Another benefit of participating in GVCs is that their robustness and resilience limits damage to the production system that may be caused by various factors. Crises caused by natural disasters, such as the Great East Japan Earthquake and the floods in Thailand in 2011, and the COVID-19 pandemic in 2020–2021, disrupted GVCs and suspended the production of parts and final products, causing economic damage to many companies and countries. In such situations, GVCs' vulnerability and the way in which these negative effects propagate were considered problematic. However, experience shows that most GVCs were not greatly damaged and in fact are quite robust. Furthermore, when GVCs were seriously damaged, they recovered rapidly and rebuilt, and their resilience was recognized. To contend with the risk of GVC fragmentation, rather than retreating to integrated production, system diversification is considered to be an effective countermeasure. As deepening and expanding GVCs are seen as important for promoting future economic growth in East Asia and Japan, this issue will be discussed later.

8 On the benefits of GVC participation, see, for example, World Bank (2020) and Urata and Baek (2021).

Fig. 11.5 GVC participation in selected East Asian countries. Source UNCTAD, GVC Database

#### 11.2.4 Factors Leading to the Formation of GVCs

The factors that led to the formation of many GVCs by MNCs in East Asia may be classified into two groups. The first group consists of supply-side factors from the perspective of MNCs, and the other contains demand-side factors from the standpoint of the East Asian countries that hosted them. As noted above, a major realignment in foreign exchange rates encouraged MNCs to relocate production from their home countries (e.g., Japan and South Korea) to developing countries in East Asia, to achieve low-cost production. Accumulated international business experience in exporting and importing businesses contributed to MNCs' ability to create and manage GVCs. In addition, major reductions in the cost of communication and transportation services, attributable to technological innovations such as the development and the propagation of the Internet in the telecommunications arena and the development of large ships for transportation, as well as deregulation in both of those sectors, played an important role.

Turning to demand-side factors, we consider two types: those pertaining to local firms participating in GVCs and those originating in GVCs' host countries. Starting with the factors related to local firms, the number of local firms with technical and managerial capabilities in East Asia has been increasing. In their study of GVC participation by firms in Asia, Urata and Baek (2020) find that competitive local firms can successfully participate in GVCs. However, many firms are not able to handle the processes or complete the tasks within the GVC network needed to produce the products to be exported to foreign countries. Competitiveness among local firms reflects various factors such as the high labor productivity, uniqueness or high quality of their product or task, low-cost production capabilities, and others. To possess competitiveness, firms need educated, trained, and high-skilled workers; capable and ambitious managers; high-quality technology; and imported inputs. Having links to MNCs, access to technology, capital, and information about foreign markets helps firms to improve their competitiveness. Local firms' competitiveness is reflected by international certifications such as ISO. As such, possessing international certifications facilitates firms' participation in GVCs.

Regarding the factors concerning the GVCs' host countries, Urata (2021) found that compared to other developing countries, many East Asian

Fig. 11.6 Changes in tariff rates (%). Source World Bank, World Development Indicators online

countries have established a business environment that is open to trade and FDI inflows, with an abundance of educated and disciplined workers, financial resources, technology and information with respect to foreign markets, and a welldeveloped infrastructure. Figure 11.6 shows tariff rates on manufacturers have declined for selected East Asian countries, reflecting the trade liberalization policies they have adopted. Infrastructure, which plays an important role in promoting economic activity, is a rather broad concept that may be divided into soft and hard infrastructures. Soft infrastructure includes educational, regulatory, and legal systems, while hard infrastructure includes transportation and communication systems. Having an efficient public sector refers to government and business associations that facilitate firms' participation in GVCs.

These findings reinforce the importance of government policies in promoting GVC participation. Governments can help local firms participate in GVCs in various ways, including technical and financial support that helps firms upgrade their technology and marketing support that disseminates information on foreign markets to the firms. Governments are also advised to establish a business-friendly environment, characterized as open, fair, transparent, and rulesbased with respect to trade and FDI. One effective way for governments to achieve this objective is to join FTAs, which we discuss in the next section. Governments can also play an important role in building soft and hard infrastructure that can contribute not only to attracting MNCs to involve local firms in their GVCs, but also to provide the building blocks that are fundamental to achieving economic growth. To the extent possible, governments should leverage economic assistance provided by foreign donor countries, international organizations, and other sources to supplement their own efforts.

#### 11.3 Regional Economic Integration in East Asia9

East Asia witnessed a rapid expansion of intraregional trade during the late 1980s and 1990s, resulting in de facto regional economic integration.

9 This section updates and modifies Urata (2019, 2022). See also Urata (2014) on regional integration in East Asia.

Fig. 11.7 Regional trade agreements (RTAs) in the world.12 Source World Trade Organization, RTA database

As discussed in the previous section, the formation of regional production networks or GVCs byMNCs drove this integration. The development of GVCs contributed to economic growth, which in turn further liberalized trade and FDI policies, resulting in greater and deeper regional economic integration. Because of the increased importance of market forces in forming regional economic integration, which results from allowing more open trade and FDI policies, such integration is characterized as market-driven regional economic integration.10

In the latter half of the 1980s, the movement toward institutionalized regional economic integration (institution-driven regional economic integration) gained momentum in various regions of the world (Fig. 11.7). In Europe, the movement that started in the 1950s accelerated: The European Single Market was established in 1992, the EU in 1993, the European Central Bank in

10 See Urata (2004) for discussions on market-driven and institution-driven regional economic integration in East Asia.

1998, and the single currency, the euro, was introduced in 1999. In North America, the US-Canada Free Trade Agreement came into effect in 1989, followed by the North American Free Trade Agreement between the US, Canada, and Mexico in 1994. One important reason for this institution-driven economic integration was the slow progress in trade liberalization negotiations that were part of the General Agreement on Tariffs and Trade (GATT) under the so-called Uruguay Round, which began in 1986.11 Faced with stalled negotiations for GATT, countries interested in trade liberalization to promote economic growth opted to sign FTA with likeminded countries, which promoted regional economic integration.

**600**

**700**

11 The Uruguay Round began in 1986 with the goal of completing negotiations in four years. However, the negotiations involved many difficult issues and agreement was not reached until 1994.

12 Regional trade agreements (RTAs) include FTAs and customs unions.

Compared to other regions of the world, East Asia has been slow to develop institution-driven regional economic integration.13 The first major regional economic integration in East Asia was the ASEAN Free Trade Area (AFTA), created by the ASEAN member countries (Brunei, Indonesia, Malaysia, the Philippines, Singapore, and Thailand) in 1993. Two external factors prompted AFTA's formation: the development of regional economic integration in other parts of the world and the rise of China. These forces had reduced ASEAN's importance as an investment destination and were negatively impacting its economic development. The ASEAN countries sought to improve the region's attractiveness as an investment destination by integrating their markets through AFTA, which was completed by 2015. ASEAN then created the ASEAN Economic Community to deepen economic integration in the region.14

In the latter half of the 1990s, support for regional economic integration on an institutional level that would encompass the countries of the East Asia region emerged. This movement developed along two tracks: one by the East Asian countries and the other by the Asia–Pacific countries. In the remaining sections, we present an overview of the developments along each track and examine the possible impacts of regional economic integration on an institutional level on economic growth in East Asian countries.

#### 11.3.1 East Asia Track

In the early 1990s, then Malaysian Prime Minister Mahathir proposed the formation of a regional economic integration that would encompass the countries of East Asia. The idea was inspired by movements toward regional economic integration in Europe and North America, but it was not until the beginning of the twenty-first century that the effort began in earnest. Here, we review the development of bilateral or plurilateral FTAs in East Asia and then analyze the trends in regional FTAs in the region.

At the start of the twenty-first century, a number of bilateral FTAs were established by East Asian countries, starting with the Japan-Singapore FTA that came into effect in 2002. Singapore, Japan, and South Korea began to actively engage in FTAs but China showed no interest in participating. After China joined the World Trade Organization (WTO) in 2001 and secured access to the world market, it began to use FTAs to advance its regional presence in Asia. China's FTA policy was different from those of other countries. First, while Japan and South Korea began their FTA participation through bilateral FTAs, China chose all ASEAN countries as its first FTA partners. Second, the China-ASEAN FTA included content that was not included in other FTAs. For example, China offered preferential treatment, including economic cooperation, to the new member countries of ASEAN, namely Cambodia, Lao PDR, Myanmar, and Vietnam, which were lagging in their economic development compared to the original AFTA members. China's FTA strategy included both economic objectives, such as expanded trade, and political objectives such as building friendly relations with neighboring countries. The China-ASEAN FTA came into effect in 2005, generating a domino effect; by 2010, Japan, South Korea, Australia, New Zealand, and India had individually ratified FTAs with ASEAN (the so-called ASEAN+1 FTA).

The movement toward forming regional economic integration within the East Asian region was triggered by the Asian currency crisis that occurred in 1997 and 1998. East Asian countries that suffered serious economic consequences from the currency crisis recognized the need for regional economic cooperation to recover and to avoid a recurrence and considered an East Asia FTA (EAFTA) with ASEAN, China, Japan, and South Korea (ASEAN+3) as one form of regional economic cooperation. The idea of regional

12 Regional trade agreements (RTAs) include FTAs and customs unions.

13 See Urata (2014, 2016) on regional economic integration in East Asia.

14 See ERIA (2014) for a detailed analysis of ASEAN's economic integration.

economic integration in East Asia was accelerated by the growth of regional economic integration in the rest of the world. The plans for EAFTA began in 2005, with China taking the lead. In 2006, Japan proposed the Comprehensive Economic Partnership in East Asia (CEPEA), which would consist of ASEAN+6, namely ASEAN+3 countries, Australia, New Zealand, and India. It was clear that the backdrop to EAFTA and CEPEA was the rivalry between Japan and China for regional economic integration in East Asia.

The feasibility studies for EAFTA and CEPEA were conducted in parallel until 2011, when Japan and China proposed establishing a joint working group to accelerate the discussions. Underlying the proposal to establish the joint working group made by Japan and China, which had been battling for leadership in establishing a regional FTA, was China's desire to create an East Asian regional FTA that excluded the US without being bogged down in debates about EAFTA versus CEPEA while the Trans-Pacific Partnership (TPP) negotiations, as discussed in the next section, progressed. The joint proposal from China and Japan created a sense of crisis for the ASEAN countries, which had a strong interest in playing a central role in regional integration in East Asia. ASEAN proposed the Regional Comprehensive Economic Partnership (RCEP) in 2011 to counter the move by Japan and China. RCEP is an ASEAN-centered framework, in which any country that has concluded an FTA with ASEAN can participate, rather than a framework that fixes the member countries as in EAFTA and CEPEA.

Although ASEAN+6 declared the start of RCEP negotiations in November 2012, the actual negotiations did not begin until May 2013. RCEP members realized the need to start their negotiations after Japan formally announced it would join the TPP negotiations in March 2013. The RCEP negotiations were contentious, and the target date for agreement was repeatedly pushed back. India withdrew from the final stage, and the agreement was reached in November 2020. Several reasons for India's withdrawal have been offered. One is that India feared that trade liberalization through RCEP would not only increase its trade deficit with China, but it would also be a major blow to India's manufacturing sector, given the country's large trade deficit due to its large volume of Chinese manufactured product imports. Another is the concern about a negative impact on India's agriculture sector, as low-priced agricultural products from Australia and New Zealand would increase substantially. RCEP is scheduled to enter into force on January 1, 2022, now that the requirements for enactment have been fulfilled. RCEP faces several challenges, including monitoring to ensure that the members comply with the agreement and their commitments. Another is to improve the quality of the agreement, as discussed in Sect. 11.3.3.

#### 11.3.2 Asia–Pacific Track

Discussions on the formation of a framework for economic integration that would encompass the Asia–Pacific region began in the 1990s with some countries participating in the Asia–Pacific Economic Cooperation forum (APEC). Established in 1989 by the economies15 located in the Asia–Pacific region, its main objective is to achieve economic growth by promoting regional economic integration through trade and investment liberalization. Due to differences in the approaches and priorities of the various economies involved, movement toward liberalization of trade and investment did not progress as hoped. Therefore, Chile, Singapore, New Zealand, and Brunei, all of whom were interested in a high degree of trade and investment liberalization, established the Trans-Pacific Strategic Economic Partnership Agreement (P4) in 2006. The purpose of P4 is to create a free and open business environment and to help realize APEC's goal of achieving a free and open environment for trade and FDI. The founding members hoped

15 The word "economies" is used to describe APEC members because the APEC cooperative process is predominantly concerned with trade and economic issues, with members engaging with one another as economic entities.

that by accepting new members, P4 would become the basis for a larger regional FTA.

In March 2008, the P4 members began negotiations to expand the scope of the agreement to include financial services. P4 was described as a living agreement because it was open to amendments based on the demands and wishes of businesses in its member countries even after it entered into force. The US, which had a strong interest in liberalizing cross-border activities in the financial services sector, decided to participate in the expanded P4 negotiations in September 2009. Following the announcement by the US, Australia, Peru, and Vietnam also announced their intention to participate in the negotiations. During this period, P4 was renamed as the TPP. It has been said that the US participated in TPP negotiations to avoid being excluded from East Asia, whose economies were projected to grow rapidly and were increasingly moving toward regional integration on an institutional level.

In the 2010s, the move toward regional economic integration on the institutional level gained momentum. Negotiations for an expanded TPP that included eight countries—Brunei, Chile, New Zealand, Singapore, Australia, Peru, the US, and Vietnam—began in March 2010. Four more countries joined after the start of negotiations: Malaysia (in October 2010), Canada and Mexico (in 2012), and Japan (in 2013). It is unusual for new countries to join after negotiations have begun, and this indicated the importance of the TPP. The negotiations took five years and seven months, culminating in an agreement in October 2015. The TPP agreement was signed by the negotiating parties in February 2016, and the 12 countries involved began the process of ratifying the agreement. However, the conditions for the agreement to enter into force were abrogated when US President Trump took office in 2017 and withdrew from the TPP. As a result, the agreement is no longer in effect.

Although the US withdrew from the TPP, the remaining TPP countries decided to establish TPP11 without the US. Negotiations were completed in a short period of time, and the agreement was signed in March 2018. TPP11 entered into force in December 2018 as the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP). To date (December 2021), the agreement has been ratified by all signatories except Malaysia, Brunei, and Chile. There are a number of possible reasons the TPP11 members promoted the agreement. First, as a continuation of the original TPP (see the next section), the CPTPP includes comprehensive sectoral rule-building and a high degree of trade and investment liberalization, and its members expect it to stimulate economic activity that will promote economic growth. Second, the CPTPP is a high-level, comprehensive FTA that will serve as a model for future FTAs. Third, the CPTPP is expected to curb and reverse the protectionism that has emerged since the 2007–2008 global financial crisis. Fourth, as there is a possibility that the US will seek to return to the TPP in the future, the CPTPP must be brought into force to prepare for such a situation. The CPTPP is attracting considerable attention, as evidenced by the UK's application for membership in February 2021, followed by applications from China and Taiwan in September 2021.

#### 11.3.3 CPTPP and RCEP

Both the CPTPP and RCEP contain comprehensive content aimed at promoting regional integration and achieving economic growth through increased trade and investment, with a particular emphasis on expanding GVCs. An important benefit of both agreements is that common rules will be applied to trade and investment for many of the participating countries, thereby avoiding the "spaghetti bowl" effect of restraining trade that results from a mix of FTAs between two countries that have different rules, or have a small number of participating countries. This emphasizes that RCEP is much more than just a combination of four ASEAN+1 FTAs and ASEAN's FTAs with China, Japan, South Korea, and Australia-New Zealand, in one framework.

While the CPTPP and RCEP share a common goal of economic growth, there are important differences: The RCEP focuses on economic development, not just economic growth; the CPTPP emphasizes the importance of active private sector involvement in achieving economic growth, while the RCEP emphasizes the importance of economic cooperation in achieving equitable and inclusive economic development. The RCEP includes countries in the early stages of development, such as Cambodia, Lao PDR, and Myanmar, and emphasizes economic cooperation because economic development in these countries is important for the region's sustainable development and social stability. Specifically, the RCEP allows for preferential treatment of countries in the early stages of development, while the CPTPP treats all members equally and does not allow for special treatment.

Both the CPTPP and RCEP are more comprehensive than the WTO (Table 11.1); however, they differ in the items they cover. The agreements cover many common issues, such as market access for trade in goods and services, trade facilitation, and intellectual property rights, but they differ on important issues. Important items addressed in the CPTPP but not the RCEP are state-owned enterprises and designated monopolies, labor, environment, regulatory coherence, transparency, and anti-corruption. While these aspects of the CPTPP are important to developed countries such as Japan and Australia in order to maintain a level playing field across firms and achieve sustainable economic growth, developing countries find them difficult to accept. For example, the regulations do not allow preferential policies for state-owned enterprises, which is difficult for developing countries where government involvement in the economy is significant. Importantly, the CPTPP includes rules that protect and promote workers' rights: requiring freedom of association and collective bargaining, forbidding child labor, forced or compulsory labor, and discrimination in employment and occupations, helping to achieve some of the goals of SDG 8, namely to promote productive employment and decent work.

Some items are common to both agreements but differ in content and degree of discipline. One clear example of this is in the liberalization of trade in goods (market access), where the CPTPP eliminates almost all tariffs on all products (100% tariff elimination rate), with a few exceptions. In the RCEP, tariff elimination varies among countries and the average rate is roughly 90%, lower than in the CPTPP. There is also a major difference in the area of e-commerce, which is attracting attention as it regulates the international movement of data that is becoming increasingly important in the global economy. The CPTPP includes the following three principles of the TPP: (1) ensuring freedom of crossborder transfer of information by electronic means, (2) prohibiting requests to install and/or use computer-related equipment, and (3) prohibiting the transfer of and requests for access to source code, with the aim of ensuring the free movement of data. In contrast, items (1) and (2) are included in the RCEP, but (3) is excluded. In addition, the content of (1) and (2) is less rigid in the RCEP, not only because exceptions are allowed for national security and other reasons, but also because they are not subject to dispute settlement procedures.

Some believe that the CPTPP and RCEP are competitors because the US took the lead in negotiating the CPTPP's predecessor, the TPP, and showed a strong desire to exclude China, while the RCEP includes China but not the US. However, as there are considerable differences between the two agreements in content and the degree of discipline, they are considered to be complementary, rather than conflicting or competing. The two agreements can be viewed as presenting a phased opportunity for countries that cannot join the CPTPP due to its high level of discipline to first join the RCEP and then join the CPTPP when the higher level of discipline imposed by the CPTPP becomes acceptable. Beyond the RCEP and CPTPP, the Free Trade Area of the Asia–Pacific (FTAAP), which encompasses the Asia–Pacific region, was agreed upon at the APEC summit in Yokohama, Japan, in 2010 as the ultimate goal of regional integration in the Asia–Pacific region.

Note ● indicates the issue is covered, and ▲ is partially covered Sources CPTPP and RCEP texts

#### 11.3.4 Economic Impacts of Regional Economic Integration

Regional economic integration in the form of FTAs affects economic activity for both member and nonmember countries, mainly through its impacts on trade and investment. Here, we examine the economic impacts of FTAs, first from a theoretical perspective and then based on empirical analyses.

We can think of the effects of FTAs as static and dynamic.16 Beginning with static effects, FTAs promote trade among FTA members (the trade creation effect), as tariffs on bilateral trade decline, and tend to reduce trade between members and nonmembers (the trade diversion effect), as some of their bilateral trade activities are likely to be replaced by trade among FTA members. FTAs give rise to these trade creation and

Table 11.1 CPTPP, RCEP, and WTO

16 For more detailed explanation, see textbooks on international economics such as Appleyard and Field (2017).

diversion effects because they give preferential access to the FTA partners' markets. A nonmember's economic welfare will decline because of the reduction in exports, while it is not known a priori whether the member country's economy will gain or lose. The member country gains from an expansion of trade, but loses from the reduction in tariff revenue. If the gain exceeds the loss, a member gains overall, but loses otherwise.

Turning to dynamic effects, FTAs may promote economic growth because expanded trade is likely to increase productivity through economies of scale and greater competition. An FTA member could gain from increased investment that may occur because the member country's future economic prospects are expected to improve. An FTA member may also expect an increase in FDI because many FTAs, including the CPTPP and RCEP, liberalize FDI policies. Expanded FDI inflows would lead to economic growth for FDI recipient countries.

With this theoretical understanding of the economic impacts of FTAs, we turn to an empirical analysis. Researchers conduct an exante analysis of FTAs before they are enacted using a simulation based on economic models. The most popular model for analyzing FTAs is the computable general economic (CGE) model, which mimics a real economy based on market mechanisms by considering consumers, producers, and governments. A typical CGE model covers all sectors of an economy (typically represented by 15–30 sectors) and the world (generally represented by 20–50 countries and regions). An ex-post analysis is conducted after FTAs are enacted to examine their impact on trade. A typical approach is to apply the gravity model, which attempts to explain the magnitude of bilateral trade using the economic size of two countries and the geographical distance between them. The name comes from physics, specifically Newton's Law of Gravity, which states that the gravitational force between two bodies is directly proportional to the product of their masses and inversely proportional to the square of the distance between them. We first consider studies that examine the economic impacts of the CPTPP and RCEP using a CGE model and then review studies that examine the trade creation and diversion effects of AFTA using a gravity model.

Petri and Plummer (2020) simulate the economic impacts of the CPTPP and RCEP by projecting economic conditions in 2030 that reflect commitments required by those agreements, such as tariff reductions. The results of their analysis with respect to national income are shown in Table 11.2, with the figures for member countries shown in bold. Consistent with theoretical expectations, national income for members of the CPTPP and RCEP increases but declines for many nonmembers. The increases in national income are mainly due to the trade creation effect, while decline is primarily caused by the trade diversion effect. In the case of the CPTPP, Japan gains the most in absolute terms and China loses the most. With the RCEP, China gains the most while India (not shown in the table) loses the most. These opposite impacts for China clearly indicate that a country benefits from being a member of an FTA. Impacts on the US are very small.

The impacts are quite different when we consider the percentage change in national income, rather than the absolute change. With the CPTPP, Malaysia gains the most, and Japan and South Korea gain the most with the RCEP. One important factor that determines the gain for a given country is the tariff reduction that the country experiences for its exports, i.e., tariff reductions in its export destination countries. For example, the large gain that Japan obtains from membership in the RCEP is mainly due to a reduction of tariffs on its exports to China and South Korea, with whom free trade is established under the RCEP. For the same reason, ASEAN members see relatively small gains because they have already established free trade with other RCEP members such as China, Japan, and Korea under the ASEAN+1 FTA frameworks. It should be noted that the world as a whole gains from both the CPTPP and RCEP.

Turning to studies on the impacts of FTAs on trade using the gravity model estimation method, there are no comparable studies to those reviewed above that use the CGE model because the gravity model applies to ex-post data,

Note Figures of the CPTPP/RCEP members are shown in bold letters Source Petri and Plummer (2020)

whereas the CGE model is used in ex-ante studies. The CPTPP entered into force in December 2018, and the RCEP has yet to be enacted; therefore, there is not yet sufficient data for a gravity model analysis of these FTAs. As a result, our discussion of gravity model studies is rather general. A large number of studies that use the gravity model have analyzed the impacts of FTAs on trade. The results are mixed in that some studies found positive impacts, i.e., the trade creation effect, while others did not.

Bair and Bergstrand (2007) conducted a rigorous analysis by addressing econometric problems encountered in earlier studies and found that on average the bilateral trade between two members under an FTA approximately doubles after 10 years. Okabe and Urata (2014) conducted one of the few studies on FTAs in Asia by analyzing the impact of the AFTA. They found the trade creation effect for a wide range of products and that such trade creation effects are relatively small for the newer ASEAN members compared to the original members. Based on these results, they claim that AFTA was successful in promoting intra-ASEAN trade. In their study of the trade creation and trade diversion effects of FTAs covering 20 products, Urata and Okabe (2013) found that FTAs among developed countries generate trade creation effects for many products, while the trade diversion effect was not found except for medical and pharmaceutical products. In contrast, FTAs among developing countries generate trade creation effects in fewer products but give rise to trade diversion for many more products when compared with FTAs among developed countries. They also found that plurilateral FTAs give rise to trade creation for many more products compared to bilateral FTAs.

Empirical studies of the economic impacts of FTAs have shown that FTA members tend to benefit in terms of increased trade and economic growth, while nonmembers are likely to lose in both respects. These findings indicate that countries should join FTAs to help them achieve economic growth; however, this is not an optimal situation for the world economy as a whole, because FTAs give rise to trade diversion. The optimal situation would be free trade among all countries. Since achieving free trade around the world is unlikely in the current environment where the WTO is not functioning effectively to liberalize trade, the second-best policy may be to expand the membership of existing mega-FTAs such as the CPTPP and RCEP, with the goal of eventually covering all countries, thereby achieving global free trade.

#### 11.4 Conclusions: Achieving Inclusive Economic Growth

This chapter examined the roles of foreign trade and FDI in achieving high economic growth in East Asia, in order to draw lessons for achieving sustainable economic growth (SDG 8). We noted the formation of GVCs through FDI by multinational corporations (MNCs) as a special characteristic of rapid economic growth in East Asia. Participation in GVCs has provided opportunities for East Asian countries to expand their foreign trade and obtain new technology, helping them to increase productivity and achieve strong economic growth. We emphasized the importance to East Asian countries of pursuing trade and FDI liberalization and constructing and managing hard and soft infrastructure to realize economic growth based upon participation in GVCs. To promote further economic growth and achieve higher levels of economic development, East Asian countries are advised to participate in mega-FTAs such as the CPTPP and RCEP to improve their business environment, which would expand and intensify GVCs.

Although East Asian countries have been successful in achieving rapid economic growth and improving the standard of living for their people, they face a number of challenges, including growing inequality, a deteriorating environment due to climate change, worsening relations between the US and China, a growing probability of infectious disease, and others. Here, we focus on the issue of inequality because it has been argued that the rapid expansion of trade and FDI—in other words, the globalization of economic activity—has significantly increased inequality. It is important to realize that greater inequality would deter economic growth as it would likely lead to political and social instability.

In discussing globalization and inequality, we need to differentiate between developed and developing countries, and this section takes the perspective of developing countries.17 For many East Asian countries, growing income/asset inequality is a rather recent phenomenon. Indeed, for many decades expanding trade and FDI helped to reduce inequality in East Asia. From the 1980s through the early 2000s, East Asian countries increased exports of unskilled labor-intensive products such as clothing in large quantities, which generated a high demand for unskilled labor. This in turn led to a rise in wages for these workers, reducing the wage inequality between unskilled and skilled labor. The situation changed when MNCs began to undertake FDI in sectors such as electric and electronic machinery and transport equipment. MNCs brought technologies that require skilled labor, and introducing such technologies increased demand and therefore raising wages for skilled labor, widening the wage and income gap in East Asia.

Large FDI inflows resulted in a different kind of inequality problem, namely inequality between large firms and small and medium-sized enterprises (SMEs). MNCs are typically large firms that tend to have advantage over SMEs in terms of financial and human resources. This resource gap between large firms and SMEs not only leads to differences in their performance, but it also increases the wage/income gap between those working for large firms and those working for SMEs.

This growing income inequality must be addressed, and inclusive growth has to be achieved to realize the political and social stabilities necessary for sustainable economic

17 See, for example, Urata and Narjoko (2017) for a detailed discussion on this issue.

growth (SDG 10, reducing inequality). This will require SMEs to improve the capabilities of their unskilled workers to stay competitive, which calls for more education and training. Public institutions/governments should provide education and training with respect to general skills and knowledge, while specialized skills and knowledge should be developed by specialized institutions or through on-the-job training. To improve SMEs' competitiveness, public institutions/governments should provide technical, financial, and marketing assistance. Furthermore, a policy to promote competitiveness for SMEs to address the risk of dominance of large firms over SMEs should be considered, to level the playing field. We emphasize that governments, as providers of assistance, must have capable personnel to identify the need of those who seek to benefit from that assistance and to apply appropriate measures so that various forms of assistance can be effective. It should be noted that assistance can be effective if it is provided in cooperation with the private sector. Finally, governments' own efforts are of utmost importance, but they should seek international cooperation with donors and international organizations.

Finally, we would like to reiterate the importance of constructing, maintaining, and managing soft and hard infrastructure (SDG 9), not only for the developing countries to participate in GVCs, but also for building the foundations for economic growth, more specifically, inclusive and sustainable economic growth.

#### References

org/research/asean-rising-asean-and-aec-beyond-2015/

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World Trade Organization (2016) WTO "trade in valueadded and global value chains" profiles: explanatory notes. https://wto.hse.ru/data/2016/02/01/11370303 36/Explanatory\_Notes\_e.pdf

Open Access This chapter is licensed under the terms of the Creative Commons Attribution 4.0 International License (http://creativecommons.org/licenses/by/4.0/), which permits use, sharing, adaptation, distribution and reproduction in any medium or format, as long as you give appropriate credit to the original author(s) and the source, provide a link to the Creative Commons license and indicate if changes were made.

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# 12 BoP Businesses of Multinational Corporations and Sustainability

Shinji Hasegawa

#### Abstract

Pessimism about the effects of official development assistance (ODA) on the poorest countries (base of the pyramid; BoP) has raised expectations of social business by multinational corporations (MNCs) since the end of the twentieth century. First, this chapter summarizes the historical developments focused on the role of MNCs in alleviating poverty at the BoP (Sustainable Development Goals [SDGs] 1, 3, and 6) through delivery of affordable products and services, following activities of non-governmental organizations, growing awareness of corporate social responsibility, and framing of development goals by United Nations agencies. Next, it discusses BoP's shift from its role as a marketplace to a production base or source of innovation, as MNCs have established global production networks. We argue that this has changed the BoP business toward contributing to the achievement of SDGs 5, 8, and 9. Finally, MNCs are required to address not only social challenges at the BoP, but also environmental challenges (SDGs 13) in both emerging and developed countries. To balance these overall SDG-related challenges with MNCs' own

S. Hasegawa (&)

Waseda University, Tokyo, Japan e-mail<EMAIL_ADDRESS>
interests, BoP business is further evolving into SDG business management, and MNCs will be increasingly required to redefine their role from a sustainability perspective.

#### Keywords

Base/bottom of the pyramid (BoP) Inclusive business Multinational corporation (MNC) Triple bottom line

#### 12.1 Introduction

This chapter discusses the role that multinational corporations (MNCs) can play in addressing the social challenges faced by the poor in developing countries. Initially, MNCs' businesses with the poor started as targeting poverty alleviation by delivering products and services to them that they could afford: of the 17 Sustainable Development Goals (SDGs), Goals 1 (no poverty), 3 (good health and well-being), and 6 (clean water and sanitation) were their direct targets. Subsequently, however, there was a growing realization that other goals were also important social agendas for the poor, such as Goals 5 (gender equality), 8 (decent work and economic growth), and 9 (industry, innovation, and infrastructure), and that pursuing them would also serve MNCs' interests. This led to significant changes in MNCs' businesses in those countries. More recently, their businesses have even embraced

© The Author(s) 2023

S. Urata et al. (eds.), Sustainable Development Disciplines for Society, Sustainable Development Goals Series, https://doi.org/10.1007/978-981-19-5145-9\_12

environmental challenges, including Goals 13 (climate action), and are now developing into ambitious initiatives that encompass the broad areas of the SDGs on a global scale, including developed as well as developing countries.

#### 12.2 What is the BoP Business?

The bottom of the pyramid (BoP) refers to those people who are regarded as the poorest in the socioeconomic strata, and the business activities of companies, particularly MNCs, targeting such people are called BoP businesses. Prahalad and Hart (1999, 2002) first introduced the term BoP, which placed the poorest people at the bottom of a pyramid structure based on socioeconomic stratification by income. Although the term BoP itself has not changed, the term "bottom" is considered to carry discriminatory overtones, and consequently, "base" is used more frequently instead. More recently, the United Nations (UN) and other international organizations have tended to prefer the term "inclusive business" instead of BoP business, arguing that using the term "base" or "bottom" to distinguish a business is not the way to solve related social problems.1

Specifically, the BoP is defined as a population group with an annual per capita consumption expenditure (or income) of less than \$3000 in purchasing power parity (PPP) in 2002 (Hammond et al. 2007).2 As Fig. 12.1 shows, there are 4 billion people at the BoP, representing 71.7% of the 5.575 billion people recorded by available national household surveys worldwide,3 with an overall market size estimated to reach \$5 trillion. At the middle of the pyramid (MoP), there are 1.4 billion people with income between \$3000 and \$20,000, representing 25.1% of the survey population. The top of the pyramid (ToP) comprises mature markets, mainly in the developed countries, with annual per capita income of over \$20,000 and a population of 0.18 billion, or only 3.1% of the total surveyed. The area of each segment in the figure is shown according to its actual share, making it easier to understand how the BoP group accounts for a large part of the total, whereas the ToP is a tiny part.

Figure 12.2, which presents a bar chart showing the distribution of the population arranged according to actual income level (established from Free data from Gapminder.org: gapm.io/d\_incm\_v2), does not have a neat shape compared to the pyramid in Fig. 12.1. The upper part of the distribution is narrow due to the lowest number of high-income earners, and the lowest part is wide due to the highest number of low-income earners, with the population increasing at a non-proportional rate as it approaches the bottom. The vertical axis could be set much higher; however, it is limited to \$100 a day in the interest of convenience and clarity.

Typically, a corporate BoP business is regarded as the business activity of a company that simultaneously satisfies the following three conditions:

In other words, the corporate BoP business represents a form of "creative capitalism" (Kinsley and Clarke 2008), wherein business is

1 According to UNDP, an inclusive business (model) is defined as "including the poor into a company's supply chains as employees, producers and business owners or develop affordable goods and services needed by the poor" (UNDP 2010).

2 PPP is a ratio of currencies calculated so that the purchasing power (quantity of goods and services that can be purchased) of each currency is equal. An income of \$3000 in PPP terms in 2002 means people with an income amount that would allow them to go to the USA in 2002 and make \$3000 worth of purchases. This definition was given in a report prepared jointly by the World Bank Group's International Finance Corporation (IFC) and the World Resource Institute.

3 Data are derived from national income and consumption surveys conducted by national statistics offices in 110 countries. See Appendix A in Hammond et al. (2007).

Fig. 12.1 Pyramid of the world's population by income group

conducted with the dual intention of pursuing economic outcomes by opening up new highgrowth markets and social outcomes by solving critical social problems in those markets.

As mentioned previously, the most commonly used quantitative definition of BoP is an annual income of less than \$3000; dividing this number by 365, we obtain the daily income of people in the BoP as less than \$8.2. Therefore, in Fig. 12.2, the bottom nine bars, that is, the area below the red-dotted line, roughly correspond to the BoP.4 This shows that in 2018, the BoP group accounted for 58.6% of the world's population (yellow bars) compared to 75.6% in 1990 (blue bars) and that the volume zone moved up slightly from the bottom. In particular, the number of people living in "extreme poverty" those earning less than \$1.9 per day (World Bank 2016), or the bottom two bars—has fallen dramatically in the three decades since 1990. Although a large proportion of the population still belongs to this segment, part of this upward shift in the volume zone can be considered to be a result of BoP businesses.

#### 12.3 Birth of the BoP Business

During the post-war period to the 1970s, when the "Global North and Global South" were raised, there was criticism that the expansion of MNCs from developed to developing countries would lead to the exploitation of the poor. A growing trend of resource nationalism has emerged among the newly independent countries to reclaim for themselves the natural resources that MNCs had once controlled during the new imperialist era, which came into conflict with the interests of MNCs. In 1962, the UN General Assembly explicitly declared the Permanent Sovereignty over Natural Resources, which led to the nationalization of extraction facilities of MNCs in many developing countries in the Middle East and South America. In 1964, the UN Conference on Trade and Development (UNCTAD) was established to redress the North–South divide through the promotion of economic development of developing countries; at the same time, the Group of 77 (G77), a coalition to increase the voice of developing

4 Since the Gapminder income data set is calculated using PPP for the benchmark year 2011, there will be some discrepancies in the definition of BoP when measured in PPP terms in 2002. This means that the number and share of people belonging to the BoP group estimated here may be somewhat underestimated.

countries, was founded, and various cartels were formed by producer countries in oil, copper, bauxite, and other resources. The Declaration for the Establishment of a New International Economic Order (NIEO), adopted in 1974 by the UN Sixth Special Session of the General Assembly on Raw Materials and Development, included the right of host countries to regulate and supervise the activities of MNCs. In the 1980s, when it was widely recognized that foreign direct investment (FDI) could contribute to the economic development of developing countries, many of these countries turned their stance toward accepting FDI, and shortly afterward, some emerging countries became even more welcoming. However, MNCs continued to operate with an imperialist mindset, viewing developing countries as places to sell their old products or squeeze profits out of their sunset technologies (Prahalad and Lieberthal 2003).

During this period, various social challenges faced by low-income groups, including poverty, were addressed through grant aid, preferential loans, technical assistance, provision of relief supplies, donations, or volunteer activities by public bodies such as governments of developed countries, UN agencies, the World Bank, the Asian Development Bank (ADB), the African Development Bank (AfDB), and other nongovernmental organizations (NGOs). In the 1990s, however, after years of official development assistance (ODA) failed to produce the desired results in poverty alleviation while breeding graft and corruption, developed countries experienced "aid fatigue," and key members of the OECD Development Assistance Committee (DAC) began to reduce their ODA spending. Concurrently, the concept of private finance initiatives (PFI) took root as Western countries sought to move toward smaller governments, raising the expectation that the private sector could finance public services to a greater extent. This trend was reflected in development aid to developing countries, wherein the importance of public–private partnerships (P3) was emphasized. Moreover, as the development needs of developing countries diversify from dealing with debt crises and structural economic reforms to broader social issues, such as poverty, hunger, health, the environment, education, and human rights, it is increasingly recognized that the administrative approach of governments and international organizations is limited. In other words, the prevailing view is that development projects can be conducted more efficiently by using private finance and technology, particularly with the help of MNCs.

Since the late 1990s, there has been growing momentum for corporate social responsibility (CSR), which posits that companies have a responsibility to return profits from their business to have a positive (or avoid a negative) impact on the environment and all stakeholders, including consumers, employees, investors, and local communities. CSR used to be regarded as selfregulatory and voluntary decisions at the individual firm level, although its interpretation and evaluation varied between countries and regions. However, CSR has evolved to include mandatory schemes at national, regional, and international levels as national governments and international organizations have pushed companies to develop sustainable practices, laws, and regulations, and stakeholders have increasingly demanded it. Some examples of these programs are the following. First was the ISO 14000 series of environmental management standards issued in 1996 in response to the Earth Summit of 1992; second, the widespread adoption of the concept of the triple bottom line (TBL) (i.e., the social [people], environmental [planet], and economic [profit] bottom lines) in accounting and auditing procedures; and third, the Global Reporting Initiative (GRI), an NGO launched in 1997 to develop international standard guidelines for sustainability reporting by companies and other organizations.

The UN "Global Compact" (UNGC), a nonbinding charter announced by the then-UN Secretary-General at the World Economic Forum in 1999 and launched in July 2000 with the signature of 7,700 companies from 130 countries, required companies to act in a socially, environmentally, and ethically responsible manner. Signatories were requested to integrate the ten principles outlined in the UNGC in four areas, namely human rights, labor, environment, and anti-corruption.5 Private companies, recognized as an essential force in achieving the development goals set by the UN for developing countries, were expected to act as catalysts through their actions in support of these goals. In September 2000, with the enactment of the UN Millennium Development Goals (MDGs), eight international goals were set with specific targets to be achieved by 2015 to solve the problems of developing countries. One of these targets was to reduce the number of people suffering from extreme poverty and hunger by half compared to 1990. To achieve these challenging development goals on time, the traditional approach of relying on ODA from developed countries or support and donations from international organizations and NGOs was insufficient, and expectations of the role that business activities could play had become increasingly important. In response, MNCs and entrepreneurs sought to address poverty reduction from a business perspective by providing products and services that meet the needs of developing countries. This led to the emergence of BoP businesses.

#### 12.4 First-Generation BoP Strategies—BoP 1.0

The BoP businesses that emerged in the early years were essentially attempts by MNCs to modify existing goods and services and offer them at lower prices so that people in the BoP markets could afford them. Poverty was defined as the deprivation of basic needs such as food and water, clothing, shelter, sanitation, health, and electricity. Accordingly, poverty-stricken people were regarded as suffering from various disadvantages known as the "BoP penalty" (Prahalad 2010), which referred to higher costs of living due to poverty, including transport, utilities, food, and medicine, among others.

Thus, the role of the BoP business was considered as elimination of the BoP penalty to

5 As of February 23, 2022, the number of signatories has grown to 19,616 companies and organizations in 164 countries. For more information, see UNGC (2022).

enable people to meet their basic needs. To this end, modifications of existing business models, such as the small packaging strategy, were suggested to eliminate the BoP penalty and achieve the 3As—affordability, access, and availability (Prahalad 2010). The idea is that this will create a fair market for the poor, improve the standard of living of the BoP, raise their income, and, consequently, help them move to the next volume zone (Hammond et al. 2007), opening up new market opportunities for MNCs. Thus, the BoP business can be considered a sustainable strategy for companies. As the "base" part of the pyramid shifts upward, it may no longer be a pyramid structure but a diamond-shaped structure with a thicker mid-layer. This approach to the BoP market, which seeks to reduce poverty through consumption, was later coined as BoP 1.0 by Simanis et al. (2008).

At the time, MNCs from developed countries did not have much business experience in developing countries, excluding their former resource development and procurement activities. Moreover, MNCs were not accustomed to doing business in the developing areas of the world, where markets—a network in which buyers and sellers interact to exchange goods and services for money—were essentially nonexistent or poorly functioning compared to those of developed countries with well-functioning market mechanisms. Therefore, MNCs often choose to work with NGOs and entrepreneurs acting on the ground. They believed that without partnerships with this third sector—the civil sector, which is neither public nor private—an approach to the BoP segment, wherein simple aid is ineffective, and markets do not function well, would be infeasible.

Accordingly, BoP 1.0 comprised the following three steps:

3. To partner with local NGOs/NPOs as mediators in implementing BoP solutions.

One well-known example of BoP 1.0 is the purified water business of Procter and Gamble (P&G). As a BoP initiative, P&G launched the Children's Safe Drinking Water (CSDW) program in 2004.6 It provides safe drinking water for children aged 0–13 years in developing countries. P&G worked with the US Center for Disease Control and Prevention (CDC) to invent a water purification powder and provide sachets of "Purifier of Water" (PUR) to children in rural villages and refugee camps. Sachets were used because the poor could not afford the cost of buying products in bulk. With just 4 g of powder, a bucket, a spoon, and a cloth, 10 L of dirty water could be turned into clean drinkable water in 30 min. P&G did not simply sell the product through its usual distribution network but worked with around 70 organizations, including international organizations such as the Red Cross and UNICEF (United Nations International Children's Emergency Fund), as well as local NGOs.

Another example is Unilever's soap business in India. In 2002, Hindustan Lever Limited (HLL), Unilever's subsidiary in India,7 launched a 5-year health and hygiene education campaign, "Swasthya Chetna" ('Health Awakening'), to promote Unilever's " Lifebuoy" brand of hygiene products.8 The program was launched in eight states of India with the objective of educating around 200 million people in rural and urban areas on the importance of health and hygiene

6 See P&G (2022).

7 Unilever set up its first production subsidiary in India, Hindustan Vanaspati Manufacturing Co., in 1931, a year after the merger of the British company Lever Brothers and the Dutch company Margarine Unie to form Unilever. At the time, India was a British colony before gaining independence in 1947. This subsidiary changed its name to Hindustan Lever Limited (HLL) in 1956 and to Hindustan Unilever Limited (HUL) in 2007.

8 Lifebuoy is a world-leading brand of their hygiene products launched by Lever Brothers in 1895, which includes soap, hand wash, body wash, sanitizer, deodorant, and other products. Although it is no longer seen in developed countries, it is highly recognized in developing countries, and products produced in India are exported to the Asian region.

(Fernando and Purkayastha 2006). Through demonstrations, interactive visuals, and drama workshops, mainly in primary schools, HLL educated children about the effectiveness of washing hands with soap to prevent diseases. The children would go home and tell their parents about it, who would, in turn, tell their neighbors, relatives, and colleagues. Through this word-of-mouth communication, the concept of sanitation took root in Indian society. Through social marketing, Unilever aimed to cause a behavioral change in two ways: attracting consumers who never used soap and convincing people to use soap more frequently, thus creating more users for its brand. Resultingly, Unilever succeeded in expanding the market for the company's Lifebuoy products, which had been introduced in India long ago but had only been recognized by a small group of wealthy people, while solving a social problem wherein many people were suffering from poor health due to lack of hygiene habits.

#### 12.5 Transformation of BoP Business

#### 12.5.1 Lack of Success of BoP 1.0

Despite many attempts, BoP 1.0 was not as successful as expected. Many businesses were unable to scale or generate satisfactory returns or failed to address the development challenges of the poor adequately. Many others continue to suffer from low profits, small market size, and slow growth, including Grameen Danone's nutritious yogurt development in Bangladesh, Nike's World Shoe project in China, P&G's Nutri Delight (a fortified orange powdered drink) in the Philippines, and Monsanto's sale of genetically modified seeds; some of which have been discontinued. Some assessments suggest that even P&G's PUR and Unilever's soap business, mentioned above, have not performed as expected (Simanis et al. 2008).

The graph in Fig. 12.3 illustrates the relationships between business and social agenda and helps to understand the background of the poor performance of BoP 1.0 for both companies and society and provides some hints on how to address it. It attempts to capture corporate BoP businesses in a box diagram measured by two dimensions: corporate profit on the vertical axis and development impact on the horizontal axis. Given the trade-off between the two challenges, the strategy a company can adopt lies in the area inside (lower left) the frontier curve, shown by the main diagonal, with the optimal strategy lying at any point on the frontier. If a company, located in the top left corner as a profit-seeking entity, tries to engage in the BoP business, it can achieve development benefits by sliding down along the frontier line from the upper left position, that is, by sacrificing some of its corporate profits. When the BoP1.0 venture does not yield satisfactory profits, it means that the company has moved below point A at the intersection of the frontier line with an acceptable profit level p\*. Further, if the BoP business is unsatisfactory in meeting the development challenge, it means that it has not moved beyond B at the intersection with the expected level of development at d\*. In short, unsuccessful BoP businesses are located somewhere on the line segment AB.

As aforementioned, CSR, UNGC, and the MDGs are the background factors that have encouraged MNCs to engage in BoP business; however, an increase of these exogenous pressures shifts the vertical line set at s\* to the right, such that, ceteris paribus, line segment AB will become even longer, increasing the likelihood that BoP businesses will create only unsatisfactory results.

There is a common feature underlying these unsatisfactory results of many BoP 1.0 ventures: They were outside-in initiatives to increase consumption in the BoP segment by modifying and applying existing products and business models created in developed countries. This was based on the mindset of approaching the unmet needs of poorer people. (Simanis et al. 2008; Cañeque and Hart 2015).

However, several serious problems are associated with this approach. First, people in the BoP segment were viewed as target customers instead of targets of certain development goals.

On the MNCs' side, the BoP business created a boom at the turn of the twenty-first century, with the illusion that it would open up unlimited sales opportunities in markets with huge populations; however, the civil and public sectors, as well as the poor themselves, have sometimes criticized the BoP business as nothing more than a strategy for selling to the poor.

Second, with no existing product market that served as a benchmark, neither firms nor prospective BoP customers had a reference point from which to assess whether a given product or service was "needed" (Simanis et al. 2008). This is why the usual market strategy of understanding potential needs through listening to prospective customers, identifying the market segments to play in, and gaining a competitive advantage could not be applied. While P&G's PUR business initially saw an enormous potential need to solve the social challenge of preventing infectious diseases with clean water, the actual demand generated was so small for the company that the CSDW project had to shift to a philanthropic model of health-related social marketing campaigns in partnership with a global health NPO (Simanis et al. 2008).

Lastly, outside-in initiatives contain paternalistic attitudes and cultural imperialism elements, which sometimes mean a devaluation of tradition and culture in the target country. This is likely to provoke a backlash from non-profit and grassroots organizations, as well as from poor people themselves. In the past, NGOs have often monitored the subsidiaries of MNCs and led boycotts of their products in protests against environmental degradation and child labor in developing countries. With such a history of adversarial relations, the basic needs approach, relying on an outside-in strategy, does not make it easy to forge partnerships with NGOs, which are crucial to the success of the BoP business.

#### 12.5.2 Advent of BoP 2.0

Reflecting on the modest success of BoP 1.0, the next generation of BoP strategies emerged: BoP 2.0. A key feature of BoP 2.0 is a radically new approach involving the "co-creation" of products and value propositions by partnering with people from underserved communities (London and Hart 2010). Co-creation refers to working together with local companies, low-income communities, and other actors to create a fortune with the BoP, which enables a deep process of social transformation (Nahi 2016). BoP 2.0 not only aims to focus on markets that previously existed but were unrecognized and to turn poor people into customers for its products, as in BoP 1.0 but also encompasses the following three elements:

Thus, theoretically, BoP 2.0 would engender culturally embedded, socially and environmentally sustainable, profitable, and more "inclusive" businesses9 which is what the BoP people want.

Thus, BoP 2.0, which seeks to commit the poor to the supply chains and innovative activities of MNCs, has been driven by the international fragmentation of production—the pursuit of offshoring strategies by splitting a production process into different steps—and the establishment of global production networks (Ernst and Kim 2002; Jones et al. 2005; Coe et al. 2008). As a result, the role of the BoP has shifted from being a mere marketplace to a production base and even a source of innovation.

Unilever's Indian subsidiary, HLL's project "Shakti" (meaning empowerment), is often described as the next-generation BoP initiative (Prahalad 2010). Although not yet fully successful in terms of profitability, probably due to Unilever's heavy financial burden and high turnover, the project is considered a BoP 2.0 scheme as it involves "innovation for the last mile"—the penetration of the company's products into traditionally unreachable rural India through direct sales using local women's channels—while simultaneously contributing to society by spreading the concept of hygiene, and thereby, improving health, creating employment, improving human capital, empowering people, and making women more self-reliant and socially empowered.

HLL set up a sales and distribution organization that contracts women, called "Shakti Amma," as self-employed traders who buy and sell Unilever products on consignment and receive a success fee. This enabled Unilever to penetrate rural areas, where two-thirds of India's population lives, at a cost more than 10% less than traditional sales agents, and promote Unilever products through word of mouth (Rangan and Rajan 2005). In particular, the expansion of sales of "Annapurna Salt," an iodized salt developed by Unilever in 1995, has had a breakthrough effect in preventing iodine deficiency disorder, which may cause mental retardation in children, and considerably contributed to reducing the health problems of India's low-income population, who do not have access to a balanced diet. Shakti Amma, now comprising more than one million women, has become not only Unilever's favorite customer by enhancing women's and their family's livelihoods by enabling them to earn the same level of income as men (\$60–150/month), but also an entrepreneurial venture that develops women's skills through training and on-site practice in product knowledge, revenue and logistics management, and contractual concepts, helping women to become spiritually independent through increased financial independence and dignity. Additionally, HLL has played a complementary role in microfinance by making Shakti Amma a self-help group with joint savings and loans among its members, which, in turn, induces bank loans and new business start-ups. In collaboration with local government agencies and NGOs, the project has effectively recruited and nurtured talented women with local knowledge and a desire to lift themselves out of poverty and become self-reliant.

9 There is no uniform definition of inclusive business, and people sometimes interpret it differently, but common features are adopting the principle of nondiscrimination, to focus on creating new economic opportunities for lowincome populations rather than maximizing corporate profits. See Likoko and Kini (2017) for more details.

Figure 12.3 illustrates the logic behind BoP 2.0, which is realized when a company can further enhance its economic profits or social benefits without sacrificing either. The social contributions brought about by Shakti Amma at Unilever's expense, such as increased employment, poverty alleviation, spread of market-based economy, improved health and sanitation, and women's empowerment, among others, will not necessarily undermine the company's financial bottom line because it will lead to a reduction in distributor commissions, increased productivity through enhanced human capital of Shakti Amma, and increased sales through higher incomes for lowincome groups. This means that, as shown in Fig. 12.3, when starting from BoP 1.0, indicated by the large circle, and seeking further to increase the social benefits on the horizontal axis, companies do not need to slide down along the frontier curve (arrow ①), but can reach BoP 2.0, while maintaining corporate profit level p\* on the vertical axis (arrow ②). In BoP 2.0, both the acceptable level, p\*, for corporate profit, and the

expected level, s\*, of social benefit are met, making the business sustainable. Therefore, BoP 2.0 is about internalizing the positive production externalities to create social value through business model innovation, rather than relying on

absolute altruism, as in philanthropy, to achieve the same results.

The transition to BoP 2.0 was driven by not only companies' efforts to overcome the flawed BoP 1.0, but also institutional pressures on MNCs to put emphasis on social and environmental aspects. In particular, as Table 12.1 shows, the P3 initiatives in development, successively launched by various international organizations, acted as a "focal point" to encourage companies to be more proactive in fulfilling their social responsibilities owing to their rational choices. Additionally, they helped the private sector find solutions to reconcile its profitability with social development at a higher level in difficult market conditions with high poverty levels by providing specific policy recommendations and illustrating other companies' initiatives as best practices. For example, the 2004 report of the UN Commission on the Private Sector and Development, "Unleashing Entrepreneurship: Making Business Work for the Poor," outlined recommendations for building the capacity of the private sector to advance the development process set out in the MDGs, with particular emphasis on providing opportunities for income generation through decent work. The growing inclusive markets (GIM) initiative launched by the United Nations

Table 12.1 Key institutional pressures to engage the private companies in BoP business

(continued)

#### Table 12.1 (continued)

Development Programme (UNDP) in 2006, and its report, Creating Value for All, published in 2008, highlighted the importance of inclusive business, which involves poor populations in global value chains as consumers, producers, employers, and workers, and provided many different examples of good practices in such business. Similarly, other UNDP-led strategies, such as inclusive market development (IMD) in 2007 and business call to action (BCtA) in 2008, have sought to promote private sector engagement in the BoP development process, with recommendations on how to build business models that achieve commercial and development objectives simultaneously. Similar efforts to get companies and NGOs to focus more on development issues at the BoP can be seen in other UN agencies, such as Food and Agriculture Organization (FAO), World Food Programme (WFP), World Health Organization (WHO), and United Nations International Children's Emergency Fund (UNICEF), with each working in its own area of expertise. Thus, all these efforts from international organizations have served as a catalyst for private sector companies to take a more active role in BoP business while maintaining their interests.

#### 12.6 Future of the BoP Business

BoP businesses need to and will evolve further to more effectively address the social challenges faced by the BoP while concurrently ensuring corporate profitability. Against this background, the "BoP 3.0" was recently proposed (Cañeque and Hart 2015). Although this initiative is still in an embryonic stage and the real picture has not yet become clear, some directions can be discerned.

#### 12.6.1 Open Innovation and Frugal Innovation

One such direction is to facilitate further "cocreation," as implemented in BoP 2.0, and move toward "open innovation." As aforementioned, co-creation involves working with local companies and other actors to develop new business models that create value for local communities at the BoP. Furthermore, open innovation is a distributed innovation process based on purposively managed knowledge flows across organizational boundaries (Chesbrough et al. 2014). In contrast, traditional "closed innovation," which is pursued in-house or through vertical integration, is when companies seek to build competitive advantages based on proprietary technology through speeding up new product development. However, increasing silos of technology have made it increasingly difficult to create innovation through in-house research and development (R&D). The boundaries between a firm and its external environment have become more permeable due to lower transaction costs in the marketplace and advances in information and communication technology (ICT). Increasing the transfer of technology and ideas inward and outward between organizations and individuals can be expected to stimulate innovation within the organization, which, in turn, will extend outside the organization (Chesbrough 2003). Technology and ideas should not be confined within an organization but allowed to flow freely to stimulate innovation. Compared to the co-creation emphasized in BoP 2.0, which was a bottom-up innovation that was undertaken with the help of BoP people, open innovation is a more participatory grassroots innovation that harnesses the knowledge of the "cloud" distributed across different sectors and actors—private, government or citizens, or formal or informal—to create solutions that were previously unforeseeable (Cañeque and Hart 2015).

As an extension of this open innovation, "frugal innovation" has attracted growing attention in recent years (Zeschky et al. 2011; Bhatti and Ventresca 2013). It is called "frugal" as it is a way of developing products and services that are more affordable and easily accessible by only implementing necessary features. It is frugal because it meets the basic needs of the BoP in a lean way, thus conserving resources and making societies and the planet more sustainable. Frugal innovation is a locally adaptive solution that develops and provides products and services that are "good enough" and affordable to meet the needs of consumers under severe financial, technological, material, and other resource constraints (Bhatti and Ventresca 2013), meeting the needs of BoP people who would otherwise be unable to afford existing products and services. Frugal innovation is a model of the social contribution that emphasizes the reduction of the global environmental footprint by providing products and services in a resource-saving manner. In other words, frugal innovation reduces public bads (negative externalities), whereas the conventional BoP business aimed to contribute to society by expanding public goods (positive externalities), that is, by alleviating poverty through delivering products and services to the poor.

However, this may not be an easy task for MNCs from developed countries as their business models and organizations are traditionally designed to develop advanced products for the few affluent people at the ToP. To overcome such strategic and organizational barriers and achieve frugal innovation, it is necessary to provide a substantial degree of autonomy to local subsidiaries of MNCs to enable them to deploy open innovation (Zeschky et al. 2011).

#### 12.6.2 Business Ecosystem

The second direction for BoP 3.0 is to use the business ecosystem. A business ecosystem is an economic community comprising many loosely interconnected participants (Clarysse et al. 2014). These participants, organizations or individuals, come together in such a community "in a partially intentional, highly self-organizing, and even somewhat accidental manner" (Moore 1998, p.169). These participants include customers, suppliers, workers, competitors, and other stakeholders, such as financial institutions, trade associations, standards bodies, labor unions, and governmental and quasi-governmental institutions (Moore 1998). In the context of BoP, human resource cultivators, supply chain players, technology and microfinance providers, and even neighboring residents, are constituents of the business ecosystem. Their relationships could be cooperative or competitive, with each participant specializing in a particular activity and depending on each other for their mutual performance. In other words, the collective efforts of many participants create value, but individual efforts have no value outside of the collective effort (Clarysse et al. 2014). Unlike conventional inter-firm networks, which tend to be geographically dense, business ecosystems form value networks distributed globally.

BoP 2.0 emphasized the need to engage people from the BoP community in the local activities of MNCs to promote bottom-up innovation. However, since an ecosystem is a network of actors with many horizontal (Moore 1996) as well as vertical relationships, many of its members fall outside the traditional value chain, which is formed by a linear process from upstream to downstream (Iansiti and Levien 2004). Thus, the innovation model of BoP 2.0 will be unable to tap into the diversity of species inhabiting the ecosystem. For BoP businesses to evolve further, it is necessary to incorporate companies as part of a larger ecosystem (Cañeque and Hart 2015). It is not about involving the BoP people in their global value chain but about the MNCs themselves becoming part of the business ecosystem, locally embedded and extending beyond regional boundaries. Therefore, it is essential to view the business ecosystem as a foundation for innovation to exploit the potential of open innovation discussed above fully.

Innovation in business ecosystems focuses on the customer (demand) side rather than on technological activities; in other words, it aims to generate value for the customer rather than new knowledge (Clarysse et al. 2014). Firms can collaborate with other participants in the business ecosystem to create solutions and deliver value that customers alone cannot create (Moore 1993). Such innovations may involve the creation of new markets and are well suited to the relatively small and poorly defined commercial opportunities that need to be pursued (Clarysse et al. 2014); therefore, it is a suitable model for innovation at the BoP.

At the BoP, the market economy—a network of buyers and sellers interacting to trade goods and services—does not function as it does in developed countries; the participants in the ecosystem include not only companies but a wide range of actors, seamlessly and intricately linked together to form a single business sphere. It is not based on market principles but on the dominant principles of a community—a group whose ties are based on trust through profound human interactions, such as bonds, blood relations, geographical ties, camaraderie, and ethnic cohesion, which are maintained through implicit contracts. Many poor people are engaged in the informal sector and deprived of legal ownership, property rights, and education rights, among others, which are largely beyond the reach of normal means of distribution, credit transactions, and communication.

Therefore, it is essential for MNCs to network with these non-traditional actors, especially if they want to create non-economic and social value. The strength of MNCs is that they can reorganize their ecosystems in a way that is not solely based on customary mechanisms, as in the past, by bringing in transparent market mechanisms. For this purpose, ICT can be used, as it helps to eliminate opportunistic behavior (Williamson 1985)—selfish actions, such as cheating or shirking, which will undermine the potential of the transactions—by reducing information asymmetries between buyers and sellers, thus allowing the market mechanism to function and realize fair trade. Further, ICT can enable joint tasks between organizations and individuals within the business ecosystem through Internet-based technologies in conjunction with face-to-face interaction (Corallo et al. 2007), thus connecting companies and individuals in the same ecosystem across traditional industry sectors and national boundaries. By evolving business ecosystems into digital business ecosystems, each company or individual will be able to exchange digital knowledge with other members and add one or more aspects of product or service value tothe value created by the ecosystem (Tapscott et al. 2000), enabling the provision of customized solutions to people at the BoP.

However, the process of building relationships and creating business ecosystems with many different stakeholders is lengthy and path dependent. Moreover, companies need to play a pivotal role in the ecosystem to orchestrate the coordination of interests, conceive a business model that satisfies social needs, and secure their own profits, which can be a daunting task. However, this is precisely why it can be a source of sustained competitive advantage by accumulating resources that are difficult to imitate and prevent others from entering (Barney 1991).

In this respect, solving social problems and pursuing economic interests, which were once thought to be opposites, can now be perfectly aligned. Reflecting on Fig. 12.3, we understand that this situation, wherein companies can increase their economic profits, or rather their sources of competitive advantage, by addressing these social challenges, can be illustrated by the shift of the frontier curve, which shows the feasible combination of the two trade-offs, to the upper right, and the corresponding shift of BoP business to BoP 3.0 (arrow ③). Such a leap can be made through open innovation, which leverages the widely distributed knowledge across BoP communities; frugal innovation, which is resource conserving and genuinely meets the basic needs of BoP people; and inclusive innovation, which comes from embedding companies in ecosystems and building truly inclusive businesses.

#### 12.6.3 Sustainable Development

The third direction for BoP 3.0 is to broaden the perspective of the challenges faced by the BoP, from poverty reduction to sustainable development. Initially, BoP businesses' motivation was focused on alleviating poverty by leveraging the resources and capabilities of the private sector, especially MNCs, to deliver products and services affordable to the BoP population (BoP 1.0), and then providing them with the means to earn a living (BoP 2.0). However, it is becoming increasingly important to consider TBL and incorporate other development challenges such as environmental sustainability.

The SDGs, adopted at the UN Summit in September 2015, set 169 specific targets in 17 areas of development goals for 2016–2030. They were introduced as successors to the MDGs, which expired in 2015 and comprised eight set goals. In addition to poverty, hunger, and health, which were emphasized in the MDGs, the SDGs encompass a wider range of environmental issues, including climate change, energy, and ecological system, as well as other social issues such as human development, decent work, women's empowerment, and inequality. The BoP faces all of these challenges, and overcoming them is defined as an essential condition for sustainability. Hence, the SDGs have a high affinity with the BoP business, and as the SDGs gain ground, companies are likely to become more proactive about engaging in "SDG business management" and incorporating those goals into BoP businesses.

Recently, there has been increasing pressure from investors to enable companies to adopt SDGs in their business. Table 12.1 summarizes some of the major developments. This pressure originally started as socially responsible investing (SRI), an investment practice that requires investee companies to manage their businesses in a CSRoriented manner. After the manifestation of environmental problems on a global scale since the late 1980s and the spread of the TBL concept in the 1990s, SRI has become more active. Companies have been evaluated in terms of the environment (environmental impact such as global warming and resource destruction) and society (impact on social stakeholders, poverty alleviation, and reduction of inequality), as well as corporate profitability, and investors' decisions have been made based on these three aspects. In 2006, the UN announced the principles for responsible investment (PRI).10 The subsequent increase in the number of institutional investors signing up to the PRI accelerated the trend toward incorporating an assessment of G (governance: appropriateness of corporate management processes) into their investment decisions, in addition to those on TBL (financial, environmental, and social bottom lines), which has come to be known as "ESG investing"—prioritizing optimal environmental, social, and governance factors or outcomes. In the aftermath of the 2008 financial crisis, ESG investing expanded rapidly (Global Sustainable Investment Alliance 2021) in response to the criticism that excessive capitalism and overstressing short-term returns caused instability in financial markets. More recently, "impact investing," which places greater emphasis on the impact of social and environmental issues (Brest and Born 2013), has grown even faster than ESG investing. These ESGs and impact investment decisions require investee companies, particularly MNCs, to internalize the positive and negative social externalities they generate as a cost of capital. Concurrently, they are known to place high demands on the financial profitability of investees.11 In Fig. 12.3, such changes in investors' behavior mean that while maintaining (or even shifting upward) the acceptable level of profitability, p\*, the expected level of development impact, s\*, will shift further to the right. Unless the BoP business model is further evolved by integrating it with SDG business management, it will be difficult to achieve a balance between corporate profits and social contribution.

#### 12.7 Concluding Remarks: Sustainable Societies and MNCs

The development challenges contained in the SDGs are not just for the poor, but many ofthem need to be addressed by the international community as a whole, including those belonging to the ToP and MoP in developed and emerging countries. As SDGs emphasize the importance of multistakeholder partnerships, the resources and capabilities of the private sector, especially those of MNCs, are expected to play a major role in addressing these challenges. In SDG business

10 As of the end of 2021, the PRI has 4679 signatories in more than 80 countries around the world, up from 81 signatories in 2006. For more information, see PRI (2022).

11 In 2018, in an effort to attract more private capital into the SDGs, UNDP began developing the SDG impact, a set of criteria for assessing the extent to which an investment object has an impact on achieving the SDGs, which is expected to be operational by the end of 2022. Additionally, in 2020, UNEP FI (UN Environment Programme Finance Initiative) launched a tool for banks to measure the impact of their loan portfolios.

management, as in BoP business, the essential question is how to reconcile social and economic interests. Therefore, an effective approach to SDG business management is to advance the "analytic generalization" (Yin 2017), which describes the logic of the BoP business as a relationship between abstracted key variables and to increase the generalizability of the model in SDG business management. Additionally, it will be possible to provide valuable implications for the BoP business based on the findings of the SDG management analyses.

For example, frugal innovation, which was initially focused on BoP customers, could be applied as a concept to address issues, such as environmental (e.g., global warming, ocean pollution, deforestation), demographic (e.g., aging population, population decline, and explosion), and socioeconomic changes (e.g., widening inequality, increasing cross-border migrations), on a global level (Agarwal and Brem 2017). Moreover, the growing interest in resource-conscious and minimalist consumption in developed countries suggests that the concept of "frugality" may also be applied in these markets. Such application to markets other than BoP may enable the generalization of the theory of frugal innovation beyond just "cheap" innovations to the creation of sustainable innovations that are more "resource efficient" (minimizing the use of resources such as water, electricity, and time) and have a higher value proposition (i.e., better quality, ease of availability). The same holds true for reverse innovation as well. Reverse innovation, which initially emerged as a product of BoP business practices, served as a useful business model in the recovery process in Japan, where the tsunami caused by the Great East Japan Earthquake in March 2011 devastated lifelines (Cañeque and Hart 2015).

A report released by the UN in 2019 warns that while progress toward SDGs has been made in some areas, overall, countries are significantly off track with respect to achieving the goals within the target timeframe (UN 2019). The COVID-19 pandemic, which began in early 2020, has further delayed these efforts, and progress toward these goals has stalled or even regressed in many areas, including poverty, hunger, health care, education, and inequality. However, the pandemic has provided a great opportunity for countries to change the course of this current trend and build recovery plans to change consumption and production patterns for a more sustainable future. In other words, countries should avoid returning to the ways of the pre-pandemic world and redesign their economies and societies to be more sustainable and resilient to build a better world. In the "with COVID-19" period, or toward the "after COVID-19" era, how can we balance business with social challenges such as ensuring public health, establishing a new normal in response to workplace and lifestyle changes, and ensuring equitable distribution among stakeholders? How are we to restore global supply chains disrupted by border blockades and the contagion of economic shocks? (Baldwin and Freeman 2020; Hasegawa 2021) Furthermore, how should we go about developing business continuity planning (BCP)? These are pressing issues for companies globally, and MNCs need to redefine their role in rebuilding their global production network from SDG perspectives.

Shortly after BoP businesses garnered attention, the concept of "creating shared value" (CSV) was proposed as a way for companies to combine the pursuit of economic profit with social contribution (Porter and Kramer 2011). CSV implies that when a company creates social value by addressing social issues and problems, it also creates economic value. Unlike CSR, which is based on the premise that solving social problems and pursuing economic profit are incompatible, and companies must sacrifice profits in the spirit of philanthropy, CSV aims to integrate social contribution and business. According to Porter, CSV is a strategy that allows companies to gain a competitive advantage over their rivals in a differentiated way (Porter and Kramer 2011). By boldly challenging social needs, which were previously left to public bodies or the not-forprofit sector, or abandoned altogether, and meeting those needs in the marketplace, companies can create economic value that their competitors never could. Thus, rather than looking for a compromise between economic and social interests, CSV focuses on creating synergies between the two in a mutually enhancing relationship, which is quite similar to the BoP 3.0 concept.

If the seeds of CSV business lie in unmet social needs (Kramer and Pfitzer 2016), such needs are inexhaustible at the BoP of developing countries and in other regions, including developed countries and emerging economies. Many developed countries are facing social problems such as aging population with declining birthrate, population decline, and increases in cross-border migrations. Issues such as gender inequalities, social disparities, human capital degradation, and lack of decent living are common challenges globally, not just in the BoP market. On a planetary scale, meeting the needs of the world's population, which is expected to reach 9 billion by 2050, while achieving growth without exceeding the available resources (e.g., food, water, and energy) or causing environmental devastation, is an extremely difficult agenda for humanity. CSV, BoP 3.0, and SDG businesses aim to make this possible.

Companies must take the initiative to solve social challenges and gain a competitive advantage. This is what the "new capitalism" based on CSV is all about, and the same is true for BoP 3.0 and SDG business management. If realized, new capitalism will be far more powerful and effective than traditional capitalism, comprising profit-maximizing businesses and wealth-redistributing governments, and will be the engine that drives social change toward sustainability. The question of how to reconcile economic and social interests by integrating findings and insights that have been conceived under different terms and concepts, such as BoP business, SDG business management, CSV, social businesses, and inclusive businesses, among others, is a key issue for business practitioners, scholars, and policymakers and will become increasingly relevant in the coming years.

#### References

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Part IV For Peace (SDG 2)

# 13 Global Food Security, and Economic and Agricultural Development

Masahiko Gemma

#### Abstract

This chapter aims to present factors affecting global food demand and supply conditions and to find potential solutions to global food security problems. First, the factors determining the supply and demand conditions of food are detailed in relation to the linkages among food, agriculture, and rural development. Second, Japan's success in securing food in the early stage of economic growth as a developing country is presented as example. Discussions on supply and demand determinants in the first part are needed to understand the reasons for success in achieving Japan's food security objectives. Policy implications are derived for developing countries that struggle to ensure global food security. Reading this chapter will assist the readers in discussing potential solutions to global food security problems. Climate change issues are also discussed in relation to global food and energy security. We examine the effectiveness of crop-based energy production and potential conflicts with food production using examples from Japan and the United States of America.

Waseda University, Tokyo, Japan e-mail<EMAIL_ADDRESS>
#### Keywords

Global food security Developing countries Agricultural and economic development Food problem

Global food security issues are discussed in relation to economic and agricultural development in this chapter.

#### 13.1 Introduction

Zero hunger of Goal 2 in SDGs aims to end hunger and to achieve food security and improved nutrition and promote sustainable agriculture. This chapter directly considers the means to avoid hunger and malnutrition and to foster sustainable agriculture in both developing and developed countries.

This chapter is also related to other SDGs. No poverty of Goal 1 can be debated in terms of the changes in social welfare. Social welfare is defined as the sum of consumer surplus, producer surplus, and government surplus in welfare economics. The process of economic development is considered as the procedure of the enhancement of these three surpluses. Income distribution is considered as divisions of social welfare among consumers, producers, and the government.

Goal 7 of access to affordable, reliable, sustainable, and modern energy for all can be also

M. Gemma (&)

© The Author(s) 2023

S. Urata et al. (eds.), Sustainable Development Disciplines for Society, Sustainable Development Goals Series, https://doi.org/10.1007/978-981-19-5145-9\_13

discussed using an example of biomass-based renewable energy generation by the agricultural and food sector.

Sustainable consumption and production patterns of agricultural and food products are discussed in this chapter for Goal 12. This chapter also talks about multi-functionality of agriculture. Agriculture is the only industry that can positively contribute to climate change challenges (Goal 13) through photosynthesis in crop production. Greenhouse gases are emitted in animal production. Life on land is also considered important in agriculture related to Goal 15 within the framework of multi-functionality of agricultural land and rural areas.

We start with what we should know about food security. On the occasion of "World Food Summit" in 2006, it was confirmed that "food security exists when all people, at all times, have physical and economic access to sufficient, safe, and nutritious food that meets their dietary needs and food preferences for an active and healthy life." Food security has four interrelated elements: availability, access, utilization, and stability as summarized by Australian International Food Security Research Centre (2014) in the below.

Availability is about food supply and trade, not just quantity but also the quality and diversity of food. Improving availability requires sustainable productive farming systems, well-managed natural resources, and policies to enhance productivity.

Access covers economic and physical access to food. Improving access requires better market access for smallholders allowing them to generate more income from cash crops, livestock products, and other enterprises.

Utilization is about how the body uses the various nutrients in food. A person's health, feeding practices, food preparation, and diversity of their diet and intra-household distribution of food all affect a person's nutrition status. Improving utilization requires improving nutrition and food safety, increasing diversity in diets, reducing postharvest loss, and adding value to food.

Stability is about being food secure at all times. Food insecurity can be transitory with short term shocks as a result of a bad season, a change in employment status, or a rise in food prices. When prices rise, it is the poor who are most at risk because they spend a much higher portion of their income on food. Social nets can play an important role in supporting people through transitory food insecurity.

Food security is still at risk even in the globalized world. According to FAO et al. (2000), "prior to the COVID-19 pandemic, almost 690 million people, or 8.9% of the global population, were undernourished." This number is in increase. The number of undernourished people is expected to exceed 840 million by 2030 if the current trend continues. Achieving Goal 2 of zero hunger in SDGs is not feasible without improved actions.

We would like to understand demand and supply determinants for food in Sect. 13.2 before discussing food problem in developing countries in Sect. 13.3. Shortage of agricultural products not only dangers food security, but also jeopardizes the process of economic development in developing countries. This is understood as food problem. Lessons learned from the Japanese experiences in overcoming food problem are discussed in Sect. 13.4. Policy implications are derived in Sect. 13.5.

#### 13.2 Demand and Supply Determinants for Food and Agricultural Products

In microeconomics, demand is considered as a function of income and prices. Changes in per capita demand on food and agricultural products are determined by the sum of the changes coming from income and the changes originating from prices. The national-level demand can be also influenced by the changes in national population. The relations can be summarized in the below.

#### National Level

Demand on Food ¼ Population per capita demand Change in demand = Change in Population

	- Determinants
		- 1: Income Change
	- 2: Price Change
	- þ ðgI Change in per capita Income)
	- þ ðgp Change in Price)

Since income elasticity of demand is larger in the absolute value than price elasticity for agricultural and food products, per capita income and population are the critical determinants for the national-level demand in developing countries. When income elasticity of demand is negative, the item is called as inferior good. For the estimation of the future changes in demand, an important macroeconomic indicator of economic growth rate is typically utilized as proxy for the rate of change in per capita income. The information on per capita income is not easy to obtain even from the household survey. It is not often accurate as respondents tend to keep the private information such as revenue information secrete.

$$\overbrace{\frac{\Delta D}{D} \times 100}^{\text{Charge in food demand } (\%)} = \overbrace{\frac{\Delta N}{N} \times 100}^{\text{Charge in population } (\%)}$$

$$\overbrace{\frac{\text{Charge in per capita food demand } (\%)}{\eta\_1 \frac{\Delta \left(\frac{f}{N}\right)} \times 100 + \eta\_p \frac{\Delta P}{P} \times 100}^{\text{Charge in food demand } (\%)}}$$

þ Change in per capita income (% ) Change in price (% )

$$\frac{\left(\frac{P}{\Theta}\right)\_{i} - \left(\frac{P}{\Theta}\right)\_{i-1}}{\left(\frac{P}{\Theta}\right)\_{i-1}} \times 100\tag{100}$$

Let me explain how the demand estimate can be made using a numerical example.

Example of demand predictions

$$\overbrace{\frac{\overbrace{\Delta D}{D} \times 100}^{\text{Change in food demand} \left(\%\right)}}^{\text{Change in food demand} \left(\%\right)} = \overbrace{\frac{\Delta N}{N} \times 100}^{\text{Change in population food demand} \left(\%\right)}$$

$$+ \overbrace{\eta\_I \frac{\Delta \left(\frac{I}{N}\right)}{\left(\frac{I}{N}\right)} \times 100 + \eta\_\rho \frac{\Delta P}{P} \times 100}^{\text{Change in food demand} \left(\%\right)}$$

Change in per capita income Change in price ¼ 0:8% þ ð Þ 1:8 ð Þþ 1% ð Þþ 1% ð Þ 0:1 ð Þ 1% ¼ 2:7% ) ¼ 0:027ð Ratio taking 1 as baseÞ D2021 ¼ 1:50 ðmillion tons) D2022 ¼ D2021 ð Þ¼ 1 þ 0:027 1:50 1:027 ¼ 1:54 1ð Þð :5405 million tons) D2023 ¼ D2021 ð Þ 1 þ 0:027 2 ¼ 1:50 ð Þ 1:027 2 ¼ 1:58 1ð Þð :5821 million tons)

The following is a set of assumptions to characterize the rice economy in Taiwan. Assuming the rice demand in 2021 was 1.50 million metric tons, we attempt to predict the rice demand for the following two years (2022 and 2023).

Population growth rate: ΔN/N 100 = 0.8%

Change in national income: D(I/N)/((I/N)) 100 = −1% (Economic growth rate is often used as proxy).

Rate of price change: DP/P 100 = −1% (With advancement in trade liberalization, domestic prices tend to decline.)

ηI: Income elasticity of demand (% change in demand divided by the % change in per capita income) = −1.8 (This food item is considered as inferior good).

ηp: Price elasticity of demand (% change in demand divided by the % change in price) = −0.1 (All the food items are normal goods. Every ηp is negative).

As for supply determinants, there are two ways to increase agricultural production (supply of products): ① increase in input use and ② improvement in total factor productivity (TFP). TFP can be improved through (a) technical change and (b) improvement in production efficiency. This analytical framework can apply to all products including agricultural and food products.

How does (b) work? If incentives to work hard function, or education and training are implemented, production efficiency improves relative to the peer producers with best practice. TFP will be improved, then production goes up.

Assuming Y is output and I is total input (aggregated figure for all the inputs),

Y: Output DY: Output change DY Y : Rate of change in output.

I: Total input.

Y I : Total factor productivity (TFP).

We can derive the relationship among the change in output, the change in total input and the change in TFP on the right-hand side from the numerical relations among output, total input, and TFP on the left side.

$$\begin{aligned} Y &= I \cdot \frac{Y}{I} \Rightarrow \frac{\Delta Y}{Y} \times 100\\ &= \frac{\Delta I}{I} \times 100 + \frac{\Delta \left(\frac{Y}{I}\right)}{\frac{Y}{I}} \times 100 \end{aligned}$$

We utilize the equation on the right-hand side in the above to conduct growth accounting studies to examine the sources of output growth.

Why do we use rates of change for empirical analyses? This is because we can be free from problems with aggregation of inputs measured in different units by using rates of changes in showing the relationship between output and the sources to influence the output (inputs and productivity).

The rate of change in total input can be measured by the following equation.

$$\begin{array}{c} \Delta I/I\*100 = 0.6\*\Delta L/L\*100 + 0.4\*\Delta K/K\\ \ast 100 \end{array}$$

0.6 and 0.4 are the weights measured in cost shares. Cost shares become the weights in the calculation of total input for a Cobb–Douglas type production function. We assume that the production function is a Cobb–Douglas type of Y ¼ a0 La1Ka2, where a1 = wL/PY and a2 = rK/ PY under the profit maximization principle for the behavior of producer.

Which approach is preferred to increase output?

① increases in input use or ② improvement in total factor productivity (TFP)?

② is preferred to ①. This is because ② can save costs and maximizes profit. ② is also a sustainable approach. This leads to environmental conservation.

Historically speaking, ② improvement in total factor productivity (TFP) explains approximately 70% of output growth for Japanese agriculture over the past 120 years.

For most developing countries, because of lack of (a) "technical change" and (b) "improvement in production efficiency", ① "increasing use of total input" is the dominant determinant for output increase. Developing countries need to move to Approach ②. We will discuss the approach by Japanese agriculture in Sect. 13.4 and policy implications in Sect. 13.6.

#### 13.3 Food Problem in Developing Countries

In the process of economic development, the speed of increase in demand on agricultural products exceeds the speed of increase in the supply of agricultural products. This results in increase in the prices of agricultural products. The nominal wages in non-agricultural sectors need to be raised. This slows down the speed of economic development (through slowdown of

Fig. 13.1 Dual-sector model in economic development. Note The author has been benefitted from Hayami and Goda (2002) and Hayami (1986) regarding their debates

on agricultural development using the dual-sector model of economic development developed by Lewis (1954)

enlargement of non-agricultural sector activities mainly in the manufacturing sector). We call this challenge in economic development as food problem. We would like to discuss how food problem happens first. We will then consider the short-run and long-run solutions to food problem using Fig. 13.1.

In our economic development model for developing countries, we assume the following in the agricultural product market and the labor market in the non-agricultural (manufacturing) sector.

①Industrial development is a key for economic development. In the history of economic development in Japan, the manufacturing sector developed about 15 times faster than the agricultural sector for 1880–1980. Other industrialized countries followed the same path as Japan.

②The wage is set at the lowest for survival (in the subsistence level) in the non- agricultural sector. We assume that labor supply exceeds labor demand. (A large proportion of the workers is under unemployment.)

③Food (agricultural products) is a wage good. (The share in the total expenditure is high so that the nominal wage is influenced by the price level of food (agricultural products).) The food price is an important determinant of the nominal wage in the non-agricultural sector. Even powerful employers need to agree to a pay raise in the nominal term to avoid a decline in labor productivity.

Here is the explanation of the labor market in the manufacturing sector shown in (b) of Fig. 13.1.

When increase in agricultural product prices happens, the following will be observed in developing countries.

The solution to food problem in the long run is to shift the supply curve to the right by reducing the cost of production through technical change. This can be achieved through technology transfer from developed countries.

Since successful technology transfer requires human resource development and improvement in agriculture and rural infrastructure, it is a timeconsuming process to overcome food problem in developing countries. In the short run, the country can, assuming lower international prices, choose to import the difference between Q1' and Q0. However, the import necessitates domestic reserve in foreign currencies to import.

Alternatively, food aid from bilateral and multilateral donors can be another shot-run solution for the developing countries. What we observe most is cheap food policy. The governments often intervene to the agricultural product market to keep the prices low. The governments exclusively buy at the price of P1 and sell at P0 where P0 < P1.<P1\*. Food rationing is frequently present. Many relied on this third option in Africa. However, this approach called "cheap food policy" has a structural problem. Incentives for agricultural producers to produce more remain low. The supply curve will not significantly shift to the right.

#### 13.4 Japanese Experiences for Overcoming Food Problem

Japan overcame food problem by shifting the supply curve of agricultural products to the right. We would like to learn lessons from the experiences of Japan. Agricultural product prices were kept low to avoid the hike in real wages in nonagriculture. We study the history of agricultural development in Japan in relation to economic development to understand what is needed to shift the supply curve. Policy implications are derived for the countries which are still struggling for food problem.

The agriculture sector subsidized the manufacturing sector in the early stage of economic development in the Meiji period. A new land tax scheme was introduced. Feudal tax (in kind) levied in proportion to quantities was replaced by a cash tax system. This (land tax) source of revenue accounted for 70% of the Meiji government revenue. Modernization of the Japanese economy was made possible using the government revenue from land tax.

The tax rates were determined in relation to the land value. 3% of land value was annually imposed as land tax. Many small-scale farmers failed to pay for the land tax and had to give up land ownership. Disparities in land asset ownership and income enhanced among rural households as a result.

Technologies imported from Europe and North America did not work for agriculture. The agricultural technology suited for large-scale production in dry areas was not useful for Japanese agriculture in wet areas. Instead, improvement of indigenous rono (veteran farmers) techniques through the application of modern science was set as means for agricultural development. Technology developed was intended to increase land productivity and was biased toward land saving. Scarcity of agricultural land represented the major constrain on agricultural development in Japan. New technology has been induced to develop for saving a scarce factor of production following the induced innovation hypothesis (Hayami and Ruttan 1985).

In terms of sources of growth (supply determinants), the contribution of total factor productivity (TFP) has been dominant in Japanese agriculture. When Japanese agriculture was rapidly expanding its production in 1880–1920 in order to conquer food problem, the growth in TFP accounted for 67% of the output growth as shown in Table 13.1. Domestic technology transfer of land saving technology was encouraged by the government to localize high yielding rice varieties from Southern and Western Japan in Northern and Eastern Japan.

The Japanese government helped the process of domestic technology transfer with the policies listed in Table 13.2. Rice yields (land productivity) increased significantly because of (1) development of a nationwide network of research, experimental, and extension stations, (2) improvement in land infrastructure, and (3) increase in availability of chemical fertilizer. High yielding rice varieties are heavy in grains. The height of rice plants should be short to stand firm even in rainstorms. Better water control became required for the high yielding rice varieties. Land

Source Adapted from Hayami and Godo (2002), Table 4.4 on Page 99

improvement efforts to install irrigation and drainage facilities in rural areas have been made. The government assisted the efforts by local land improvement associations with easier decisionmaking rules and formal legal status of the land improvement associations and financial supports through the newly created public financial institution which was able to provide long-term soft loans.

#### 13.5 Conflicts Between Energy Security and Food Security Goals

Securing natural resources for energy use has been always a challenge for natural resourceless countries like Japan. The use of biomass resources was thought to be a good idea when crude oil and other natural resource prices were record high in the 2000s before the economic crisis happened in 2008.

In the USA, a promotional policy to produce bioethanol from maize started. This created a conflict between energy crop and food crop in land use. The agricultural product prices as well as land prices soared. Biofuels came out from agricultural land, competed with food and thus endangered food security.

Table 13.2 Government policies for agricultural development in Japan

This bank aimed to extend long-term credit for land infrastructure investments

• 1888—Establishment of the Tokyo Artificial Fertilizer Company

Commercial production of superphosphate began

• 1893—National Agricultural Experiment Station

This was created to counteract the request to reduce land tax

Despite its meager (insubstantial) resources, it was able to work on indigenous technological potential

• 1894—National Agricultural Association

A larger and more systematic organization was required for promoting agricultural interests, one that could exercise political influence

• 1899—Fertilizer Control Law

This ensured quality of fertilizer being sold to the farmers

• 1899—Arable Land Reallotment Law

With this law, the participation in a land improvement project became compulsory upon the consent of more than 2/3 of the landowners in the region concerned owning more than 2/3 of the arable land

Legal person status was given to the land improvement associations so they can receive credit from financial institutions such as Japan Hypothec Bank

Source Chapter 2, Hayami and Yamada (1991)

As land stays scarce in Japan, promotion of energy crop production is not desirable. Use of the second-generation (more efficient) technology is an option. High cost of production is a problem. Direct use of local forest resources such as wood chips is becoming popular in the local level in Japan. There is no significant development of bioethanol production beyond pilot cases.

Problems exist related to bioethanol production and use in the local communities in Japan. First, legal problems occurred in getting permissions to sell biofuels to others, getting permissions to blend bioethanol with gasoline, and getting permissions to modify vehicles to use blended gasoline. Technical problems are high cost of production and low-energy efficiency. Biofuels use renewable resources when produced, but still emit greenhouse gasses when used. If more energy is used to produce and emit lots of greenhouse gasses, it would not be sustainable to utilize biofuels.

Promotional policy of bioethanol production has implications on alternative energy production, food security, climate change problems, agricultural and industrial development, and rural and community development. Political decisions need to be made.

Unless we use by-products from agricultural and forest production or use marginal land for energy crop production, we will face conflict with food security. Improvement in energy efficiency is another technological challenge.

#### 13.6 Concluding Remarks

Policy implications for developing countries are discussed related to global food security and related to SDGs.

Production increase in agriculture has come from the improvement in productivity in Japan. Increasing use of inputs has been playing a minor role with the exception of the food shortage period of the late 1940s and the 1950s. Zero hunger (Goal 2 of SDGs) and zero poverty (Goal 1 of SDGs) were achieved in Japan thanks to the efforts for technical change over time.

Production increase in agriculture for the rest of Asia had been observed based on the increasing use of inputs. However, in recent decades, productivity improvement has become important, especially in Korea, China, and ASEAN countries.

Governments can play significant roles for promoting productivity growth-based output growth for securing the availability for food security in developing countries. Like Japanese agriculture was helped, the governments can develop research and extension networks. Direction of technical change should be the direction to save a scarce factor of production for economic and sustainability reasons. The scarce factor in Japanese agriculture was initially land in the Meiji period. Later, in the post-World War II period, labor has become scarcer than land. Biological technology of high yielding rice variety was developed with scarcity in land. Mechanical technology has been developed in recent years. Researchers and policy decision makers might have to carefully observe the scarcity of individual inputs. Improvement in agricultural and rural infrastructure such as irrigation and drainage systems would be quite critical. High yielding rice varieties have been more effectively adapted to the new agricultural and rural environment in the new locations with better control on water in the paddy field in Japan.

As for other functions of agricultural and rural development like energy security and mitigation of climate change, many governments are still struggling with what to do locally. The nationallevel global goals including SDGs have been set by the governments in developed as well as developing countries. There exist conflicts between different SDGs as we discussed the example of energy security and food security in this chapter. We hope to collect the cases of good practice from local stakeholders and widely share the lessons learned from them for the globalized world.

#### References

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Part V For Peace (SDG 16)

# 14 Designing Allocation Rules in Economic Problems

Yoichi Kasajima

#### Abstract

How should we divide a resource among a group of agents who have conflicting claims for it? A typical example is the bankruptcy problem: The liquidation value of a bankrupt firm must be divided among creditors. An alternative example with the same mathematical structure is the taxation problem: The cost of some public projects must be collected by a government through taxing incomes. An awards vector determines the division of the resource among the agents. An allocation rule, or simply a rule, is a function that associates an awards vector to each problem of this kind. Our goal is to construct "good" rules. By that, we intend to learn how to achieve one of the Sustainable Development Goals (SDGs) (Goal 16: Peace, Justice and Strong Institutions). In our study of rules, we follow the axiomatic approach. That is, we (i) formulate rules (mathematically), (ii) introduce "desirable" properties of rules (called axioms), and (iii) study those implications (e.g., identify rules that satisfy those properties). We present some well-known characterization results based on the properties analyzed.

#### Keywords

Economic problems Claims problems Allocation rules Axiomatic approach

#### 14.1 Introduction

The problem of allocating scarce resources among agents is called an "economic problem." The resource could be a variety of goods, including natural resources, foods, clothes, houses, etc. It could also be economic services, money, time, or human resources. An "allocation rule," or simply a rule, is a systematic way to determine an answer (or a recommendation) to such an economic problem. More precisely, it is a mapping that associates an allocation with each economic problem. Our goal is to study how to design "good" rules. By that, we intend to learn how to achieve Goal 16 (Peace, Justice and Strong Institutions) of the Sustainable Development Goals (SDGs). Designing good rules for economic problems makes each nation wealthy and achieves world peace. Fairness (equity) is the key to designing good rules in this chapter. However, how can we construct a fair rule? How can we evaluate whether a rule is fair? We adopt an axiomatic approach. That is, we (i) formulate rules (mathematically), (ii) introduce "desirable" properties of rules (called axioms), and (iii) study Y. Kasajima (&)

Waseda University, Tokyo, Japan e-mail<EMAIL_ADDRESS>
© The Author(s) 2023

S. Urata et al. (eds.), Sustainable Development Disciplines for Society, Sustainable Development Goals Series, https://doi.org/10.1007/978-981-19-5145-9\_14

those implications (e.g., identify rules that satisfy those properties).

The value of the designed rule depends on the types of economic problems that we face. Among the many economic problems, we consider one of the simplest economic problems called the "claims problem" (O'Neill 1982), described as follows.1 There are a set of agents and a resource to divide among them. Each agent has a claim over the resource, but the quantity of the resource is not sufficient to cover all claims. We assume that the resource and each agent's claim are non-negative real numbers. The question is how to allocate the resource to the agents. For instance, suppose that there are three agents: agents 1, 2, and 3. Let c1 ¼ 100, c2 ¼ 200, c3 ¼ 300 be the claims of agent 1, agent 2, and agent 3, respectively, and E ¼ 250 be a resource to divide. As c1 þ c2 þ c3 [ E, the resource is clearly not sufficient to cover all claims. However, we still have to divide E ¼ 250 among the agents. A typical example of this is bankruptcy: The liquidation value of a bankrupt firm has to be divided among creditors. Another example with the same mathematical structure is taxation, where the cost of some public projects must be collected by a government through taxing incomes. Here, each agent's claim is considered the agent's pre-tax income, while the resource corresponds to the amount of money needed to implement the project. However, we will use language based on the bankruptcy interpretation.