Economic Research Forum (ERF)

Global value chains and domestic innovation: evidence from MENA firms

1762
Global interlinkages play a significant role in enhancing innovation by firms in developing countries. In particular, as this column explains, participation in global value chains fosters a variety of innovation activities. Since some countries in the Middle East and North Africa display a downward trend on measures of global innovation, facilitating the GVC participation of firms in the region is a prospective channel for stimulating underperforming innovation.

In a nutshell

Global interlinkages play a significant role in enhancing firms’ innovation performance in developing countries; participation in global value chains is a vital channel for catching up to the fast-shifting world technological frontier.

GVC participation provides incentives for firms’ technological and auxiliary services innovation in the MENA region; medium R&D intensive sectors strengthens the positive effect of GVC participation on auxiliary services innovation.

Investing in physical and human capital is key to enhancing firms’ absorptive capacities and stimulating innovation output; fiscal policy can also play a vital role in easing the financial constraints that are obstructing firms from innovation.

Despite the rapid technological advances of the fourth industrial revolution, firms in emerging regions continue to lag behind the technological frontier (UNCTAD, 2021). But although innovation remains spatially clustered in advanced economies, foreign interlinkages provide the opportunity for the dissemination of knowledge between firms participating in global value chains (GVCs). Foreign knowledge sourcing is a key input into domestic innovation, and participation in GVCs directly stimulates that (Coe and Helpman, 1995).

Achieving greater impact of GVC participation on firms’ innovation performance will help to deliver on the ninth United Nations sustainable development goal, which aims to foster innovation and infrastructure. Equally important, revealing the moderating role of sectoral heterogeneity is necessary for GVC-driven progress on innovation in Middle East and North Africa (MENA) countries that are abundant in unskilled labour.

Because of several disadvantages, GVC participation is mitigated in many developing regions. In MENA, more than four-fifths of firms do not participate in GVCs. In addition, most economic activities are highly intensive in unskilled labour and low-intensive in research and development (R&D).

Yet, compared with skilled labour and medium-high R&D intensity, the innovation shares of firms engaging in unskilled labour and low R&D intensive activities indicate that the comparative advantage of the MENA region does not justify its poor innovation performance.

Research on innovation and global value chains

In recent research, we show that GVC participation by MENA firms positively affects different innovation measures (Eissa and Zaki, 2023). We distinguish between two kinds of innovation: technological innovation, which encompasses new products and services, and new production processes; and auxiliary services innovation, which relates to less substantive innovation such having a website and communicating by email.

Figure 1 presents the shares of firms’ innovation against GVC participation in the MENA region. On average, along the two innovation measures, GVC-participating firms perform significantly higher than their non-GVC-participating counterparts.

Figure 1: Technological and auxiliary services innovation against GVC participation

Source: Authors’ construction based on the comprehensive WBES dataset.

Notes: GVC 1 entails that firms are engaged in exporting and importing activities. GVC 4 entails that firms are engaged in exporting and importing activities, have foreign-owned shares, and have international quality certification.

Studying the impact of GVC participation on firms’ technological and auxiliary services innovation emphasises a learning opportunity for firms in the region. In addition, since sectoral heterogeneity potentially catalyses the positive impact of GVC participation on firms’ innovation, we integrate sectoral analysis and distinguish between two factor intensities: skill level and R&D. While skilled labour directly motivates technological innovation, unskilled labour does not mitigate the GVC-positive effect.

By underlining the importance of firms’ GVC participation in realising innovation progress, we highlight that sectoral heterogeneity does not regulate the GVC impact on technological innovation in MENA countries. Put differently, sectoral heterogeneity remains neutral in catalysing the GVC-positive effect on technological innovation.

Yet, medium R&D intensive activities strengthen the GVC-positive effect on auxiliary services innovation. Given the slow progress of innovation in the region, encouraging GVC participation is a vital channel for catching up to the fast-shifting global technological frontier.

Implications for policy

From a policy standpoint, recommendations for realising greater GVC-driven innovation in the MENA region are twofold. First, ample GVC participation in the MENA region necessitates minimising underlying mitigators. Aside from controlling trade costs, a revitalised investment climate is necessary to encourage greater integration into GVCs.

Second, investing in physical and human capital is key to enhancing firms’ absorptive capacities and stimulating innovation output. Undoubtedly, R&D spending requires sufficient access to finance, which is limited in developing regions due to undeveloped financial markets.

Hence, fiscal policy can play a vital role in easing the financial constraints that are obstructing firms from innovation. For example, implementing tax incentive programmes for innovative firms can counterbalance the burden of innovation costs.

In addition, directing government spending to knowledge-intensive services and providing direct financial support to research activities can enhance domestic capabilities and facilitate the process of absorbing new technologies.

Finally, at the institutional level, providing more extensive protection of intellectual property is indispensable to initiate the virtuous circle of innovation.

Further reading

Coe, DT, and E Helpman (1995) ‘International R&D Spillovers’, European Economic Review 39(5): 859-87.

Eissa, Y, and C Zaki (2023) ‘GVC and Innovation: Evidence from MENA Firm-level Data’, ERF Working Paper No. 1672.

UNCTAD (2021) ‘Technology and Innovation Report: Catching Technological Waves, Innovation with Equity’, United Nations.

Most read

Adoption of decentralised solar energy: lessons from Palestinian households

The experience of Palestinian households offers a compelling case study of behavioural adaptation to energy poverty via solar water heater adoption. This column highlights the key barriers to solar energy adoption in terms of both the socio-economic status and dwellings of potential users. Policy-makers need to address these barriers to ensure a just and equitable transition, particularly for households in conflict-affected areas across the MENA region.

Migration, human capital and labour markets in MENA

Migration is a longstanding and integral part of the MENA region’s economic and social fabric, with profound implications for labour markets and human capital development. To harness the potential of migration for promoting economic and social development, policy-makers must aim to deliver mutual benefits for origin countries, host countries and migrants. Such a triple-win strategy requires better data, investment in return migration, skill partnerships, reduced remittance costs and sustained support for host countries.

Shifting gears: how the private sector can be an engine of growth in MENA

Businesses are a key source of productivity growth, innovation and jobs. But in the Middle East and North Africa, the private sector is not dynamic and the region has a long history of low growth. This column summarises a new report explaining how a brighter future for MENA’s private sector is within reach if governments rethink their role and firms harness talent effectively.

Building net-zero futures: Asian lessons for MENA’s construction sector

Three big economies in Asia are achieving carbon neutrality in construction. This column draws lessons from Japan, Taiwan and Thailand – and explains why, given the vast solar potential and growing focus on environmental, social and governance matters in the Middle East and North Africa, governments in the region must adopt similarly ambitious policies and partnerships.

Losing the key to joy: how oil rents undermine patience and economic growth

How does reliance on oil revenues shape economic behaviour worldwide? This column reports new research showing that oil rents weaken governance, eroding patience – a key driver of economic growth and, according to the 13th century Persian poet Rumi, ‘the key to joy’. Policy measures to counter the damage include enhancing transparency in oil revenue management, strengthening independent oversight institutions and ensuring that sovereign wealth funds have robust rules of governance.

Artificial intelligence and the future of employment in MENA

Artificial intelligence offers opportunities for boosting productivity and innovation. But it also poses substantial threats to traditional employment structures, particularly in economies like those in the Middle East and North Africa that are reliant on low-skill or routine labour. This column explores how AI is likely to affect employment across the region and proposes policy directions for governments to harness AI for inclusive and sustainable economic growth.

Freedom, agency and material conditions: human development in MENA

Conventional approaches to measuring human development, which are primarily centred on income, health and education, provide an incomplete assessment of people’s opportunities to improve their lives. As this column explains, it is essential to understand how institutional and social environments influence individuals’ agency over their development outcomes. Analysis of the diverse recent experiences of Jordan, Lebanon, Morocco and Tunisia illustrates how such an approach can inform policy-making.

Fiscal limits and debt sustainability in MENA economies

Public debt is piling up across the Middle East and North Africa after years of political upheavals, economic shocks and the Covid-19 pandemic. With fiscal space shrinking, governments are under pressure to act. This column explains why for many countries in the region, the room for manoeuvre on the public finances may be smaller than policy-makers think. Urgent action is needed to restore debt sustainability.

Market integration in the Middle East and the Balkans, 1560-1914

Trade has re-emerged as a central issue in global policy debates, as governments debate not only the costs and benefits of trade, but also the underlying determinants of market integration. To inform the discussion, this column reports new research evidence on the experiences of the former Ottoman territories in the Middle East and the Balkans over nearly four centuries, tracing the evolution, drivers and consequences of trade integration across these regions.

From rentier states to innovation economies: is a MENA transition possible?

The combination of climate change, energy price volatility, high unemployment among educated youth, and global technological competition is exposing the vulnerabilities of MENA’s traditional economic structures and the need for structural transformation. This column examines whether such a transition is feasible and the policies that could promote such a shift.