By contrast, the seven clusters selling into the immediate vicinity show the least signs of growth and innovation—they are predominantly survivalist clusters. It is not possible to determine the direction of causality in these numbers, that is, whether only dynamic clusters are able to sell outside local markets, or whether the act of selling outside local markets leads to enhanced growth and upgrading. Table 3 | The nature of external economies in clustered enterprises Evidence of external economies Number of clusters Availability of labour supply 18 Availability of suppliers 23 Customer attraction 22 Interfirm specialisation 19 Two external economies 5 Three external economies 8 All four external economies 12 Table 4 | Market orientation and upgrading and growth trajectories Market orientation Evidence of dynamism Number of clusters Growth Upgrading Growth and upgrading Local only 1 2 0 7 Domestic (local and national) 2 2 2 6 Domestic and international 5 5 5 5 R. Kaplinsky and M. Morris / Journal of African Trade 6(1-2) 47–59 53 3.3. Joint Action and Upgrading International experience shows that clusters achieve collective efficiency when members build on these accidental external economies and take deliberate joint action to strengthen cluster performance. Table 5 considers three types of joint action—skill development, marketing and logistics—and the extent to which this is associated with cluster dynamism. Three-quarters of the 16 clusters cooperating in skill development have experienced sustained growth or upgrading, or both. A smaller number of clusters cooperated in either marketing (10 of 25 clusters) or logistics (11 of 25 clusters). Logistics cooperation is particularly closely associated with growth and upgrading, whereas joint marketing does not appear to be as important. The more clusters engaged in different types of joint action simultaneously, the more likely this was associated with cluster dynamism. Once again, causality cannot be imputed from these aggregate data alone. 3.4. External Support and Upgrading There are a variety of forms of institutionalisation of joint action activities. One source of support is through government, either national or local government, or both. Another form of institution is that created by the members of the cluster itself, or by sectoral associations. These institutions are both private sector driven. The third form of support is provided by parties external to the economy, such as through aid or Non-governmental Organisations (NGOs). Table 6 shows the distribution of these institutional support programmes in the 25 clusters. The largest number of clusters received multiple types of support—from government, through the firm’s own contributions and from external sources. Four of the clusters support institutions were entirely the result of private sector cluster and sectoral initiatives, and an additional three involved collaborations between governments and the private sector. 4. FURTHERING AFRICAN SME EXPORTS IN GLOBAL MARKETS To briefly recap the discussion so far on the basis of global experience, the preceding discussion has reviewed six major developments relevant to SME participation in global trade. First, without the capacity to upgrade, and in the context of a highly competitive and liberalising global economy, sustainable growth cannot be achieved. Second, drawing on the work of Adam Smith, GVC analysis and innovation studies, the capacity to upgrade and the direction of upgrading are a function of market size and market characteristics. External trade is an important conduit for increasing market size, particularly for economies with small markets. Third, the greater share of global trade occurs within GVCs, and a large proportion of this is governed, subject to exacting market preferences, and consequently involving standard-intensive value chains. Fourth, and perhaps surprisingly, in many parts of the world SMEs manage to participate in export markets, but this invariably involves colocation in industrial clusters and various forms of collective action. Fifth, regional markets play an important role in enabling developing-country firms, especially SMEs, to learn about exporting, in many cases through less standard-intensive RVCs as a transition to GVCs. Sixth, despite the overwhelming preponderance of informality in African clusters, there is evidence of growing SME participation in wider markets and related enterprise and cluster dynamism. Unfortunately, there are no measures of the extent and share of SMEs in Africa’s trade. However, given the need to enhance the inclusivity of growth paths in Africa, and given the latent and exploited competitive advantages which SMEs possess, there is clearly an important policy Table 6 | Institutional support for joint action Evidence of institutional support Number of clusters Only government 1 Only cluster/sectoral 4 Only external 2 Government and cluster/sectoral 3 Government and external 1 Cluster/sectoral and external 2 Government, cluster/sectoral, external 9 Table 5 | Cluster dynamism and joint action Evidence of collective activity Evidence of dynamism Number of clusters Growth Upgrading Growth and upgrading Learning 12 11 10 16 Marketing 8 6 6 10 Logistics 10 10 10 11 One collective activity 0 3 2 5 Two collective activities 7 5 5 9 All three collective activities 5 5 5 5 54 R. Kaplinsky and M. Morris / Journal of African Trade 6(1-2) 47–59 requirement to enhance their participation in both regional and national markets. We can group these policy challenges in four major areas, the first three of which predominantly involve formal sector SMEs: (i) participation in governed GVCs feeding into high-income markets, (ii) export sales to non-regional low-income markets, (iii) export sales to regional markets and (iv) informal sector cross-border trade to regional economies. The analysis and policy prescriptions which follow address SME participation in global trade as exporters. There is an analogous discussion to be pursued with regard to imports by SMEs which can be both productivity enhancing (cheaper and better inputs) and consumer welfare enhancing (cheaper and better consumption goods), but these are outside the scope of this paper. 4.1. SMEs Exports to High-income Markets6 Exports to high-income markets involve a number of characteristics, each of which poses particular challenges for SME exporters. First, despite the existence of niche markets, the scale of demand is invariably beyond the reach of individual SME exporters. This is particularly the case in the non-durable good markets served by relatively low-tech African SMEs. Second, these markets are often finely segmented, with distinctive consumer preferences. Market intelligence, often quite sophisticated and costly to generate, is required to understand and serve these demanding consumers Third, many of these markets are dominated by retail chains, large intermediaries such as category buyers purchasing for retail chains, large first-tier TNC or emerging economy firms with subsidiaries in low-income countries supplying retailers (termed triangular manufacturing by Gereffi, 1999) and global brands. These buyers not only purchase in large volumes, but also require conformance to exacting process and product standards along their chain.7 In addition, governments in high-income markets impose a variety of regulations which limit market entry if producers are unable to conform to specified standards. The GVCs in which exporters are incorporated are thus heavily governed by lead firms. They also invariably involve certification costs which are beyond the reach of individual SMEs. For example, for enterprises employing up to 400 workers (considered as SMEs by many certification service providers but which are large firms in much of Africa), the quality certification costs to meet International Organisation for Standardisation (ISO) standards are fairly onerous. The industry certification rate is $850/day and the time (days) required for certification range from 2 days for an enterprise with 6–10 personnel up to 10 days for 276–425 personnel. Certifying environmental management standards likewise ranges from 3.5 days to 15 days, respectively (Kaplinsky and Morris, 2018). The costs of meeting these requirements for entry into final high-income product markets generally creates insuperable barriers to SME exporters and there is abundant evidence that they lead to the exclusion of SME suppliers, many of whom lack the education and skills required to consistently document and meet process and product standards required by global buyers (Kaplinsky and Morris, 2018). In the face of these obstacles, and in the context of the flexibility of SMEs and the external economies arising from participation in industrial clusters, various sets of policy support may enable them to overcome these barriers to exports to high-income markets. Support may be provided directly by government (national and local), by civil society institutions (local and international), by collective action by cluster firms and of course through a combination of these three forms of support. Beyond the capacity to meet the requirements of these markets is the related challenge of market entry. Unlike the decades before trade liberalisation, market entry is increasingly governed by private and civil society actors rather than by tariffs and quotas. One possible entry point into these final markets is through participation in governed GVCs which solves many of these problems. It promotes entry into final markets, it reduces the needs for market intelligence and it provides support for skills development and certification. In some cases, meeting these standards has been an important conduit for upgrading by SMEs, including in Africa’s fruit, horticulture and flower sectors and in the apparel and footwear sector (Kaplinsky and Morris, 2018). However, for the reasons outlined earlier, involvement in these GVCs is not easy for SMEs to achieve, particularly not as standalone producers. Hence, the role of enterprise and cluster support should thus be to simultaneously lean on lead firms in GVCs to draw on SME suppliers, to assist SMEs to develop the skills and capabilities required by these lead firms and to assist SMEs to combine their efforts to produce to the scale and standards required by lead firms. Realistically, possible roles for SMEs in these chains is probably limited to second- and third-tier suppliers to the large TNC firms, where volumes are limited, technological and skill barriers are lower and certification is less prevalent. Another possible entry point into high-income markets is to target niche markets, such as arts, crafts and jewellery. Many of these niches involve small volumes, and market entry is intermediated by NGOs. It is commonly thought that these are high-margin markets, but this is not always the case. For example, a small handicraft enterprise in South Africa targeted high-income niche markets using Fair Trade certification. However, it found that the transaction costs involved in meeting these standards cut too deeply into its profit margins to make it sustainable (Kaplinsky and Morris, 2018). It is also possible for SMEs to sell directly into high-income markets without the involvement of foreign intermediaries, either through their direct action or by drawing on domestic buyers who onsell to external markets. But in these cases, there are a number of scale barriers which will need to be surmounted. In the case of Italian industrial clusters, minimum scale requirements were met by individual SMEs cooperating to sell under a common brand name. Another barrier is market intelligence which can often be a costly exercise; even occasional visits to 6Not all high-income markets are in high-income economies, and conversely, not all low-income markets are in emerging economies. Although it is the character of the market rather than the location of the market which determines the organisation of the value chains and the role played by SMEs, for ease of treatment we assume an identity between market location and market character. 7For example, among other requirements the Forestry Stewardship Council (FSC) standard precludes logging with 3 days of rain, requires that certain chemicals are not used in processing and that the rights of indigenous people are respected. Final certification requires a chain of custody evidencing conformance to standards along all links in the chain.