East Asian Economic Integration Report

Manuel Panagiotopoulos
East Asian Economic Integration
March 2012
EAST ASIAN ECONOMIC INTEGRATION BY MANUEL PANAGIOTOPOULOS
A REPORT FOR THE AUSTRALIAN TRADE COMMISSION
MARCH 2012
This information is provided on the basis that it carries no warranty of completeness, accuracy or suitability for any particular purpose. The Australian Trade Commission (Austrade) denies liability for any loss arising from reliance on such information, such reliance being entirely at the users discretion. In any business decision, independent professional advice should be sought.
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Key Questions: Q 1: There is much discussion around East Asian regional integration (notably between and across China, Japan, Korea, the Association of Southeast Asian Nations -ASEAN and Australia). Is it regional integration or global integration centred on China? Q 2: How is regional integration affecting importers and exporters and investors in the region by priority sector: construction, education, Information & Communication Technology (ICT), financial services, legal services, manufacturing (Elaborately Transformed Manufactures -ETMs and Simply Transformed Manufactures - STMs) and Mining Equipment and Technology Services (METs)?
Hypotheses: That economic integration has been occurring at the regional level in East Asia, which is evident in the levels of intraregional trade, the expansion of intermediate goods trade and the coordination amongst fragmented parts of the production processes in the electronic and automotive sectors. Further, while accepting the huge changes that have been created by Chinas entry in this process, it remains a regional integration, one amongst three (European Union - EU and the North American Free Trade Agreement NAFTA nations being the others). The huge levels of foreign direct investment (FDI) in the region, coupled with the ability to finely slice the value-chain, should provide entry points for providers of goods and services to these producers and to the countries which host them.
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Conclusions and Recommendations
The answer to Question 1 is that there is regional economic integration ongoing in East Asia largely driven by market forces but assisted by freer trade negotiations. While China is playing a key role, however, it is not the centre of globalisation. There are three regional hubs of globalisation: United States/NAFTA, Germany/EU and China-Japan/East Asia. The ongoing trend of regional integration will create opportunities for Australian companies, primarily in the services and mining sectors and niche manufacturing, as the extensive production networks intersect with numerous demands for services and products that are outsourced. There is a complementarity between demographic factors, macroeconomic policies, trade and investment policies and positive externalities from extensive FDI. These will most likely result in a long-term rise in per capita gross domestic product (GDP) in the East Asia region such that consumer demand will become self-sustaining. There has been significant under-investment by Australian firms in the Asian region, although it has the highest growth rate of the regions reviewed in this study. Trade and investment policies continue to matter. There will be a critical role for the governments to promote further multilateral trade and investment liberalisation at the macro level and provide on the ground guidance and support to minimise the transaction and information costs of Australian companies that venture into the region. Regional and bilateral market intelligence and the search for appropriate partners are two key services. The mapping of significant regional value-chains in automotive, infrastructure, financial services, health, food and pharmaceuticals would provide valuable information for Australian companies. The detailed maps of value-chains allows for the disaggregation of products and services into more discrete units. A variety of cost competitive models, locations, potential partners and the key Australian value-add will become clearer. Australian companies could expand their relationships with Japanese companies to enter the East Asian region. Japanese companies have been major investors in East Asia for four decades, with large production networks throughout the region. Japanese companies are also expanding their non-manufacturing investment into the region. Australian companies have many years of close collaboration with Japanese companies in Australia and Japanese companies have upgraded their perceptions of the capabilities of Australian firms. The recent example of joint business missions in infrastructure and public private partnerships (PPPs) in India and Indonesia could be repeated in other sectors.
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CONTENTS
Section 1 Chapter 1 Chapter 2 Chapter 3 Chapter 4 Chapter 5 Chapter 6 Chapter 7 Chapter 8 Chapter 9 Literature Review Definitions of economic integration De facto and de jure integration Trade Patterns Investment Patterns Production fragmentation / Intermediate goods trade Measurement issues (Trade Intensities, Value-added, Input-Output) Multinational Firm Perspective (Interfirm and intrafirm transactions) Introduction to the Value-chain approach Policy (FTAs, rules, regulations) 7 12 17 20 24 30 33 36 39
Section 2 Chapter 10 Chapter 11
Commercial Aspects Value-Chain Approach in Detail Value-Chain Implications Regional and Local Strategies Services Manufacturing Building on the Japanese Relationship 58 61 73 78 43 54
Chapter 12 Chapter 13 Chapter 14 Section 3
Firms responses to policy decisions (FTAs) Final demand patterns in Asia Examples Australian and Japanese companies strategies in Asia References
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Chapter Outlines Section 1 Chapter 1 Literature Review Definitions of economic integration: Includes overview of economic integration, definitions and trends and the question of China-centred globalization.
Chapter 2
De facto and de jure integration: includes distinction between de facto and de jure integration and their relationship in historical and logical sequence.
Chapter 3
Trade Patterns: includes latest figures on overall intra- and extra-regional exports and imports in East Asia, plus comparisons with EU and NAFTA and questions of validity of using trade data.
Chapter 4
Investment Patterns: includes historical flows and stock data for FDI, general factors which have promoted FDI and the growth of intra-regional FDI.
Chapter 5
Production fragmentation / Intermediate goods trade: includes data on production fragmentation in East Asia, both history and underlying factors, the growth of intermediate goods trade and the locational aspects of economies of scale.
Chapter 6
Measurement issues): includes overview of various methods of analyzing intraregional trade beyond total export and import data, e.g., value-added by industry, product and country and more generalised input-output data.
Chapter 7
Multinational Firm Perspective (Interfirm and intrafirm transactions): builds on earlier chapter 4 to provide micro-level data on the history and strategy of MNEs in East Asia, a comparison of Japanese and US MNEs and the choices made by MNEs regarding intrafirm and interfirm transactions.
Chapter 8
Value-chain approach: includes an overview of the value-chain approach in studying intra-regional trade and production fragmentation.
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Chapter 9
Policy (Bilateral and multilateral FTAs, Coverage and gaps, Unilateral reform): includes development of trade and investment policies in East Asia, both bilateral and multilateral FTAs and the gaps which persist.
Section 2 Chapter 10
Commercial Aspects Value-chain approach: a more detailed analysis of the value-chain method as the most appropriate method to use for uncovering commercial opportunities. Also includes existing case studies of industries. Value-chain implications for firms strategies: regional and local strategy; services sector; Australian manufacturing; building on the Japanese commercial relationship. Firms responses to policy decisions (FTAs): includes the impact of FTAs on firms commercial decisions, the response of firms to different types of FTAs and the impact of shortcomings such as numerous Rules of Origin.
Chapter 11
Chapter 12
Chapter 13
Final demand patterns in Asia: includes contrasting perspectives on the level of dependence of East Asian growth on extra-regional demand, the impact of second and third-generation suppliers on technology upgrading and per capita income, long-term forecasts for the East Asian region, with special emphasis on the development of regional final consumption growth, urbanisation and the contribution made by the existing production networks of MNEs and local firms.
Chapter 14
Examples Australian and Japanese companies strategies in Asia.
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Chapter 1. Economic Integration
Discussion and analysis of economic integration, whether regional or global, is dominated by trade and investment. Essentially, though, these two are just different aspects of international commercial transactions. Trade is usually the first activity to be undertaken by firms, for various reasons of production and transaction costs, followed by FDI, which, in turn, creates more trade. This pattern is especially marked when FDI takes the form of the placement of distinct but connected parts of a production process in diverse geographic locations, which has been proceeding mainly during the past four decades in East Asia. The defining element is that the locations are in different countries, i.e., it is part and parcel of the rapid increase in the size, scale and scope of MNEs. Starting from the textile and clothing industries, this disaggregation process has moved into footwear, automotive, electrical equipment, electronics, precision goods, publishing and others. This process has been given several labels, depending on the theoretical perspective of the analyst: production sharing; international production fragmentation; vertical specialization; slicing the value chain; and outsourcing. Each of these labels, in turn, influences the way trends and statistics are interpreted and policies are formulated. In general, there are three factors that have supported this rapid transformation. First, rapid advancements in production technology have enabled industries to slice the value chain into finer, portable components. Second, technological innovations in communication and transportation have shrunk the distance that once separated the worlds nations, and improved the speed, efficiency, and economy of coordinating geographically dispersed production processes. This has facilitated the establishment of services links that combine various fragments of the production process in a timely and cost-effective manner. Third, liberalization policy reforms in both home and host countries have removed a considerable amount of barriers to trade and investment (Athukorala, 2010).
As these processes have moved from single to multiple country locations, the causal and reinforcing relationship between trade, FDI, technology transfer and capital flow has resulted in what is called regional economic integration. The regional aspect refers to the geographic proximity of the various countries, although there remains a subjective element about the extent of the region. It also does not imply a lack of commerce outside the region.
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Japanese companies have been a driving force of the process since the 1960s, when Japan first emerged as a major exporter. Then the second generation, the NIEs (Hong Kong, South Korea, Singapore and Taiwan) followed in the 1970s. In the 1980s the third generation included Malaysia, Thailand, Indonesia and the Philippines) and finally China and Vietnam, in the 1990s. While unilateral liberalizations by individual countries helped initiate export-led development in the region, the increasing economic integration of East Asia has been an important factor in sustaining the regions growth (Haddad, 2007). Since 2000, East Asias trade expansion has been due to the processing of inputs goods or production sharing, with China as the main manufacturing and assembly centre importing intermediate goods from neighboring countries. The massive movement of Asian firms into China has integrated China into the regional economy and the region into the global economy. The production networks that initially linked Japanese industry vertically with Korea and Taiwan (China) in low-skill assembly activities have gradually been transferred to lower-wage countries such as Malaysia, the Philippines, and Thailand. (Indonesia, however, has shown little success despite even lower wage levels.) These networks are also now being transferred to China and Vietnam (Haddad, 2007).
The mechanism for this transformation has been the multitude of multinational national corporations (MNCs), which mobilize resources across countries, regions and the world through vertical and horizontal networks of procurement, production, distribution and sales. As a result, regional economic integration has been brought forth into existence and the process of globalization intensified. Thanks to the openness of global trade and foreign investments advocated by WTO and responded by national authorities, together with the advancement of transportation and communication technologies, MNCs are able to rapidly expand with much less obstacles than before (Yang and Huang, 2011).
In general, the determinants of integration amongst different economies are proximity, market size, growth rate, trade and investment policies and corporations. International firms contribute to integration because their cross-border investments in affiliates and their joint ventures and strategic alliances are trade promoting. MNE affiliates are more trade oriented than local firms, and the relationship between trade and their investments in local affiliates is increasingly complementary. Historically, the major foreign investors in East Asia have been Japanese and American firms. Since 1980, however, Taiwanese and Korean firms and, more recently, firms 8
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from Southeast Asia have become more significant sources of investment flows in China, Indonesia, Malaysia, Thailand, and the Philippines. (Dobson, 1997).
There has also been investment by European firms, especially in Singapore and Indonesia. Investment is distributed into natural resources, wholesale trade, services and manufacturing, which is concentrated in the electronics and electrical, textile and garment, chemical, and auto industries (Dobson, 1997).
The impact of trade- and investment-friendly policies has been beneficial to East Asia, more so than other regions. Economic liberalization has provided low income economies with opportunities to become integrated into the regional production network, enabling the sequential takeoff of industrialization in these economies (Hamaguchi, 2007).
Definitions of economic integration include both process and structural elements. Lower barriers to trade and investment allow the more efficient use of economic resources, generate employment in less developed economies, narrow the gaps in development and sustain long-term regional economic growth. Economic integration in East Asia has already progressed in a de jure fashion, with bilateral and multilateral trade agreements. Most of the trade agreements in the region include elements that go beyond trade and look toward deep economic integration in the sense that virtually all of them intend to include provisions on trade facilitation, services liberalization, investment liberalization and facilitation, economic cooperation, and reforms and harmonization of domestic rules and regulations, in addition to the reduction and elimination of tariffs (Corbett and Umezaki, 2009). Another formulation of a definition: Economic integration generally refers to a staged process through which a group of countries gradually coordinate or merge their economic policies over time. This coordination may be bilateral or carried out through a multilateral organization such as ASEAN. The purpose of economic integration is to lower trade barriers and other economic obstacles between countries, thereby expanding markets and trade, lowering prices, and improving the competitiveness of trade partners through lower costs and economies of scale. For some economic integration arrangements, the ultimate goal is a single market in which there is a free flow of goods, services, capital and labor, and harmonization of economic and monetary policies. In other cases, member countries design the arrangement to be a free trade area, a customs union, or a common market, with no intentions to integrate further (USITC, 2010).
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However, the wider aspect of the relationship of the region to the global economy and Chinas position also has to be addressed. One of the key questions of this project relates to the nature and extent of the transformation of world production with regard to Chinas impact. The question then becomes, is it regional integration or globalisation or globalisation centred on China? China has loomed as the largest topic of interest since the decade beginning 2000. There is a tendency to see China as the hub of Asia and Asia as the hub of global manufacturing. A typical quote: The recent advent of free trade agreements (FTAs) will likely have a marked impact on Asias trade policy and its cherished status as the global factory (Kawai and Wignaraja, 2009). (Global factory is a loose usage, implying one hub, but see below for the counter argument.) The analyses of intermediate trade or production fragmentation are more nuanced, but still retain the focus on China: The progressive integration of world markets has led to the fragmentation of production across countries and the formation global supply chainsThe evidence arising out of this literature points to a strong expansion of production sharing and vertical trade in the global economy, particularly since the 1990s. Nowhere has the expansion of vertical trade networks and supply chains been more pronounced than in Asia, largely in relation to the Peoples Republic of Chinas (PRC) ascension as a regional hub of assembly and global trade power. (Ferrarini, 2011). However, Ferrarini (2011) has carried out some recent careful analysis on the development and interaction of regional networks and how they connect to the global network using a measure of the direction and intensity of countries network relations as providers and assemblers of parts and components within the international production networks. This is achieved through the Network Trade Index (NTI), which is definedas a supplier countrys share in parts imports by a processing industry in the hosting country, weighted by that industrys share of total final goods exports. The index is computed at the level of industries, or sectors, and for each country pair in both directionse.g., from Japan to the PRC and vice-versaand is then averaged and normalized to derive a more synthetic indicator for comparison across countries and industries (Ferrarini, 2011). Ferrarinis results show that there are three major regional hubs. The US is the centre of one hub, based on the automotive and electrical/electronic production network in NAFTA, plus its connections to Asian electronics production. A second hub is Europe centred on Germany, especially via the automotive production network. The third hub is the Asian network, especially in relation to trade in parts and components within the electric and electronics industries surrounding the PRCJapan axis, also involving a number of economies in East and Southeast 10
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AsiaApart from Mexicomainly because of its maquiladoras network ties to the US industries and marketsthe analysis suggests that outside East and Southeast Asia, developing countries are not yet involved in global production networks to any substantial degree (Ferrarini, 2011). The final point made above is fundamental for this project, hinting at the more sustainable economic future of the Asian region. Further analysis elaborated in Chapter 5, below, on value-added statistics, also does not support a China-centred globalisation.
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Chapter 2. De Facto and De Jure Integration It is useful and instructive to distinguish between economic integration that occurs de facto and de jure. The former reflects the idea that the private sector reaches across national boundaries to expand and coordinate trade and investment in ways that create a larger, more integrated market without the mechanism of trade and investment agreements. De jure integration is promoted by the use of formal treaties and legal instruments: There is no doubt that these two instruments of integration are very much related and indeed ultimately they are complementary. Integration of neighboring markets without formal regional trade agreements can create uncertainty among businesses since the institutional foundations may not be sufficiently clear and transparent. Integration by agreements can be vacuous if the underlying economic factors are not favorable for integration (Aminian et al, 2008). Monetary union amongst countries within a region is often talked about as an advanced step in de jure integration. Although there have been some policies aimed at financial cooperation, there has been little practical progress in this area. Most of the important legal accords have occurred in the real sector, with a rapid increase of FTAs in East Asia since the beginning of the 21st century. Perhaps this is due to a natural sequencing of economic integration, i.e., first the real sector and then monetary integration, which is the experience of, for example, the EU. Or perhaps it results from more coincidental factors, e.g., the global movement toward FTAs or the fact that, for whatever reason, there is a strong demand for economic cooperation, and the real sector is the easiest to negotiate in practice and is less compromising in terms of perceived national sovereignty. Is there a case for monetary union in East Asia? Is there a case for wider FTAs? (Plummer & Wignaraja, 2007). In the current and ongoing fiscal crisis in the EU, with the Euro under constant pressure of becoming obsolete, such questions must loom even larger in Asia than previous periods. It would be completely surprising if any moves towards currency union in Asia moved past the stage of rhetoric for the foreseeable future. ASEANs first major economic integration initiative was the AFTA in 1992, which is effective in the original members. The transitional members (Vietnam, Laos, Myanmar and Cambodia) have additional time to fully comply. ASEAN also has formed the ASEAN Investment Area (AIA). These efforts at industrial cooperation have been designed with essentially the same goal in mind as AFTA: reduce transactions costs associated with intraregional economic interaction 12
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(Plummer and Wignaraja, 2007). The goal of an ASEAN Economic Community (AEC) was proposed at the ASEAN Heads of Government meeting in Phnom Penh in November 2002. Originally aimed for 2020, it was moved forward to 2015 in 2007. The AEC would crate a single market for goods and services and allow freer movement of capital and people. Although very ambitious for ASEAN, it remains a challenge to be implemented in a context where tariff removal is the dominant instrument. In the past few years there has been a proliferation of FTA proposals in Asia, including an Asia Pacific Free Trade Area (APFTA), which would include all APEC members, an East Asian Free Trade Area, proposed by Japan, and a proposal to create an FTA between the ASEAN+3, New Zealand, Australia, and India (ASEAN+6). As the Doha Round of negotiations is currently indefinitely suspended, it is expected that regional and bilateral trade deals will become even more prevalent. The creation of Preferential Trade Agreements (PTAs) such as Free Trade Areas (FTAs) is by no means new. But the sheer number and the speed with which these agreements have been negotiated in the past ten years are simply astonishing. By 2005, all but one WTO member was trading under one or more PTAs (Aminian et al, 2008). The countries in East Asia, until very recently, have achieved market integration via the market rather than formal agreement. East Asian economic integration is much greater than Latin America, which has used mainly the de jure process. Integration using the marketplace or via de facto agreements (together with business-friendly policies by individual countries) leads to more intense integration than de jure agreements the proper sequencing of the two forms of integration should first be the freeing of the domestic private sectors which allow them to mature and to use the international markets to integrate, before establishing legal treaties to further deepen the relationshipsTrade agreements are both economic agreements as well as foreign policy agreements. Regional trade agreements can also be inward-looking or outward oriented. To keep the primary focus on the open-trade and economic objectives, it is thus important to first develop a thick market for exporters and traders, who can pressure the government to pay attention to the signals of the economic forces (Aminian et al, 2008). A number of factors have contributed to the recent proliferation of FTAs in the East Asian region. Firstly, the establishment of NAFTA and the EU created the need for a response to the barriers erected by these FTAs and to the opportunities to expand exports within East Asia. Secondly, the stalled discussions of the Doha Round focused members attention to smaller, more achievable 13
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agreements. Thirdly, the Asian financial crisis of 1997, which prompted more regional cooperation initiatives. Finally, rivalry among East Asian economies over leadership in the region has activated strategies involving FTAs (Haddad, 2007). The Asian financial crisis is probably the most important catalyst for the turn to de jure integration. Before that crisis, the East Asian countries had been convinced that the de facto, market-based approach they had used was the more successful. But the crisis and its rapid movement throughout the region, plus the inadequate response by the SU and IMF demonstrated the weaknesses of informal regional cooperation and gave East Asians a strong impetus to search for a regional mechanism that could forestall future crisisThe crisis and its subsequent contagion to a number of economies in Northeast and Southeast Asia painfully demonstrated that the East Asian economies were closely related and a resolution to the crisis could require a regional cooperation...The ASEAN+3 Summit in November 1999 released a Joint Statement on East Asian Cooperation that covers a wide range of possible areas for regional cooperation (Aminian et al, 2008). Again it is worth remembering that trade integration within East Asia was high even before the Asian financial crisis. In 1995, 48.7% of East Asian exports were intra-regional trade integration among ASEAN countries (25.2% in 2005) is higher than the trade integration among ANDEAN community (8.2% in 2005) or MERCOSUR countries (12.9% in 2005) (Aminian et al, 2008). The de facto process of East Asia was more effective than the de jure process used in Latin America and it may be a better sequence for de jure to follow de facto because this sequence can enhance the internal bargaining power of the outward-looking trade interests first, which may tilt the implementation of the formal regional trade agreement to be more market-friendly (Aminian et al, 2008). The outward-looking trade interests should ideally be focused outside the region, too. Trade policies have been extensively studied because there is a danger that the progress made in successive multilateral trade negotiations to reduce barriers to trade and investment could be undone by preferential agreements that turn into trading blocs and a much lower level of economic welfare. Historically, preferential trading arrangements have not played much of a role in the integration of East Asian economiesIndeed, the fastest trade growth within the region has been the growth 14
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of trade with China since 1979, and this has occurred in the absence of formal trade-liberalization agreements. Such trends toward spontaneous regional integration result from progressive outward orientation of individual economies' trade and investment policies and unilateral liberalization of goods and capital markets (Dobson, 1997). On the contrary, the long period of economic growth called the East Asian miracle was due to macroeconomic stability, high investment in human capital, stable and secure financial systems, limited price distortions and openness to foreign technology (Hamaguchi, 2007). The general pattern is East Asia has been that wide disparity of income levels amongst different countries in close proximity has attracted investment from industries in the advanced economy, e.g., Japan, which are no longer competitive due to higher labour costs. Those host economies in turn have upgraded their own industries and moved production to even less-developed economies. The result has been the current situation of fragmented production and high levels of intermediate goods trade. But this situation is still considered to entail some risk under a system of numerous bilateral preferential trade deals, which are neither disciplined by the WTO rules nor counts on the supra-national regional-level management body such as the case of the European Union, hence countries in the region should strengthen the de jure feature (Hamaguchi, 2007). It is noteworthy that ASEAN has been very active in FTAs in response to the rise of China, which competes for the inflow of resources and investment and there has been no real progress in trade agreements between the largest economies of Japan, China and South Korea. East Asian integration has had both de facto and de jure elements, the former based on factor price differences and the latter being rather haphazard and unorganised but aimed at the large multinational companies. These provisions have contributed to reduce setup cost of offshore factories and operational cost of linking various factories in different countries. Thus, trade integration also has strengthened the role of scale economies to shape the competitiveness of East Asian industries (Hamaguchi, 2007).
The resulting integration, production networks and supply chains has created the need for more de jure action, more liberalization in trade and investment policies, harmonization of regulations, rules and standards. East Asias policymakers are increasingly of the view that FTAs, if given wide scope, can support expanding trade and FDI activities through further elimination of cross-border impediments, facilitation of trade and FDI, and other such harmonization efforts. Thus, FTAs can be regarded as part of a supporting policy framework for deepening production networks and supply
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chains formed by global MNCs and emerging Asian firms ((Kawai and Wignaraja, 2009).
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Chapter 3. Trade Patterns Analysis of East Asian economic integration is first approached through the dramatic rise in trade, both global and by Asian economies with those outside the region. Since 2000 these measures have both doubled but the striking feature is that intra-Asian trade has tripled, and regional trade involving emerging Asia, in particular, has increased even faster. As a result, Asian economies accounted for 35% of world exports in 2009, compared with 25% 10 years earlier, with the share of intraregional exports rising to 55% from 45% over the same period(IMF, 2011). Furthermore, intraregional trade is most often indicated by the use of total merchandise exports. According to WTO data, the share of intra-Asian merchandise exports in 2005 was 51% and was 53% by 2010 (cf www.wto.org/english/res_e/statis_e/world_region_export_10_e.pdf). These data include non-East Asia, so would underestimate the East Asian share. Similar figures are found in the International Monetary Fund statistics, as shown by the following chart. Despite slight differences in the totals, both WTO and IMF data show a renewed increase in intra-regional trade.
(Shinohara, 2012) 17
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Starting in the 1970s and 1980s, when Japan accounted for more than half of the regions trade, there has been strong growth in trade over the past two decades by other Asian countries, including China, Taiwan, South Korea and ASEAN. These now account for more than 80% of regional trade. Chinas rise especially has resulted in the relative decline of Japan, Taiwan and South Korea. Chinas accession to the WTO in 2001 and the wide disparity of labour costs resulted in the mass movement of supply chains into China that produced for the US and EU markets, a redistribution of trade resources within the region. The redistribution of trade among Asian trading partners of the United States is typical of the surge in international and regional supply chains, with part of the production initially located in Japan or in other economies transferring to China. Usually, it has been the last stage of the supply chain, the assembly of the final products, which has relocated to China, with the production of the core components remaining within the original country (WTO/IDE-JETRO, 2011). The share of Asia in world machinery and transport equipment exports increased from 14.5% in 1994/95 to 42.4% in 2006/7, with emerging East Asia accounting for over 80% of the increment. By 2006/07, over 58% of total world ICT exports originated from Asia, with the PRC alone accounting for 23%. In electrical goods, the PRCs world market share increased from 3.1% to 20.6% between 1994/95 and 2006/07 (Athukorala, 2010). These statistics show how rapidly the East Asian region expanded its intermediate goods trade as an aspect of its integration into the global manufactured goods trade. Proliferation of disaggregated production networks has resulted in faster growth of intra-regional trade compared to extra-regional trade and intra-industry trade growing faster than inter-industry trade. A dominant portion of the intra-industry trade takes the form of vertical intra-industry trade or production sharing networks. Indeed, the trade in parts within East Asia accounts for a large share of the total trade (that is, the trade in parts and finished products), and the share is increasing: over 50 % of textiles and garments and over 80 percent of electrical machinery (Haddad, 2007). However, at this point it is critical to understand the differences between the use of total trade figures and intermediate goods trade and their effects on measures of integration: In 2006/7, intra-regional trade accounted for 55.1% of total manufacturing trade in East Asia, up from 53.2% in 1992/3. The level of intra-regional trade in East Asia was higher than that of 18
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NAFTA throughout this period and was rapidly approaching the level of the EU. For developing East Asia (Asia excluding Japan) and ASEAN+3, the ratios are lower than the aggregate regional figure, but they have increased at a much faster rate However, the picture changes significantly when parts and components are netted out: the share of intra-East-Asian final trade (total trade parts and components) in 2006/7 was 46.4%, down from 50.3% in 1992/3. The estimates based on unadjusted data and data on final trade are vastly different for East Asia, particularly for DEA and ASEAN. Both the level of trade in the given years and the change over time in intra-regional trade shares are significantly lower for estimates based on final trade. Interestingly, we do not observe such a difference in estimates for NAFTA and the EU (Athukorala, 2010). These different calculations point to asymmetry in imports and exports in the East Asian region. Unlike in EU and NAFTA, in East Asia the increase over time in the intraregional trade ratio (both measured using unadjusted data and data for final trade) has emanated largely from a rapid increase in intra-regional imports as the expansion in intra-regional exports has been consistently slower This asymmetry is clearly seen across all sub-regions within East Asia (Athukorala, 2010). This asymmetry is due to the heavy component bias in Asian intra-regional trade and the multiple border-crossing of parts and components within regional production networks. On the export side, the intraregional share of final goods declined continuously from 46% in 1995 to 37% in 2007, whereas the intra-regional import share increased from 56% to 63% between these two time points. The observed asymmetry in intra-regional trade in East Asia reflects the unique nature of the involvement of Japan and the PRC in regional production networks (Athukorala, 2010). The implications of this asymmetry are that economic has not progressed as much as the total trade statistics would indicate and that the East Asian region may be unduly dependent on the economic demand emanating from the US and the EU. While these concerns are valid, recent developments in the East Asian region and the responses to the severe economic downturns of the US and EU suggest these fears can be discounted (see Chapter 12 below).
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Chapter 4. Investment Patterns In general, multinational investment and disaggregation of the value chain have expanded due to the significant reductions in international communications and transport costs. For transport costs, geographic distance remains a key factor. These general factors complement the East Asian specific factors that have supported the strong growth in economic integration through the proliferation of production networks and the expanded trade that accompanies it. First, the region is well placed to benefit from fragmentation-based specialization countries in terms of relative wages. Second, relative cost advantages arising from these wage patterns seem to have been complemented by the quality of trade-related logistics. Third, first comer advantage and market thickness and agglomeration benefits evolved over a long period of time seem to have played a pivotal role. The latter two factors would have jointly brought about significant cost advantages in maintaining services links in production networks in the region (Athukorala, 2010). This pattern of production sharing or fragmentation is proceeding globally, but East Asia is the region that is preeminent in this activity. A fundamental factor is the great diversity of labor supply and costs, from Japan, to the NIEs and ASEAN members. Over the past two decades wages in Korea; Taipei, China; and Hong Kong, China have been rapidly approaching developedcountry levels. But, despite rapid growth, manufacturing wages in the PRC and other latecomers to export-oriented industrialization in East Asia (Malaysia, Thailand, Viet Nam, and the Philippines) remain lower than or comparable to countries on the European periphery and MexicoMoreover, there are significant differences in wages among countries in the region, providing a basis for a shift in activities to lower-wage sources within the region and rapid expansion of intraregional product sharing systems (Athukorala, 2010). As a succinct summary, we could say that significant investments in ports and other logistics services and communications networks have complemented the historic pattern of early entry of MNEs and the close proximity of relative cost differentials amongst trade-oriented economies. Factor costs differentials have been supported by policy choices and investments in ports and communications systems, which reduce the cost of maintaining services links in global production sharingSingapore, by far the biggest transshipment hub in the region, tops the worlds logistics quality ranking. The other major transshipment hub in the region, Hong Kong, China, is eighth in the global ranking (Athukorala, 2010).
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The choice of location by MNEs is determined by the presence of the other market participants in the specific or neighboring countries. Over a long period of operating in the East Asian region, MNEs have invested in the capabilities and technology of their subsidiaries and affiliates, often to the extent of giving them responsibilities for regional or global production. In addition, there has been the emergence of China as a vast home to the assembly of electrical/electronic and other products, which has expanded the component industries in other countries in the region. For over 3 decades there has been rapid economic expansion in several countries in the region and this seems to have brought about market thickness, which refers to the diversification of the composition of the traded goods of a country as an outcome of rapid growth and structural transformation, with a positive impact on the location of outsourcing activity (Athukorala, 2010). A further important factor that promotes the clustering activities in a region is the achievement of economies of scale. Scale economies create an incentive for firms to cluster spatially. If average production costs decline as the scale of production rises at the firm, industry, or regional level, then there are advantages to concentrating production in a particular location... Scale economies represent an incentive for the formation of regional production networks (Haddad, 2007). The Japanese MNEs have been major drivers of the growth of intraregional trade and integration through their development of highly disaggregated, region-wide production and distribution networks. Of the exports from the head offices of Japanese multinational corporations, 74 percent are destined to the overseas affiliates, while 56 percent of the imports come from overseas affiliates (Haddad, 2007). We can distinguish foreign direct investment (FDI) in three ways. Firstly, horizontal FDI, in which operations are set up in host countries to supply that hosts domestic market, not exports. This type of FDI is considered in the literature to be export-substituting. Secondly, vertical FDI, in which operations are established in a low labor cost host and capital-intensive inputs are imported from the home base. Thirdly, there is export-oriented FDI, whose purpose is to serve third markets. Vertical and export-oriented FDI form the basis for the development of production networks. In terms of affiliate numbers, in opposition to the theoretical literature in which horizontal FDI prevails, export-platform FDI holds the largest share for Japanese multi-national affiliates; in particular, in the textiles and precision machinery industries. Furthermore, complex vertical-FDI, in which a parent country invests in a particular host country with the intention of serving third markets with exports of final goods from an affiliate in the host country, and of procuring from the third country, accounts for a large share in the electronics, information and 21
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technology, and precision machinery industries (Hiratsuka, 2011) Rather than being substitutes, as traditional, constant returns to scale theory would suggest, FDI and expanded trade go hand in hand. FDI has been instrumental in the shift to international production networks, and economies that have experienced the largest FDI inflows have also seen the largest expansion in merchandise exports. The fragmentation of production presents producers in developing countries with a golden opportunity to widen their export markets. Indeed, developing economies make up three of the top six destinations for FDI flows, with China moving up to become the second largest FDI recipient in 2009 behind the United States (WTO/IDEJETRO, 2011). One example of the interplay between FDI, factor cost differentials, regional proximity, economies of scale and production fragmentation is the hard disk drive (HDD) industry, itself a component of other industries (which is explored in more detail in Chapter 12). Originally, US HDD manufacturers set up facilities in Singapore and in time shifted various aspects of the process to other factories in Malaysia, Thailand and China to take advantage of labor cost differentials. These latter hosts became major producers. Thailand had become the second largest exporter of HDDs behind the PRC. Thailands trade share of HDDs accounted for 17% in 2007, compared with the PRCs 35% (Hiratsuka, 2011). The success of industries like HDDs in emerging economies has led to more confidence from MNEs in such investments, which in turn support the sustained growth in wealth in the region. TNCs (Transnational Corporations) FDI plans are increasingly focusing on developing and transition economies, especially in South, East and South-East Asia, and, to a lesser extent, Latin America (UNCTAD, 2011). Asia has been the exemplary region in which a sequential upgrading has occurred in terms of industrial development. Global competition and freer markets has driven advanced economies to invest in higher value-added production and services, while relocating the more labor-intensive activities to less developed countries. This provides the latter with opportunities to engage in the regional and global economies and benefit from the import of capital and technology that accompanies MNEs. FDI has played a crucial role in the process, serving as a vehicle for transferring technologies, recycling comparative advantages and enhancing competitiveness. For low income countries in the region, participation in TNCs regional production networks has become an effective way to build productive capacities and promote exports, industrial development and economic growth (UNCTAD, 2011). 22
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The success of this process is highlighted by the more recent trends in FDI, with the investing firms being from inside the region. Intraregional FDI has made an increasing contribution to industrial upgrading. The relative weight of the regions FDI sources has shifted: while the United States played a leading role in the 1960s and 1970s, followed by Japan in the 1980s, their share has been declining since the early 1990s (table II.6 from the UNCTAD World Investment report 2010). Regional economic integration has boosted intraregional investment, which now accounts for around 40 per cent of the total FDI stock of the regionFollowing in the footsteps of Japanese TNCs, companies from NIEs have been relocating their production operations within the region to take advantage of lower costs, thereby enhancing their competitiveness and promoting industrial restructuring and upgrading in their home countries. Through this process, neighbouring host countries have gained increased access to capital, technology, productive capability and foreign markets. 19 (Refer also to the chapter on final demand in Asia, below, for additional analysis on intraregional investment and its impact on economic growth).
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Chapter 5. Production Fragmentation and Intermediate Goods Trade The vast networks of production and distribution managed by MNEs in Asia are also based on the low transport costs due to their proximity and low trade barriers due to policies. As a result, growth in one East Asian economy tends to favor an expansion in trade with other East Asian economies rather than with, say, Latin America. Low trade costs may magnify the advantages of fragmenting production, rendering the impact on trade of incremental reductions in trade barriers potentially large (Haddad, 2007). The resulting enormous intra-industry trade is vertical in two senses. Firstly, the trade in goods and services that is based on the differing levels of economic development. Secondly, as a feature of the fragmented production network as various components of final products move between different facilities. Production sharing, by definition, incorporates the back-and-forth nature of trade: the importation of inputs for assembly or additional processing, as well as the exportation of intermediate goods for assembly or additional processing by third countries. This is distinguished from pure intra-industry trade, one-way production sharing, and the trade in intermediate goods (Haddad, 2007). There has been a shift, not just from trade in consumer and capital goods but also from intermediate goods, to trade in parts and components within the same industry. Trade patterns in todays global competitive climate where economies of scale strongly work are quite different from the traditional ones that are based on static comparative advantage. The whole production processes involve sequential production blocks located across countries. Different stages of production are shared by different suppliers located in different countries (Lim, 2007). The result of the development of the extensive networks of production in Asia has been that network trade (intermediate plus component goods) has more than doubled its share of total exports to about 50% by the end of the 2000s. The shift from mature to developing economies is also evident. The share of developing countries in total network exports increased from 22.0% in 1992/3 to 45.7% in 2005/6, driven primarily by the growing importance of East Asian countries in global production sharing. The share of East Asia (including Japan) increased from 32.2 % in 1992/93 to 40.3% in 2006/7, despite a notable decline in Japans share, from 18.4% to 9.5%. The major driving force has been the PRC, whose share increased from 2.1% to 14.5%. Within East Asia, world market shares of ASEAN countries, with the exception of Singapore, have grown faster than the regional average (Athukorala, 2010).
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There is a significant bias in the component trade of China: a much larger share of component imports compared to exports, which means that other countries in the East Asian region are providing parts and components for assembly in China. The share of components in the PRCs total manufacturing imports from East Asia increased from 16% in 1992/3 to 46% in 2006/7 (Athukorala, 2010). Furthermore, there is no one-way flow towards a single destination. The intermediate good trade is multi-directionalthe traditional image of the flying geese pattern which depicts international structure of trade within the framework of vertical division of labour does not fit wellmore than 73% of VCR and DVD players and 80% of personal computers (PC) are made in China. On the other hand 62% of hard disk drives (HDDs) and 38% of DVD-ROM drives are produced in ASEAN countries. These products are used for assembling PCs, hence the production linkage between ASEAN and China is obvious (sic) (Hamaguchi, 2007). As mentioned previously, while China plays a key role as the final assembler in the region, Ferrarinis paper also shows that globalization is not centred on China but has at least three anchors. Furthermore, the changing demand dynamics in the US and EU after the severe downturns from 2008, will favour a shift of policies towards generating more regional demand. The economic integration of China has deepened production fragmentation in East Asia to an unprecedented level. The rapid integration of China into regional production networks has countered fears that Chinas global integration would crowd out the opportunities of other countries for international specialization (Haddad, 2007). Until recently, it could be said that intermediate goods exports have accounted for about 70 percent of the annual export growth in Asia over the last decademore than double the contribution of capital and consumer goods together. This has been particularly the case for the ASEAN-5, the NIEs, and Japan. Exports of intermediate goods have been particularly strong to other Asian economies, whereas consumer goods and intermediate goods have contributed roughly equally to the increase of exports outside AsiaThe average share of intermediate goods exports between Asian trading partners has increased to nearly 80 percent in 2009 from about 60 percent a decade earlier (IMF, 2011). If the expectations of shifting demand patterns are realized, these shares should converge somewhat, as the economies inside the Asian region become the final destination for more consumer goods. However, to a large degree, it is the previous dynamic trade performance which will provide the basis for this convergence. 25
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Evidence of the appearing shifts is the increasing importance of China as a destination for capital goods. For Japan and Korea, capital goods exports to China now account for 20 percent to 25 percent of their total capital goods exports (a fourfold increase from a decade earlier), making China by far their single most important capital goods export destination in Asia, and comparable to the United States or the European Union as export markets (IMF, 2009). At the same time, as shown by the major disruptions to regional and global supply chains after the tsunami in March 2011, Japan remains a key driver of economic growth in the East Asian region. For all major Asian economies, Japan remains the second most important source of intermediate inputs after China, and it remains the single most important supplier to China, where it accounts for 36 percent of all imported inputs sourced from Asia (IMF, 2009). As the Asian region continues to dominate the trade in intermediate goods and components and expands the trade of consumer goods, the advanced economies will focus more on diversifying their trade in services. Once again, some of these services can be called intermediate because they could meet demand at various points of regional and global value-chains. New theories have been formulated to understand the formation of international production networks. Firstly, new economic geography (NEG) attempts to explain the agglomeration and dispersion of economic activities in geographical space. The spatial structure of economic activities is considered to be the outcome of a process involving the opposing forces of agglomeration and dispersionOne important factor that subtly affects the balance between agglomeration and dispersion is the cost of transport, which includes freight costs, tariffs, nontariff barriers, and the risk of exchange-rate variations (Hiratsuka, 2011). An allied approach, also using net cost analysis and comparative advantage, is fragmentation theory, which focuses on the location of production processes, and it suggests that production processes should be fragmented into several stages with separate production blocks being located at different sites, either domestic or international. By dividing the production process into separate blocks and situating each block in the most appropriate location, the total cost of production can be reduced (Hiratsuka, 2011). For example, in the case of capital intensive and labour intensive components of a product, marginal costs can be reduced by locating one component in a capital endowed country and the other in a labour endowed country. In addition, though, fragmentation theory also includes the calculation of the cost of incurring setup cost of establishing extra production plants and 26
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service link cost for utilizing transportation and communication services in order to link the two operations. Firms choice whether or not to split up the production depends on the balance of the marginal cost saving and the additional costs (Hamaguchi, 2007). The defining characteristic of NEG is its emphasis on the synergies that accumulate from geographically adjacent economic activities that are also connected in a production process. Scale economies and the presence of skilled labour attract more capital and raise incomes. Production processes that are located in neighbouring countries likely face lower transport and transaction costs and more efficient use of inventories on a just-in-time basis. The positive feedback mechanism leads to the self-organization of an agglomerationA remarkable feature of the recent economic development in East Asia is not successive dispersion of industrialization but the emergence of new agglomerations (Hamaguchi, 2007). The stress is on the plural. It may have begun as kind of flying geese pattern, starting with Japan, but the development of intermediate goods production and trade, especially in electronics and automobiles, has led to a new pattern. The region has multiple technological centres and coagglomerations undertaking final-good and intermediate-good production, with intermediate goods moving bi-directionally between countries (Hamaguchi, 2007). A good example is the hard disk drive (HDD) industry, which has critical applications in both electrical/electronic and automobile sectors. The HDD sector has its own intermediate and final products. Due to the low cost of transportation, the HDD industry has developed a system of production fragmentation, where the production process is divided into several discrete stages and the separate production blocks are located in different countries (Hiratsuka, 2011).
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(Hiratsuka, 2011) We could say that in the East Asian region, from a value-chain perspective, national borders resemble notional borders. While remaining fully identical with sovereignty, borders are no longer impediments to trade and investment. The level and location of trade and investment are much more function of time, costs and scale. Trade and investment policies have achieved much, although more could be done. There remain real regulatory and related mechanisms that add to the transaction costs between countries. In this context, especially from the point of Australian opportunities, the following conclusion has important implications: Japanese firms investing in East Asia are likely to more flexibly deinternalize their production processes and conduct outsourcing activities than those going to other regions such as North America and Europe (Hamaguchi, 2007). In the East Asian region, there are more opportunities for Australian providers of goods and services to build on the extensive relationships they already enjoy with Japanese firms in the Australian and the Japanese markets. There are literally thousands of Japanese firms throughout the Asian region, deeply embedded in the industrial and consumer base. As mentioned before, Ferrarinis research shows that there are three global hubs: the United 28
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States, China-Japan and Germany. Each hub has connections outside its own region with other hubs and networks. In East Asia, the China-Japan core is connected closely to several other countries as fragmented production activities scattered across the region typically involve the provision of high value-added parts and components by leading economies, such as Japan and the Republic of Korea, further processing in countries such as Malaysia and the Philippines, and final assembly in countries involving low labor costs and value added, predominantly in the PRC (Ferrarini, 2011). The East Asian region dominates the global electrical/electronic sector, with Japan in the core position. The global automotive industry networks are more evenly distributed, led by Germany and the US. By comparison, Asias industrial network is relatively less developed [but] Japans automotive industry positions itself at the centre of Asias networks, as a prime source of auto parts and components. Japans strongest network partner is Thailand, which sources 67.5% of its automotive parts from Japan. Other relevant partners within the Southeast Asian region are Indonesia, and to a lesser extent the PhilippinesThe PRC has not yet reached a status of major influence in the regional automotive industries. Nevertheless, in 2006/2007 the country represented the second-largest regional network leg, in connection with Japan, and also integrates strongly with the Republic of Koreas auto industry. The Republic of Korea itself represents a more significant element in the Asian networks, and also has significant relations to the German and the US hubs (Farrarini, 2011).
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Chapter 6. Measurement Issues There is a voluminous literature dealing with the growth of intra-regional trade and investment, typically in the context of economic integration. It is very common to find this type of statement: Asia is a highly integrated trading bloc, with buoyant intra-regional commerce (58 per cent of its trade in 2009). Furthermore, it has diversified its extra-regional markets to reach beyond its traditional partners, the European Union and the United States. The share of extra-regional trade excluding the European Union and the United States has increased from 12.9 per cent in 2001 to 18 per cent in 2009 (WTO and IDE-JETRO, 2011). As useful as these statistics can be, they also suffer from serious deficiencies. When they are used in analysing international production networks, aggregated trade data can actually obscure those networks. Global production sharing opens up opportunities for countries to specialize in different slices (tasks) of the production process depending on their relative cost advantage and other relevant economic fundamentals. In this context, the decisions of how much to produce and for which market have to be combined with decisions on where to produce and with what degree of intraproduct specialization. Consequently, trade flow analysis based on data coming from a reporting system designed at a time when countries were trading only in final goods naturally distorted values of exports and imports, leading to a falsification of the nature of emerging trade patterns. The degree of falsification is likely to increase over time as more complex production networks are created with an ever-increasing number of participants (Athukorala, 2010). There is a vast literature on what may be termed standard trade data analysis based on the traditional notion of horizontal specialization in which trade is an exchange of goods that are produced from start to finish in just one country (Athukorala, 2010). Such analysis does show an increase in intra-regional trade in Asia since the 1980s and forms the foundation for arguments in favour of regional trading agreements. At the same time, there has been a concomitant expansion of international production fragmentation, both regionally and globally. This phenomenon has been reflected in a growth in the trade in parts and components at a rate exceeding that of the trade in final goods because a good crosses multiple borders while it is involved in processing (Haddad, 2007). The driving force in the growth of production fragmentation and intra-industry trade has been
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foreign direct investment (FDI, i.e., the activities of multinational corporations (MNCs), including a significant amount of intra-firm trade. With the importance of MNCs in trade, the nature of MNCs exports has been reconsidered. In the negotiations of US-China trade disputes, the representatives of China have repeatedly pointed out that a large portion of its exports to the U.S. was produced and traded by the MNCs of other countries in China and should be treated as the exports of these FDI source countries. The trade balances based on ownership should be a better revelation of trade relationship among countries. This point of view was recognized by the United States. Since 1995, the U.S. Bureau of Economic Analysis has annually published the report of An Ownership-based framework of the U.S. Current Account (Yang and Huang, 2011). International trade statistics account for the gross cumulated value embodied in goods crossing international borders, not just the value added by the segment of the production process hosted by the exporting country and attributable to its resources (Ferrarini, 2011). Aggregated data do not adequately reflect the distribution of value-added in the international value-chains and often include products that have been counted at least more than once as they travel across the same borders several times. This characteristic of trade data has led to new methods of calculation, from looking at intra-firm sales of MNCs to the analysis of specific value-chains such as the iPhone, apparel or hard disk drives. A more comprehensive, economy wide approach to measuring value-added trade combines national inputoutput tables to identify the sources and destinations of value added as intermediate goods pass through global supply chains (Farrarini, 2011). More detailed disaggregated trade data has also been compiled, to identify the parts of parts of components of intermediate goods that are traded in production networks. Compared to input output analysis, this method is less comprehensive a gauge of processing trade and is limited to the subcategory of intermediates that are clearly recognizable as parts and components, thus disregarding processing and assembly activities characterizing vertical trade more broadly. However, it offers the advantage of parsimony, in terms of both data requirements and the methodological complexities involved (Ferrarini, 2011). These various methods have arisen in specific policy contexts, such as economic integration or trade imbalances or development economics, etc. Each method has its uses and limitations, both in their original and additional contexts. Taken together they do provide a key insight, which is that vertical trade is but one aspect of economic integration. FDI and other capital flows are also important. 31
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The use of value-added or input-output analyses produces important insights for both policy formulation and corporate strategy. A good example is provided by looking at China, a key economy that is well integrated into global production networks. China has raw material and intermediate goods inputs and a large share of GDP as exports, much higher than other large economies. A detailed analysis of the imported inputs shows a much lower share of value-added generated in China. Koopman, Wang and Wei (2008) modified existing methods of analysing value-added. By applying our methodology to Chinese data, we have found several interesting patterns. First, we estimate that the level of foreign content in Chinese exports is close to 50%, almost twice as high as what we calculate by using the HIY formula. Second, we find interesting heterogeneity across sectors: those sectors that are likely to be labelled as sophisticated or high-skilled, such as computers, electronic devices, and telecommunication equipment, tend to have especially low shares of domestic content. Conversely, many sectors that are relatively intensive in low-skilled labour, such as apparel, are likely to exhibit a high share of domestic content in Chinas exports. Finally, we find that foreign invested firms (including both wholly-owned foreign firms and Sino-foreign joint venture firms) tend to have a relatively low share of domestic content in their exports (Koopman, Wang and Wei, 2008). However, one of the consistent messages in this report is that the economic upgrading of the East Asia region, including of course China, is proceeding quickly, especially in the past few years. Recently, Koopman et al (2011) updated their analysis of value-added in Chinese exports and found that domestic value-added had risen to 60.6% in 2007. By 2012 this figure is likely to be even higher; an indicator that value-added will support the future economic growth of the East Asian region.
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Chapter 7.
Multinational Enterprise (MNE) Perspectives, Inter-firm and Intra-firm Transactions
Global Value chains, production sharing/networks/fragmentation are all driven by the international strategies of MNEs and the evolution of their choices between intra-firm and inter-firm transactions (make or buy). Early on, the strategy might be to locate some parts of production in a lower cost market and re-import the parts for final assembly. Later in the process, several countries could be engaged, with multiple export-import movements of parts before being assembled into an end product. As international networks of parts and comments supply have become firmly established, producers in advanced countries have begun to move the final assembly of an increasing range of consumer durables (e.g., computers, cameras, TV sets, and automobiles) to overseas locations in order to be physically closer to their final users and/or take advantage of cheap labor (Athukorala, 2010). Different industries have distinct internal-external transaction strategies. In the case of standard consumer goods such as clothing and footwear, global production sharing normally takes place through arms length relationships, with international buyers playing a key role in linking producers and sellers in developed countries. On the other hand, production sharing within vertically integrated global industriessuch as electronics, electrical goods, and automotivehas evolved in a different manner (Athukorala, 2010). Moving from an initial position in which a subsidiary performs the same operations as the home plant, a fully internal corporate operation, albeit in an overseas location (offshoring), eventually some activities or components are sourced from other suppliers. Some technology transfer would also occur. In the East Asian region, MNEs pursue two different types of strategies. One rests on cost differentials and economies of scale to use networks for exports to final markets in the US and EU. The other is the production of goods for the local markets. The division between the two types of investment is not clear-cut, and many foreign affiliates operating in East Asia have progressively adopted the characteristics of both vertical and horizontal multinationals (WTO and IDE-JETRO, 2011). The increasing complexity of multi-country production networks forces MNEs to redefine and concentrate on core activities. This leads to more extensive outsourcing, providing both technology transfer and opportunities for new firms to enter the network. A reliable and conducive international trading environment ensures the unhindered and efficient flow of investment, goods and services among nations. Through successive negotiations under 33
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GATT/WTO, trade barriers have been significantly reduced or eliminated and a stable, rules-based trading system has guaranteed and encouraged firms to engage internationally with confidence. The availability of efficient and affordable logistics, transport and communication services supports this global production system (WTO and IDE-JETRO, 2011). The same considerations apply to services activities. Both manufacturing and non-manufacturing firms can and do outsource or offshore various types of services, from basic and routine to complex and customized, even R&D. Data processing, call centres, virtual assistance, legal support (legal transcription, drafting contracts, legal representation, etc), medical support (medical transcription, interpreting x-rays, etc), finance and accounting, software and applications development and R&D are all activities that enterprises can assign to foreign firms. All these activities are designated as business process outsourcing (BPO) or information technologyenabled services (ITES). Of the Asian developing economies, it is India and the Philippines that are benefiting increasingly from offshored computer and IT-enabled business services (WTO and IDE-JETRO, 2011). A general framework for understanding some of the issues related to intrafirm and inter-firm or make and buy decisions and the variations is provided by Gereffis governance diagram:
(Gereffi, 2011) 34
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In brief, these depend on the complexity of transactions, the extent to which codification can occur and the capabilities of external suppliers in relation to the requirements of the firm (Gereffi, 2011). The rapid establishment and proliferation of global value chains or production networks has rested on large intra-MNE transactions, as much of the trade is carried within a firm but between countries (Lanz and Miroudot, 2010). Over time, however, many activities are outsourced as communications become cheaper and faster, standards become ubiquitous and technology and capabilities improve.
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Chapter 8. Introduction to the Value-Chain Approach In its simplest terms, the value chain describes the full range of activities which are required to bring a product or service from conception, through the different phases of production (involving a combination of physical transformation and the input of various producer services), delivery to final consumers, and final disposal after use. Considered in its general form, it takes the shape as described in Figure 1. As can be seen from this, production per se is only one of a number of value added links. Moreover, there are ranges of activities within each link of the chain (Kaplinsky and Morris, 2001).
(Kaplinsky and Morris, 2001) In addition to the manifold links in a value chain, typically intermediary producers in a particular value chain may feed into a number of different value chains (Kaplinsky and Morris, 2001). The various alternative or additional links to intermediary suppliers provide a glimpse of the extensive commercial linkages and hence opportunities that can be evaluated and explored. Porter (1985) made the fundamental definition of a firm in terms of activities, from input to transformation to output. This allowed a more detailed understanding of the numerous components of the firm and facilitated the understanding of how value was created and which activities were critical, depending on the product or service. Five major categories of activity (inbound logistics, operations, outbound logistics, marketing and sales and service) could be further and further 36
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subdivided. Over time, as these elements became better understood, decisions could be made about outsourcing and/or offshoring, both within and across national boundaries. Value-chain analysis provides insights into the value-added of each link. For example, global value-chain analysis has found the share of foreign content of the PRCs exports to be particularly high in certain electronics products for which key components, as well as product design and brand values, originate outside the country. For example, the PRC was found to add as little as $4 in value to an Apple iPod fetching a factory gate price in the PRC of $144 (Ferrarini, 2011). Using the end-prices in the US, Hal Varian (2007), made the following calculations, illustrated by Gereffi (2011) (Note that this is a snapshot of the mid-2000s. It would be a mistake to think that these values have remained or will remain unchanged).
(Gereffi, 2011) Over time, value-chains become established and expand their capacity. Agglomeration at each section of the value-chain provides enough scale for the development of services and niche products by outside firms (see also the chapter on fragmentation). Global value chains foster the parallel development of trade and foreign direct investment. Industrial clusters created by supply chains tend to grow up around specific tasks and business 37
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functions. The process is cumulative and, in time, modifies the production system of an economy (WTO and IDE-JETRO, 2011). Identifying the discrete links in the regional/global value chains will allow Australian companies, including Small and Medium Sized Enterprises (SMEs), to find economies of scale appropriate for the costs involved in entering the value chains. Government can play a part in closing the information gap.
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Chapter 9. Policy (FTAs, rules, regulations) Although coming late to the practice of bilateral (and then plurilateral) free trade agreements (FTAs), since the late 1990s the Asian region has seen the highest proliferation of such instruments. Four main factors underlie the recent spread of FTA initiatives in Asia: (i) deepening market-driven economic integration in Asia, (ii) European and North American economic integration, (iii) the 19971998 Asian financial crisis, and (iv) slow progress in the WTO Doha negotiations (Kawai and Wignaraja, 2009). Mostly they deal in the trade of goods and services, but also the so-called Singapore issues (i.e., trade facilitation, investment, government procurement, and competition policy), which are currently beyond the scope of the WTO (Kawai and Wignaraja, 2009). However, whilst aimed at liberalisation, the proliferation of bilateral and sub-regional FTAs has also created duplication and overlap, especially in regard to rules of origin, dispute settlement and other non-tariff issues. These constraints tend to increase transaction costs and trade barriers despite continuing reduction in average tariff rates in developing countries in East Asia. Increased transaction costs would tend to reduce industrial dispersion effect in less-developed economies in the region and, thus, the phenomenon of growth gaps in East Asia would tend to persist (Lim, 2011). Nevertheless the numerous regional trading agreements (RTAs) among Asian economies have contributed to regional integration (WTO and IDE-Jetro, 2011). The examples given are the ASEAN Tree Trade Area (AFTA) and the ASEAN FTAs with China, Japan, Korea, India and the ANZAFTA. These larger, more encompassing agreements seem to be more appropriate in a context of production fragmentation, intermediate goods trade and global value chains. Thus, the rising importance of product fragmentation seems to have strengthened the case for a global approach to trade and investment policymaking rather than a regional one (Athukorala, 2010). Policy generally tends to lag behind market evolution and the desirability of a global agreement aside, its achievement seems a long way off. In its stead, though, it may be realistic to aim for a wide regional agreement, such an East Asia FTA. There has been some analysis of the economic effects of such an agreement. Plummer and Wignaraja (2007) looked at general equilibrium simulations of six policy scenarios:
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1) A fragmentation scenario: a continuation of the current wave of bilateralism, where the region is fragmented by several bilateral or small regional FTAs; 2) An ASEAN+3 FTA scenario: free trade among ASEAN countries; PRC+Hong Kong, China; Japan; and Korea; 3) An ASEAN+6 FTA scenario: free trade among ASEAN+3 countries, India, Australia, and New Zealand; 4) An Asia-wide FTA Scenario: free trade among all Asian countries; 5) An APEC FTA: free trade among all APEC members; 6) A global trade liberalization scenario: complete abolition of import tariffs and export subsidies. The estimates of the economic impacts of FTA scenarios were prepared using the Asian Development Banks General Equilibrium Model for Asias Trade (GEMAT). GEMATwhich is an applied general equilibrium model of the global economy with a focus on Asiaextends the LINKAGE model developed at the World Bank It comes as little surprise that scenario 1a fragmented reality of multiple bilateral and regional FTAsis the least attractive for all regions and countries. Among others, this scenario may give rise to the famous spaghetti or noodle bowl effect, which refers to higher transactions costs from multiple rules of origin and standards in the growing number of FTAs in East Asia. Global free trade (scenario 6) is the most attractive but unrealistic bearing in mind that even the WTO process has been beset by uncertainties on the timing and depth of multilateral agreement to reduce trade barriers (Plummer and Wignaraja, 2007). The other four FTA scenarios (APEC, ASEAN+3, ASEAN+6, Asia-wide) all produce different gains or losses, either between members and non-members or amongst members. Such general equilibrium simulations are useful in indicating the channels by which the formation of an FTA translates into improvements of the economy. Existing studies have focused on liberalization of import tariffs on goods trade. A major shortcoming of such studies is their inability to incorporate rules of origin and non-tariff measures which are likely to afford more protection for domestic industries than tariffs Plummer and Wignaraja, 2007). A few years ago, Haddad (2007) could argue: Despite the possible benefits of FTAs through the expansion in trade to members, FTAs in East Asia have not been very successful. A substantial
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number of products, including important commodities mainly in agriculture, are excluded from trade liberalization. Many agreements take the form of economic partnerships that include trade and FDI facilitation, liberalization, and economic and technical cooperation. However, the implementation of these partnerships has been slow. The proliferation of FTAs with different specifications and rules of origin is likely to give rise to a noodle bowl effect, an entangled system of rules among the economies in the region and many economies outside the region. FTAs are also likely to have a negative impact on multilateral negotiations by diverting interest and negotiating resources away from the World Trade Organization. Similarly, Lim (2007): The development of vertical production networks have (sic) certainly been supported by trade liberalization efforts. On the other hand, the trade regime in East Asia is still far from a single production base and a single market. However, apart from the ideal of a single market being not only too ambitious, but equally undesirable as the ongoing experience of the EU indicates, much recent work on policy formulation is working explicitly on these issues to find solutions to the problems of numerous and onerous rules of origin and other barriers (e.g., Kawai and Wignaraja, 2011). It is being recognized that the experience of companies engaged in regional commerce has been to either baulk at the use of FTAs due to lack of clear knowledge or to defer investments due to rules of origin issues. Haddad, (2007) did recognize a central issue: Because economic integration in East Asia involves extensive trade in intermediate inputs, trade flows tend to be responsive to changes in trade costs. Small reductions in trade costs may have large impacts on trade since these reductions tend to increase trade along supply chains that link multiple countriesWhere production networks are dense, global outsourcing may be especially sensitive to border trade barriers, because, within a given supply chain, inputs may need to cross multiple bordersthe trade in inputs allows a decline in trade barriers to trigger magnified decreases in production costs and thus dramatic increases in total trade flows. The dominating position of semi-processed products in Asian trade is reflected in the tariffs that countries in the region impose. Tariffs on semi-processed products are low compared to either raw materials or processed products. In the cases of the Republic of Korea and Thailand, tariffs on semi processed products are less than one-third of those for raw materials. 10 As an example, there is a much larger network trade in the electronics sectors in East Asia than in 41
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the automobile sector. There are two possible reasons for this contrast that deserve further study. First, in most East Asian countries, binding content protection requirements for the domestic production of automotives and tariffs on final products (usually implemented side-by-side with low or zero tariffs on components) remained relatively high until recently. Tariff protection and content protection requirements usually lead to more components being produced domestically. They also tend to retard exports not only because of the incentive bias against exports, but also because domestic market-oriented production usually does not achieve the quality standards and cost competitiveness required for export success. Second, unlike electronics and electrical industries, components in the automotive industry, are generally characterized by low value-toweight ratios, which make it too costly to use air transport for timely delivery. This could well be an important consideration for locating parts and component production/assembly plants close to the final assembly plants within automobile production networks (Athukorala, 2010). In the literature on production networks, these trade and investment barriers are called service links costs. This means that reductions in service link costs are essential for further production fragmentation. The border effect is very large in vertical specialization because the tariffs impose two taxes on the first stage of production for only one fragmentationonce when the first stage good enters the foreign country and again when the second-stage good is imported back to the home country (Hiratsuka, 2011). There are two main conclusions and policy requirements for governments that arise from these considerations. Firstly, the inclusion of WTO-plus provisionsparticularly the four Singapore issueswould be desirable in all future Asian FTAs and there is increasing recognition in Asia of the merits in forming a region-wide FTA as a means to consolidate the plethora of bilateral and plurilateral agreements. Such an FTA would confer various economic benefits: (i) increase market access to goods, services, skills, and technology (ii) increase market size to permit specialization and realization of economies of scale; (iii) facilitate the FDI activities and technology transfer of MNCs; and (iv) permit simplification of tariff schedules, rules, and standards (Kawai and Wignaraja, 2009). Resources: A list of all Regional Trade Agreements can be found here: http://rtais.wto.org/UI/PublicAllRTAList.aspx A list of all Preferential Trade Agreements can be found here: http://ptadb.wto.org/ptaList.aspx
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Chapter 10 Value Chain Approach in Detail Although related conceptually to the notions of production fragmentation or networks, value-chain analysis is a more commercially useful framework for corporations. It has the clarity of linking activities to value-added and dealing more extensively with the services links. It has been well formulated by Michael Porter and others, mainly within the corporation. By Gereffi and others, it has been applied to the full value-chains of global industries, such as apparel, pharmaceuticals, coffee, fruit and vegetables and ITC services. Value chain analysis (VCA) is a method for accounting and presenting the value that is created in a product or service as it is transformed from raw inputs to a final product consumed by end users. VCA typically involves identifying and mapping the relationships of four types of features: (i) the activities performed during each stage of processing; (ii) the value of inputs, processing time, outputs and value added; (iii) the spatial relationships, such as distance and logistics, of the activities; and, (iv) the structure of economic agents, such as suppliers, the producer, and the wholesaler. Value chains can become complex when they reflect multi-stage production systems with multiple types of firms operating in different locations in one country or multiple countries around the world. (FIAS, 2007) The identification and mapping of value-chains are key services that academia or government can provide to overcome information gaps that may inhibit investment or trade. The global value chain (GVC) approach has been developed by researchers in various countries to study the processes of value-added, the management of MNEs and the development opportunities for host economies. The recent GFC highlighted the interconnectedness of numerous economies through the global value-chains. Trade in the various types of goods, including intermediate, capital and final goods plummeted as the MNEs and local firms that constitute the GVCs responded quickly to changes in demand and lack of finance. Similarly, on the supply side, the Japanese earthquake and tsunami of 2011 led to a sharp, temporary shock to the automotive and electronics sectors. Given that production processes in many industries have been fragmented and moved around on a global scale, GVCs have become the world economys backbone and central nervous system. (Cattaneo et al, 2010). From our perspective and purpose, GVCs exhibit a large measure of complexity and a corresponding number of opportunities for Australian companies to explore.
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Economic development has become increasingly associated with economic upgrading or industrial upgrading within GVCs, requiring that firms move up through the chain of production of a particular commodity into higher value added activities. This involves raising productivity and skills through training, mechanization, and the introduction of new technologies. It also requires fitting into existing corporate strategies by linking closely to lead firms. In manufacturing, such upgrading has also been associated with qualitative change, with firms moving from parts production or assembly, to design and more integrated production, to fully integrated production, to original brand design (Milberg and Winkler, 2010) As more and more firms, whether MNEs or local, move further up the value-chain, there are general positive effects on the whole economy, providing more foundations for broad-based and sustained growth. Dynamic change within value-chains also provides critical opportunities for new suppliers of specific inputs, whether goods or services. Australian firms, by linking into regional global value chains, can benefit from the competitive pressures, larger scale and technology transfer. The more this occurs, the more the Australian economy will become enmeshed into a much larger market. Case Study Apparel The apparel industry has been studied in detail for years and provides an instructive case study. The analysis provides insights into the complexity of the global apparel value chain, the way that various countries have become important links and the development paths from low to higher value-added elements. This is especially true of the Asian region, which is of most importance to Australian firms. It also highlights the variety of links in a value chain. In the Asian region, from the 1990s there has been a shift from earlier suppliers like Hong Kong, South Korea, Taiwan and Malaysia. China, Bangladesh, Vietnam, and Indonesia are increasing their market shares in North America and the European Union, primarily at the expense of nearsourcing options such as Mexico and the Central American and Caribbean suppliers to the United States, as well as apparel exporters from North Africa and Eastern Europe to the EU-15 (Gereffi and Frederick, 2010). In East Asia, China has not only increased its share of overall exports, but it has also significantly diversified its export partners It is also important to recognize the size of Chinas apparel production for its domestic market. In 2007, the estimated value of sales to the Chinese apparel market totaled $93 billion for the year, indicating that 56% of the overall apparel production 44
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activities in China were for local consumers (Gereffi and Frederick, 2010). In the apparel business, China will have to move up the value chain as its labour costs rise and the new suppliers like Bangladesh and Vietnam will supplant some of Chinas production.
( Gereffi and Frederick, 2010) Figure A-3 (from Gereffi, 2010) gives an overview of how industrial upgrading has occurred in the apparel value-chain, but more importantly, about Value Chain Analysis in general. First, individual countries tend to progress from low to high value-added segments of the chain in a sequential fashion over time. This shows the importance of looking at the entire constellation of value-added steps in the production process (raw materials, components, finished goods, related services, and machinery), rather than just the end product. Second, there is a regional division of labor in the apparel value chain, whereby countries at very different levels of development form a multi-tiered production hierarchy with a variety of export roles (e.g., the United States generates the product designs and large orders, Japan provides the sewing machines, the East Asian newly industrializing economies (NIEs) supply fabric, and low-wage Asian economies like China, Indonesia or Vietnam sew the apparel). Industrial upgrading occurs when countries change their roles in these export hierarchies. Finally, advanced economies like Japan and the East Asian NIEs
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do not exit the industry when the finished products in the chain become mature, as the product cycle model implies, but rather they capitalize on their knowledge of production and distribution networks and thus move to higher-value-added stages in the apparel chain (Gereffi and Frederick, 2010).
(Gereffi and Frederick, 2010)
Apparel has been the classic buyer-driven global value chain. Unlike producer-driven chains, where profits come from scale, volume and technological advances, in the buyer-driven global apparel value chain, profits come from combinations of high-value research, design, sales, marketing, and financial services that allow the retailers, designers and marketers to act as strategic brokers in linking overseas factories and traders with product niches in their main consumer markets (Fernandez-Stark et al, 2011).
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Distinguishing between buyer-driven or producer-driven value-chains provides further insights into understanding where the value-added is occurring and what are the core activities or competencies of the lead firms. Once again, these insights clarify the points or links at which opportunities for entry arise. Similar types of value chain maps have been developed for other products, such as coffee, fruit and vegetables. They are shown here for illustrative purposes The high-value activities in the downstream end of the value chain include customer support, retailing, distribution in final markets, marketing, product design, purchasing, international transport, and production.
(FIAS, 2007)
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(Fernandez-Stark et al, 2011)
Another value-chain map for pharmaceuticals is presented on the next page.
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Pharmaceuticals In the therapeutic pharmaceutical value-chain (left) there are numerous opportunities for buy decisions. The global pharmaceutical industry is dominated by large MNEs, many of whom have engaged in mergers and acquisitions in recent years in order to consolidate operations and reduce costs. Therefore, the main opportunities for related suppliers are points at which the MNEs buy products or services. These have become more numerous in recent years. Pharmaceutical MNEs have lessened the amount of activity they undertake internally. Many of them are creating alliances and licensing arrangements with biotechnology firms, which have opportunities to provide basic product and early testing. The pharmaceutical MNEs emerging core competencies are distribution, marketing and capability to get the drugs through the onerous regulatory processes The development of new drugs is no longer as core an activity (Wadhwa et al, 2008; Rasmussen, 2007)). There are potentially real opportunities for Australian biotechnology companies, which have a history of having good research but lacking access to funding. (Whadwa et al 2008) 49
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What these value chain maps are missing are more details about the various services that connect to the value chains of products, such as marketing, advertising, accounting, legal, ITC, banking, trade credit, human resources, R&D, waste management, etc. Furthermore, as analysed below, the services sectors in general have their own globalised value chains. Although they give a good insight into how value-chains are structured, how linkages are connected and where the value is created, there are not enough detailed value-chains available. This is a gap in available information that may support some government investment in mapping. The mapping of significant regional value-chains in automotive, infrastructure, financial services, health, food and pharmaceuticals would provide valuable information for Australian companies. The detailed maps of value-chains allows for the disaggregation of products and services into more discrete units. A variety of cost competitive models, locations, potential partners and the key Australian value-add will become clearer. In the global value chain, six distinct value-adding activities can be identified: (1) research and new product development (R&D), (2) design, (3) production, (4) logistics (purchasing and distribution), (5) marketing and branding, and (6) services). What is striking about this schema is that the most important value-adding stages are intangible services that occur before and after the apparel production process, which requires us to expand considerably our ideas about where the greatest gains from workforce development are likely to occur (Fernandez-Stark, 2011).
(Fernandez-Stark, 2011) 50
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R&D: R&D, product or process improvement, as well as market and consumer research. Design: aesthetic design services for products and components throughout the value chainto attract attention, improve product performance, cut production costs and branding. Purchasing/Sourcing (Inbound): inbound processes involved in purchasing and transporting products, technology and equipment for supply chain coordination. Production/Assembly: all or part of production can be in-house or provided by external firms. Distribution (Outbound): wholesalers, agents, logistics firms. Marketing and Sales: pricing, selling, and distributing a product, including activities such as branding or advertising. Services: This includes any type of activity a firm or industry provides to its suppliers, buyers, or employees, from consulting to legal to IT. (Fernandez-Stark, 2011).
Knowledge and Information Services Innovation and change in information and communication technology (ICT) has allowed developed and developing economies to engage in the internationalisation of these services. No longer relegated to manufacturing and natural resource-intensive industries, developing countries now have an important opportunity to advance both their economic and social conditions. The global economic crisis has highlighted an important characteristic of the industry for developing countries: it demonstrated significant resilience to downturns due to its principle raison dtre to lower costs for all industries around the world and this focus leads the industry to constantly seek out lower cost destinations. This dynamic, in turn, opens up opportunities for new countries to enter the industry value chain (Gereffi and Fernandez-Stark, 2010). As in manufacturing, this has allowed the offshoring and trade in services via the separation of their production and consumption. What began with the outsourcing of basic information technology (IT) services to external firms now includes a wide array of activities known as business process outsourcing (BPO), knowledge process outsourcing (KPO), and other advanced activities in the value chain such as research and development (R&D), which were previously considered core functions of the firm (Gereffi and Fernandez-Stark, 2010). 51
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Wide differentials in labour and other costs have allowed the entry of developing nations and provided further sources of wealth creation. This provides emerging economies with an opportunity to drive sustainable growth through the expansion of the knowledge economy and to reduce their traditional dependence on manufacturing and natural resource industries (Gereffi and Fernandez-Stark, 2010). Outsourcing refers to the sourcing of services outside the firm and offshoring refers to their provision within the firms boundaries but across national boundaries.
(Gereffi and Fernandez-Stark, 2010). Some services can be applied across various industries, whiles others are industry-specific. They can include generic functions such as payroll management, accounting, human resources and also more specialized, higher value services such as market intelligence and business analysis. Each of the service types has commensurate human capital requirements, which range up to postgraduate qualifications. Various data collection difficulties make accurate assessments of the global services value chain 52
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difficult. Gereffi and Fernandez-Stark (2010) have gathered some data from a variety of sources (Table 1). They also point out that India and the Philippines are leaders, with China and Malaysia emerging players. The generalized and consistent focus of Asian societies on education will provide a sustainable base for future development of these value chains.
(Gereffi and Fernandez-Stark, 2010) As the analysis above indicates, there are already significant movements of people within Asian economies towards high value or advanced services provisions. For potential Australian services firms, there are two important corollaries: 1) there are numerous opportunities in the high labour costs sectors, which is where Australian providers would be found; 2) there will be a pool of qualified local talent which can be tapped. 53
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Chapter 11 Value-Chain Implications Regional and Local Strategies Australian firms that enter the Asian markets will make strategic decisions to coordinate their activities across the region or focus on each market. These are the same decisions already taken by existing MNEs. For example, makers of electrical goods coordinate a large number of inputs across various countries. Automakers also coordinate across markets, but at a less complex level than electrical goods. Processed food makers often approach each market as distinct, due to local tastes or specific distribution networks or the need for locally procured materials. Similarly, Australian companies that want to enter an existing value chain have to understand the strategy of the sector and the firms within it. For example, the Australian firm WorleyParsons, which provides numerous professional services in the mining and energy sectors, has several operations across Asia, including a procurement centre in China. In Thailand and Malaysia, the operations are for hydrocarbon engineering, whilst in Singapore it is power generation and in Hyderabad it is design. These operations are coordinated across the region. WorleyParsons has global clients such as Shell and BP and provides services for them around the globe. In contrast, the Japanese and beverage company Kirin, uses a local strategy in key Asian growth markets. Kirin has significant investments in the Asian region, including the San Miguel brand in the Philippines and Indonesia. For Kirin, China, Vietnam and Thailand are seen as growth markets based on population and economic growth. Each of these markets is treated individually due to variations in consumer tastes and cost of inputs, which cannot be easily transported across borders at reasonable cost. Company decisions about regional, local or hybrid strategies will differ according to the sector involved. Value-chain analysis clarifies the numerous links that each sector contains and guides strategic decisions. Services Australian involvement in regional services value chains will be in high-value, high-labour costs segments, commensurate with Australias status as an advanced economy with a high share of services in GDP. As mentioned below in the chapter on final demand patterns in Asia, these will
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include engineering, design, finance, funds management, infrastructure project management, R&D, mining services and others. Whereas the academic literature on value chains is from the point of view of development economics (what policies are needed for developing economies to become part of regional or global value chains; how can they make use of their comparative advantage in labour costs; how to climb up the value added curve), our interest is to locate those elements of the value chains that a high-wage, high skill economy like Australia can plug into. Once again, there is room for government to help close information gaps that inhibit investment and expansion. The Asian region is in a state of transition now, as it moves away from a dependency on exports to the US and the EU and focuses more on its own, regional economic demand and supply. In this context, Australia is actually well placed. In the past decade or so, Australia has greatly increased its skills and advantages in areas like design, financial services, infrastructure. It has become a very wealthy society and thus carries a stronger brand in general. Australia has brushed off the Asia financial crisis and the GFC. This economic strength has positive flow-on in terms of brand. The burgeoning tourism from China will also heighten the popular love affair and allow Australian soft power to be leveraged. Brands like Billabong could have the opportunity to appeal to the Chinese consumer, for example, whose perceptions will not be coloured by comparisons with the US.
Manufacturing Manufacturing in Australia as a share of production and as a share of employment has been falling steadily for decades. However, this is typical of any advanced economy, where the value-added shifts primarily to services. This is true in Japan, too. Taking further lessons from the Japanese experience of investing offshore in the Asian region, the surprising recommendation is that Australian manufacturers should be encouraged and helped to expand offshore, to engage in FDI in the Asian region. Growth opportunities for manufacturing exist offshore and the most attractive growth options are in the Asian region: massive expansion of urbanisation and the middle class; proliferation and
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establishment of global value chains in various sectors. FDI has always been accompanied by expansion in exports. It is not an export-substitute. Entry into Asian value-chains requires direct investment at some stage, although it can begin with an export strategy. An FDI strategy into Asia can begin with a joint venture approach, with a partner firm to mitigate lack of brand awareness and gaps in local knowledge. Manufacturing value chains expose opportunities at the consumer end (e.g., Billabong), the producer end (e.g., Bradken) and in-between (e.g., Futuris). In the longer run, FDI by some large Australian companies will also encourage and facilitate the offshore growth of companies that provide the former with inputs and services. Some Australian companies have moved their manufacturing facilities offshore, e.g., to China, to re-import for the Australian market. But there would be an equally compelling case to manufacture for the Chinese/Asian markets, which would require investment in design in China as well. Building on the Japanese Relationship The commercial relationship between Australian and Japanese companies has been built and expanded for more than five decades. Although anchored in resources, energy and food, it is moving quickly to embrace numerous industrial and service sectors. The value of this extraordinarily deep relationship is multi-dimensional. Extensive networks of human capital built up over these five decades; well established business, cultural and social networks; firmly established business links; tried and tested official channels. This relationship may not have been fully exploited but it represents an enormous reserve of investment (Panagiotopoulos and Cornell, 2009). This relationship has enormous potential to expand within the Asian region. As we have seen, Japanese firms have been fundamental in the expansion of production networks in Asia and have been core investors in the region. Therefore, it is important to note that a large component of Japanese demand lies outside Japan. As Japans position in the global economy continues to change,
exports from Japanese companies, including in the transport, electrical equipment and machinery sectors, are increasingly procured from Japanese firms in third countries, such as China, Thailand and
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other ASEAN nations. Australian firms are also increasing exports to these markets though not often in collaboration with Japanese firms in Australia, which typically export directly to Japan. This is changing and there is scope for greater change. Over the past eight years, exports to Asia from Japanese firms based in Australia rose from A$1 to A$6 billion Drysdale, (2009). Japanese companies have also been major investors in Australia. By the end of 2010, Japanese stock of FDI in Australia was about A$50 billion, the third highest after the US and UK. Japanese companies are quickly expanding their investments into Australia in numerous sectors, from food and beverages, to water desalination and purification, financial services and housing construction. As Japanese companies invest in many new areas of Australian business, they become aware of the various high quality inputs and services that Australian companies can provide. It is becoming obvious that the extensive relationships of Australia-Japan commerce in Australia could be leveraged in the Asian region.
Australian companies could expand their relationships with Japanese companies to enter the East Asian region. Japanese companies have been major investors in East Asia for four decades, with large production networks throughout the region. Japanese companies are also expanding their non-manufacturing investment into the region. Australian companies have many years of close collaboration with Japanese companies in Australia and Japanese companies have upgraded their perceptions of the capabilities of Australian firms. The recent example of joint business missions in infrastructure and public private partnerships (PPPs) in India and Indonesia could be repeated in other sectors.
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Chapter 12 Firms Responses to Policy Decisions (FTAs) In the earlier chapter on trade policies, primarily free trade agreements (FTAs), the potential problems of numerous FTAs at the bilateral and sub-regional level were introduced. They have been identified as being problematic especially in the context of production networks and in particular the nature of non-tariff elements such as rules of origin (ROOs). Athukorala (2010) articulates these issues: The trade-distorting effects of ROOs are presumably more detrimental to network trade than to conventional final-goods trade, because of the inherent difficulties in defining the product for duty exemption and because of the transaction costs associated with the bureaucratic supervision of the amount of value-added in production coming from various sources. Formulating ROOs for network-related trade is rather complicated business...The only viable option is to pursue so-called change-in-tariff-lines-based ROOs, but this leads to insurmountable administrative problems because trade in electrical and electronics goods, and their related parts and components belong to the same tariff codes at the HS-6 digit level, which is the normal base for designing these type of ROOs. Moreover, the process of global production sharing is characterized by the continuous emergence of new products. Given the obvious administrative problems involved in revising ROOs in tandem, the emergence of new products naturally opens up room for unnecessary administrative delays and the tweaking of rules as a means of disguised protection. Kawai and Wignaraja (2009) also point out the problems of ROOs, which deter firms from using the FTA preferences and raise their costs: multiple ROOs in overlapping FTAs pose a severe burden on SMEs, which have less ability to meet such coststhis phenomenon has become widely known as the noodle bowl effect in Asia. In addition, they point to the excessive exclusions and special treatment in FTAs and suggest that well designed and comprehensive FTAs provide numerous benefits, including preferential tariffs, market access, and new business opportunities (Kawai and Wignaraja, 2009). It is worth stressing that trade expanded free trade areas do have a positive effect on firms behaviour. Both horizontal and vertical production patterns can coexist, and the flexibility in sourcing components from various countries, while exporting the resulting final goods, is closely linked to trade policies. Japanese automobile assemblers procure key parts from four ASEAN countries, taking advantage of the ASEAN Free Trade Area (AFTA) (WTO and IDE-JETRO, 2011). 58
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For example, an automobile maker such as Toyota, could take advantage of the ASEAN Free Trade Area (AFTA) to rearrange its production in the region. Similar automobile parts could be produced in one of four countries, thus creating the capacity for economies of scale to be gained for each component, reducing costs and increasing production.
(WTO and IDE-JETRO, 2011) To understand how firms actually deal with and feel about FTAs and the various rules, the Asian Development Bank Institute carried a series of surveys (see Kawai and Wignarja (2009) and updated in Kawai and Wignaraja (eds) (2011). Five comprehensive surveys of exporting firms conducted in 20072008 by ADB and several partners in Japan, Korea, Philippines, Singapore, and Thailand shed light on the use of FTA preferencesEast Asian exporting firms tend to utilize FTA preferences more frequently than previously thought and may even be increasing their utilization rate. Of the 609 East Asian sample firms, 22% use FTA preferencesa classic firm size effect seems to underlie the pattern of FTA preference use in the East Asian sample. The results suggest that using FTAs entails large fixed 59
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costse.g., learning about FTA provisions, tailoring business plans to complex tariff schedules, and obtaining certificates of originand larger firms are better able to muster the requisite financial and human resources than small- and medium-sized enterprises (SMEs) (Kawai and Wignaraja, 2009). Larger firms would be expected to be subjected to more ROOs, but their financial resources allow them to handle it better. Apart from the expected comments about multiple ROOs, administrative costs and non-tariff issues, they found an important factor that can be alleviated: Surprisingly, a lack of information on FTAs is the most significant reason for non-use of preferences as reported by 45% of firms surveyed (Kawai and Wignaraja, 2009). Accordingly, use of FTA preferences can be encouraged by raising awareness of (i) FTA provisions, including phasing out tariff schedules; (ii) margins of preference at product level; and (iii) administrative procedures for rules of origin (ROOs). Business associations and governments could make information on how to use FTAs more transparent, particularly for SMEs. Practical ideas include frequent seminars with SMEs, television programs directed at businesses, and dedicated websites and telephone help lines (Kawai and Wignaraja, 2009). There have been other studies of differences in regulatory environments. For example Findlay (2009) reports on the logistics regulations within ASEAN, an important issue since smooth logistics support the potential for network trade. Large differences exist in the regulatory environment for logistics of the ASEAN+6 economies. Many of these economies are open to trade in logistics services, while others are relatively restrictive. However, Findlay also found that generally the degree of restrictiveness falls as per capita income rises and that he values of this index from 1990- 2007 indicate a falling trend of trade costs in ASEAN countries. There is therefore, room for optimism that feedback from research a general underlying intention to facilitate trade and the liberalization that will accompany rising incomes, will indeed create a more liberal environment for logistics. Since the rules and provisions and exclusions in FTAs are primarily a matter for governments, in this area government has a continuing role to negotiate more comprehensive FTAs as well expanding the scope as much as possible to include the largest number of countries. Ideally, it would include all of ASEAN, plus China, Japan, Korea, Taiwan and India. Furthermore, effort could be made to simplify and harmonize the various ROOs.
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Chapter 13 Final Demand Patterns in Asia Long-term forecasts of economic growth in East Asia are mostly sanguine, with justification. Recent economic crises have generated some disquiet and skepticism, which are mentioned below, but the view of this analysis remains optimistic, for reasons also outlined below. During the period from 2000-2008, in which China joined the WTO and became the regional economic driver of integration, there was a widely held view that the East Asian region had become decoupled from the US and EU. This view stressed that the region had reached the stage of self-sustaining economic growth. The validity of the decoupling thesis has been sorely tested during the period since 2008 due to the effects of the lingering economic slowdown in the US and EU. One of the key factors that could and did undermine the decoupling thesis is the widespread network of intra-regional trade in component and intermediate goods, for which the largest markets of final demand remain in the West. The dependence of East Asia (and East Asian country sub-groups) on extra-regional markets, in particular those in NAFTA and the EU, for export-led growth is far greater than is revealed by the standard intraregional trade ratios commonly used in the debate on regional economic integrationFrom April 2008 to June 2009, world trade contracted by about 20%, which amounted to almost the total contraction in world trade during the first 30 months of the Great Depression (starting in April 1929). Interestingly, trade contraction in East Asian countries during this period was even greater than the contraction in total world trade (Athukorala, 2010). Vertically integrated production networks across the region were extremely sensitive to final demand outside the region, but this network interdependence was accompanies by other factors. These include the much larger contraction of trade credit, a greater share of consumer durables in contemporary world trade compared to the 1930s, and the effect of recent advances in communications technology on inventory cycle and just-in-time procurement practices (Athukorala, 2010). Japans experience during the GFC, during which its exports were hit the most of all Asian economies, shows both the strong interdependency of production networks and also the fragility of the decoupling thesis, as Japanese exports to China were also affected. Similar, albeit less acute, effects were felt by Taiwan and South Korea.
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The rapid and extensive growth in intra-regional trade, which is connected to the production networks, has been both a key ingredient of the economic dynamism of Asia, but also a point of vulnerability. Some recent views have become the antithesis of decoupling: The high intraregional trade shares reported in recent studies largely reflect rapidly expanding intra-regional trade in components. There is no evidence of rapid intra-regional trade integration in final products. In fact, the regions growth based on vertical specialization depends inexorably on its extra-regional trade in final goods, and this dependence has increased over the years. Extraregional trade is likely to remain the engine of growth for the region in the foreseeable future. Put simply, growing trade in components has made the East Asian region increasingly reliant on extraregional trade for its growth (Athukorala, 2010). While this perspective has clear merit in terms of highlighting possible constraints on growth, it is largely overstated. There are several reasons why the expected rebalancing of global economic weight will shift to Asia: the widespread transfer of capital and technology by multinational corporations; the massive development of urbanization in China, India and other Asian countries; and the establishment of a critical mass of middle class consumers numbering in the hundreds of millions. Ever since the Japanese multinationals began to transfer production to locations in Asia due to labour cost differences, similar investment by firms with high levels of technology and skills have been made for decades. Over this period, the level of technology and skills in the host countries has also increased, rising to a level that generates its own innovation. This pattern started with South Korea, Taiwan, Hong Kong and Singapore, what may be called the second generation. They were followed by Thailand, Malaysia and the Philippines, then by China and India. The process continues with Vietnam, Indonesia, Bangladesh, Pakistan, etc. As second-generation economies have moved out of the production of low-end consumer goods, they have created room for third- and fourth-generation economies to enter these product niches. At the same time, the emergence of a large fourth-generation economy, China, has created a supply of labor-intensive intermediate inputs sufficient to push second- and third-generation economies up-market in terms of the activities they perform. Trade has thus contributed to complementarity between the production structures and the development paths of countries in the region, even as it has fostered rivalries between countries for market share abroad. Income growth in one country increases the demand for intermediate inputs produced in nearby countries, which, by allowing input producers to enjoy scale economies, lowers input production costs and enhances 62
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regional growth (Haddad, 2007). The pattern of investment and trade cascaded across industries from textiles, clothing, wood, paper, furniture and rubber to sophisticated manufactures such automobile parts, office machinery, telecommunications and electrical equipment. The export commodities where East Asia is specializing are inherently products with increasing returns to scale and high skill intensity (Haddad, 2007). Economies of scale and skill development are fundamental factors in rising incomes and valuable human capital formation. As the trade in machinery in developing East Asia increased, its nature evolved. Products made in China are shifting to more sophisticated machinery and away from mass-manufactured, low-technology goods. For example, China now exports more personal computers and related accessories than metalworking tools. China is also exporting more cellular phones, personal digital assistants, and flat-screen televisions instead of transistor radios. While much of this production involves the assembly of high-technology products using low-skill workers, there has been true improvement in Chinas technological production capacity (Haddad, 2007). Production networks in East Asia are a good starting point to see how there has been a growth in host country firms that have been able to benefit from capital, technology and skills transfer. The hard disk drive (HDD) sector, which is at the core of the electrical equipment production networks, has been well research in detail by Hiratsuka (2011). Large US anchor firms initiated the clustering of the HDD industry in Singapore by outsourcing supply to Singaporean firms for parts of heads and printed circuit boards. A good example is Seagate, which had to provide technical support to the local firms in order to raise technical standards to the required level. With technical support from Seagate, the local suppliers were finally able to supply precision parts and components to Seagate. Other American suppliers also outsourced to local suppliers. Fourteen of them are now listed on Singapores Stock Exchanges (Hiratsuka, 2011). Japanese firms also established affiliates in the HDD sector in Asia. Developments in the Singapore cluster led to other investments in Malaysia (Penang), then to China, Thailand and the Philippines, where important clusters of first and second-tier suppliers of HDD parts were established, some Japanese but also many Singaporean and Malaysian firms that have made crossborder investments. 63
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For example: Eng Technology (1988) and LKT Technology (1978) produced actuators. Eng Technology provided HDD parts for Maxtor who started the HDD business in Penang in 1986. Maxtor expanded operations into the PRC in 1996 and into Thailand in 1997, where they supplied Seagate, and into the Philippines in 1997 where they supplied NIDEC and Fujitsu. LKT Technology provided HDD related parts for Seagate in Penang, Malaysia, and Thailand and for NIDEC in Thailand. Several indigenous Malaysian subcontractors expanded overseas to countries such as Thailand, the Philippines and THE PRC and became regional suppliersKobay Technology (1984) provided automate industrial machinery for AMD, Intel, and Motorola.4 Pentamaster (1987) provided automate industrial machine for Dell (1984). Micro Modular System (1997) started with a small factory shop and went on to become listed on NASDAC Malaysia in 2005A small mechanical-part cluster has developed in the Philippines, where three Japanese final assemblersFujitsu, Global Data Storage, and Toshibahave located...These were Japanese first-tier and second-tier suppliers, such as Nidec for spindle motors (1996), TDK for magnetic heads (1997), Nitkoshi for head storage (1999), and Touritsu for plastic filters (2001). Singaporeand Penang, Malasia-based second-tier suppliers followed, including Singapore-based CAM Mechatronic for bases (1996) and Malaysia-based Engtek for spoilers and shrouds (1997). By the end of the 1990s, Manila was the new HDD industry center next to Singapore and Thailand (Hiratsuka, 2011). These examples of the HDD sector, its sub-sectors and related sectors give a good micro example of how human resources and technology have been developed by firms in the host countries and which then have become multinationals themselves and have also listed on Asian stock markets. These are the kinds of developments that underpin sustainable wealth creation. Of equal importance are similar developments occurring within the Asian region, as second, third and fourth generation economies are investing in the next generation. Some parts of the manufacturing sectors in China and Malaysia have become more advanced and the lower-vale added sectors have engaged in some relocation. Viet Nam, for instance, is an increasingly important node in such networks, thanks in part to the multi-billion dollar investments undertaken by companies from within the region. In addition, the least developed countries (LDCs) in the region Cambodia, the Lao Peoples Democratic Republic and Myanmar have also started to reap the benefits of increased intraregional FDI: the major sources of their FDI inflows are now countries within the region, such as China, Indonesia, Malaysia, the Republic of Korea and Thailand Beyond electronics, more production activities have been subject to sequenced relocation within the region in recent years, as highlighted by the investments in steel and 64
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automotive industries in Viet Nam. Chinese companies in the textile and automotive industries have also been relocating part of their production operations to ASEAN countries, such as Cambodia, Indonesia and Thailand. As intraregional FDI flows in manufacturing continue to increase, those in related services, such as finance and infrastructure, are expanding as well (UNCTAD, 2011).
(UNCTAD, 2011) At the level of international business, these decades long processes have resulted in the rapid proliferation of new global companies based in Asia. The type of MNEs that played a key role in producing the production networks in Asia are now based in Asia. An analysis of the Forbes Magazine Global 2000 firms provides stark evidence of these trends: During 2002-2009, the U.S. and Japan have kept the positions of the 1st and 2nd largest source countries owning the most of the Global 2000 firms, though the share and the number of firms have been declining. The most significant change should be the rapid climbing-up of China and India. In 2002, China and India were ranked the 21st and 16th owning only 13 and 20 firms in the Global 2000. Yet in 2008, they became the 3rd and 8th owning 113 and 55 firms respectively. In only five years, China surpassed the technologically advanced and capital abundant countries such as UK, France, Canada and Germany, gaining a leading stand in the world investment race. In addition to China and India, the Asia NIEs (newly industrial economies), including South Korea, Hong Kong and Taiwan, have remained steadily in the list of the top 15 countries throughout the period (Yang and Huang, 2011).
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The United States, although predominantly a services economy, remains a leader in manufacturing, as a single economy. On the other hand, the performance of the East Asian countries in manufacturing is stronger than that in overall aspect. Japan, China and Taiwan are consecutively ranked as the 2nd, 3rd and 4th, followed by South Korea as the 7th, Hong Kong the 11th and Singapore the 16thEven with modest size, the rapid growth of MNCs of the emerging Asian countries has changed the dominance of the global economythe Herfindahl concentration index based on the shares of the source countries owning the Global 2000 firms, either measured by firm number or by sales, has declined over time. It may imply that the rise of emerging Asia has made the distribution of global economic power decentralized and spread more evenly among the three continents of Europe, Americas and Asia(Yang and Huang, 2011). This conclusion, presented tentatively, points to the next important aspect to be considered, i.e., the rebalancing of the worlds wealth creation and the potential for long-lasting higher economic growth rates in Asia. Several forecasts have been consulted, both medium and long term. The investment bank UBS has looked at a ten year period and concluded that while the US will remain the dominant power in the worldits relative strength will continue to slip over the coming decadeAs far as economic size is concerned, the US is the worlds uncontested economic heavyweight. Although China is catching up, it is unlikely to exceed the US in terms of economic output over the next decadeGrowth leadership is the one area where the balance has already shied away from the US. In 2000, the US accounted for nearly a quarter of global growth in economic output, more than double Chinas contribution. However, in 2009, the US accounted for a mere 20% of global economic growth, while China had a 26% share. This matters because such a shift in growth contribution means that a large share of new global investment and business opportunities is progressively tilting away from the US (UBS, 2011) However, UBS also acknowledges that there are structural elements that will challenge China in the long-term. An open immigration policy for highly skilled, foreign-born workers has also afforded the US a significant demographic advantage enjoyed by few others. This means that the US suffers less from an aging population than other developed nations that do not have the benefit of immigration...Clearly, the reintegration of China into the global economy has been an extraordinarily positive development over the past decade and a half. The potential shortage of skilled workers is partly a function of a demographic profile that looks more like Western Europe than Southeast Asia. But China must not only deal with issues such as limited pension assets for an aging population, but also significant gender issues as well, given the large disparity between 66
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male and female populations (UBS, 2011). The demographic and labour force issues of China will be emerging within the next decade and will impose constraints, but can be mitigated by good policy and, perhaps surprisingly, can play a part in the re-balancing towards domestic consumption. Since 2000, the response of labour costs in China has largely matched demand-supply conditions, i.e., market and productivity-based. Therefore it does not weaken the competitiveness, but instead tends to enhance long-term competitiveness and sustainability of growth if it successfully pressures the economy to complete its transition from an inputs-driven growth pattern to a productivity-driven one. Furthermore, the current diminishing of labor supply is only an incremental phenomenon, which will not change the stock of labor force in China in the near future. In fact, Chinas working-age population will remain in an annual growth rate of 0.7 percent between 2005 and 2015, and the large scale and proportion of the labor force in the total population will remain a feature of the Chinese population structure for quite a while (Cai and Wang, 2010). China continues to be a powerful economic engine for the whole region, supporting a situation in which emerging markets now seem to have reached an inflection point. Not only are the emerging markets contributing a larger portion to global growth than ever before, this growth also appears more sustainable and the underlying economies less crisis-prone than in the past. Many of these countries have improved their macroeconomic policymaking framework and improved their resilience to economic and financial crises (UBS, 2011). The UBS analysis also makes mention of two fundamental factors, which will also be used for long-term forecasts: population and urbanization. Based on forecasts prepared by the United Nations Population Division, the global urban population could expand by almost 700 million people in the next 10 years, with nearly half of the increase coming from the E7 countriesPricewaterhouseCoopers projects that the 25 fastest-growing cities from 2008 to 2025 (based on GDP) are likely to be in emerging markets (UBS, 2011). Of course, long-term forecasts are extremely vulnerable to modeling assumptions regarding basic factors such as economic governance, productivity, education, population, labour force participation, etc. There is also the well-known and rightly feared potential problem of the middle income trap. The Asian Development Bank has a specific section on this problem in its recent publication Asia 2050. But for the middle income trap to occur Asia follows the pattern of Latin America over the past 30 years (ADB, 2011).
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We can be justifiably more optimistic than that, considering the actual history of Asian economic growth during the past 30 years. It has been more in keeping with the expectation of convergence of developing and developed economies, which is predicted by growth theory. (For more background on convergence see Thirlwell (2010) and Rowthorn and Kozul-Wright (1998). Convergence is not simply a statistical inevitability but the result of an ongoing, iterative interaction between numerous factors: institutional settings, such as property rights and prices set by a market; investment in infrastructure and education; investment in technology; lessons from successful policies applied in advanced economies; lower trade barriers and liberalized trade and investment policies. Investment in R&D is especially crucial for the transition to technology and productivity-led growth, one of the key ways to avoid the middle income trap. In 2009, the United States still led the world in R&D with a share of 31% (down fro 38% in 1999). But second and third were China (12%) and Japan (11%), both in the East Asian region. Besides the generally vigorous pace at which the global total of R&D is now growing, the other major trend has been the rapid expansion of R&D performance in the regions of East/Southeast Asia and South Asia, including countries such as China, India, Japan, Malaysia, Singapore, South Korea, Taiwan, and Thailand. The R&D performed in these two Asian regions represented only 24% of the global R&D total in 1999, but accounted for 32% in 2009, including China (12%) and Japan (11%) (National Science Foundation, 2012). Until 2000, global growth was primarily driven by the developed world with about two thirds of growth coming from the developed world, and one third from the developing world. Between 2000 and 2010, this pattern was turned on its head. In the five years to 2010, almost three quarters of global growth came from the developing world. Long-term forecasters typically believe that this trend will be sustained (ANZ Bank, 2011). Urbanisation has been growing in China and India. This is expected to continue. In China this represents around 15-20 million people per year moving to urban areas, whereas in India it is closer to 10 million. Across the world, expectations are that close to 70 million people will be added to the urban population every year from 2010 to 2050 (ANZ Bank, 2011). McKinsey Global Institute (MGI) projections show Indias urban population soaring from 340 million in 2008 to 590 million in 2030 (McKinsey Global Institute, 2010). This will create tremendous demand for infrastructure, transportation, healthcare, education and recreation: the 68
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economy will have to build between 700 million and 900 hundred million square metres of residential and commercial space a year350 to 400 kilometres of metros and subways every yearbetween 19,000 and 25,000 kilometres of road lanes (McKinsey Global Institute, 2010). The scale and pace of Chinas urbanization continues at an unprecedented rate. If current trends hold, Chinas urban population will hit the one billion mark by 2030. In 20 years Chinas cities will have added 350 million peopleBy 2025, China will have 221 cities with one million plus inhabitants compare with 35 cities of this size in Europe today and 23 cities with more than five million (McKinsey Global Institute, 2009). Urbanisation will be accompanied by the enormous increase in the middle class in developing economies, predicted by McKinsey and Co to be an additional three billion people by 2030 (McKinsey and Co, 2011). In addition to the demand created by urbanization, there will be middle class-specific consumption: inexpensive automobiles, cosmetics, snack food, infant hygiene products, beer, financial services, household goods, leisure services, communications, healthcare, etc. (McKinsey and Co, 2010). China and India will produce the biggest new middle classes. As China transitions to a more consumption-led economy, Chinese incomes will grow and a massive middle class is expected to emerge. The urban consumer markets, in particular, will develop rapidly, moving from 43% of the population today to 69% by 2015 and 75% by 2025As the incomes of the new middle class rise dramatically, China will become the third-largest consumer market in the world by 2025 (McKinsey Global Institute, 2006). Similarly, for India, MGIs analysis shows that if India continues on its current high-growth path, over the next decades the Indian market will undergo a major transformation. Income levels will almost triple and India will climb from its position as the twelfth biggest consumer market today to become the worlds fifth largest consumer market by 2025 (McKinsey Global Institute, 2007). Parallel research by the OECD also shows enormous increases in the middle class, especially in the Asia-Pacific area. For example, in 2009 the Asia-Pacific region had 525 million or 28% of the global middle class. By 2030 this is predicted to be 3.2 billion people or 66% of the global middle class. In spending terms (2005 PPP dollars) the Asia Pacific middle class value was $5 trillion in 2009 and predicted to be $33 trillion in 2030 (Kharas, 2010). Note: to clarify the definitions of middle class: McKinsey uses emerging middle class to mean an
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annual income in purchasing power parity (PPP) terms between US$13,500 and US$113,000. These are wide differences and McKinsey makes further breakdowns into lower middle class (US$13,500 - US$22,499), middle (US22,500 US$56,499) and upper middle (US$56,500 US$113,000) (McKinsey and Co, 2010). Kharas uses a different definition of middle class, with a range, again in PPP terms, of US$10 US$100 per day, which makes his lower bound less than McKinseys and his upper bound also less (Kharas, 2010). There are numerous long-term economic projections and they have the same general message: that the biggest increase in economic growth and thence in share of global GDP will come from the Asian region. One such easily clear example is the following graph from Buiter and Rahbari (April 2011).
These projections are dramatic and may look overblown, but it is worth remembering that the concomitant rise of China, India and the rest of Asia and the concurrent existence of the wealthy economies like the US, Japan and the EU is a situation that has not been encountered before. As the OECD report reminds us, Chinas middle class today is already large in absolute terms at 157
million people, only the United States has a larger middle class. This is why so many retailers and businesses are already eager to penetrate the Chinese market. Though retail sales in the country have slowed from the 20+ per cent growth achieved in mid-2008, they continue to rise by a robust 15 per cent. In certain key industries reflective of middle class consumption, China is already rising to overtake the United States as the most important market. As recently as 2000, for example, the US accounted for 37 per cent of global car sales, while China accounted for barely 1 per cent. This year
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China is expected to account for 13 per cent of global car sales. Including trucks and buses, vehicle sales in China may surpass 13 million in 2009, which would make China the worlds largest vehicle market...China has recently emerged as the worlds biggest cell phone market, home to an estimated 700 million subscribers. Last year Nokia, the largest cell phone maker in the world, had net sales of USD8.2 billion in China, more than three times its US revenues (Kharas, 2010).
These unprecedented changes to regional demand will provide enormous opportunities for Australian exports of energy, resources and food. In parallel with the demand for natural resources, there will be a huge increase in opportunities for the services and manufacturing sectors that connect with energy, resources and food. The mining sector in Australia is a huge network of value-chains, with large technology and value-added components. Australias revealed comparative advantage in food exports also supports a large network of value-chains in this sector. The scale and diversity of these connected sectors should not be underestimated: Engineering consultancy services; heavy industry; building and non-building construction; plant hire and leasing; explosive manufacturing; machinery and equipment wholesaling; surveying services; port operators; rail freight transport; road freight transport; shearing, cropping and other services to agriculture; fertilizer manufacturing; pesticide manufacturing; scientific research; contract mining; information technology; consulting & process engineering; logistic suppliers; labour hire; electrical contractors; electrical utilities; drillers; testing services; remote housing; mining software; recycling/waste management; financial services; project development business. Farther afield, processed food, tourism, legal and accounting, education, medical, banking, real estate and specialty manufactures will also have huge demand. The energy, resources and food sectors of Australia have a further significance: they form the key focus of demand for long-term food and energy security that concern the Asian region. These concerns will be addressed in a global supply context, but Australia will be a major supplier. While these sectors will require huge investments within Australia, they will also provide the base for direct Australian involvement in the Asian region in the form of direct investment. As a market becomes more mature and the consumer or customer becomes more sophisticated, direct investment must grow faster than exports in order to understand the market better, provide the right service faster, respond to competitors and cultivate the relationships in-market which are the prerequisites to success. The growth of the middle class and greater urbanization will intensify the existing multitude of production and service networks in the region and thus create more opportunities for Australian companies throughout the array of value chains. 71
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Finally, the increasing share of global R&D that is occurring in the Asian region has the potential benefit of reverse technology transfer, that is, Australian companies entering the Asian market will not only contribute to the increase in technology of the region. They will also gain from the technology transfer that will accrue to them from the R&D in the region, which will then find its way back to Australia through intra-firm mechanisms. At the end of 2010, Australias stock of outward foreign direct investment had reached a value of A$378 billion (ABS, Cat. No. 5352.0). Of this total, A$23 billion had been invested into the 10 largest Asian economies (China, India, Indonesia, Japan, Malaysia, Republic of Korea, Singapore, Taiwan, Thailand and Vietnam). This represents a share of 6.2% direct investment into the region that accounts for two thirds of Australias exports and has the highest current and future economic growth. Since the 1980s Australia became a much more open trading nation and the future growth prospects will require similar commitment to overseas direct investment in the Asian region.
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Chapter 14 Examples of Australian and Japanese Companies Illustrative Examples of Australian Companies in Manufacturing and Services AAM Pty Ltd AAM Pty Ltd is a leading firm in the spatial information technology sector. It is the kind of service company that has significant IP and some international experience. Their expertise and technology are international standard and the potential applications cover many fields. It is the type of company that should grow with overseas income. The companys output benefits engineering projects as diverse as industrial survey, digital preservation of cultural heritage sites and road asset management. The company has personnel in Australia, New Zealand, Malaysia and South Africa. AAM has introduced leading innovations to the market such as Terrestrial Laser Scanning, LiDAR, high resolution Satellite Imagery (GeoEye, RapidEye), 360o Spherical Imaging, SiteSeeTM and Pictometry.
NAVITAS Navitas is an education services provider with operations in numerous cities around the world, including in the US and Europe. Its Asian operations are in Singapore, Hong Kong, Sri Lanka and Indonesia. Navitas has won the Australian Education and Training Export Awards. It has four lines of business: The University Programs business delivers education programs, via pathway colleges and managed campuses, to students requiring a university education. The SAE business delivers education programs in the area of creative media including courses in audio, film and media. The English business delivers English language tuition. The Workforce business delivers vocational and job skills training. The Student Recruitment business delivers student recruitment services to students seeking international education experience.
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GHD Established in 1928, GHD is a leading engineering, architecture and environmental consulting company. It has a global network of engineers, architects, planners, scientists, project managers and drafters. GHD provides services covering the full life cycle of projects including water treatment plants, mining, energy, buildings, roads and the environment. GHD has more than 6000 personnel in 100+ offices across five continents. GHD has won numerous engineering awards in Australia, NZ, Middle East and US GHD has already completed some projects in Asia: Manila Sewerage Implementation, Maynilad Water Services & Manila Water Corporation; Taysan Copper Mine Feasibility Study, Philippines; Huyuan Jin Wai Tan Stage 2, China; Changsha South Bus Station Transport Hub, China.
BRADKEN Bradken is a leading global supplier of differentiated consumable and capital products to the resources, energy and freight rail business in international markets. As a leading heavy engineering company, Bradken can manufacture fully machined cast iron and steel products from a mass of 0.5kg to over 25 tonnes. Bradken employs over 5,600 people globally and operates 32 manufacturing, sales and service facilities throughout Australia, New Zealand, the United States of America, Canada, China, Malaysia, South Africa, Indonesia, South America and the United Kingdom.
FUTURIS AUTOMOTIVE (now part of Elders Group) Futuris Automotive is a leading automotive components supplier. Futuris designs, engineers and manufactures automotive seating and interior solutions. It has an international network of design and manufacturing facilities across Australia, China, South Africa, North America and Thailand. Futuris provides products to some of the worlds leading vehicle producers, including GM, Ford, Toyota, Chery, JAC, Brilliance, GreenTech, Daimler, Tesla, Fisker and others. Products designed and produced by Futuris include: seating, door trims, carpets, steering columns, window regulators, etc. Futuris has a range of strategic joint venture partners globally, including with Chery Automobile, Huarui and Pangeo in China, and with Feltex in South Africa.
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ANZ ANZ Banking Group is a major Australian-based bank with retail and business banking in Australia, NZ and the Asia Pacific. Australian operations comprise most of ANZ's business, offering commercial & retail banking & funds management. ANZ is the largest bank in New Zealand with the National Bank of New Zealand. Expansion into Asia has secured ANZ a presence in 14 countries. ANZs 'super-regional strategy aims to generate an increasing proportion of earnings from Asia, the Pacific, Europe and America (APEA) at the expense of traditional markets Australia and New Zealand. ANZ aims to grow in APEA by i) capturing banking business associated with trade and investment flows between the various countries and ii) cross-selling fee-based services to institutional banking clients. The proportion of earnings sourced from APEA is steadily increasing from 12 per cent in FY07. The initial target of 20 per cent by FY12 has been upgraded to between 25-30 per cent by FY17.
WORLEYPARSONS WorleyParsons provides professional services to the oil & gas, power, minerals & metals and infrastructure & environment industries, including feasibility studies, design, project services, upgrade services and maintenance services. WorleyParsons uses an alliance based approach to provide services for a significant proportion of the company's contracts. This is a diverse global business with wide geographic coverage and skills across all project phases from feasibility to design, execution, operation and maintenance. Services are offered in a variety of fields namely hydrocarbons, minerals and metals, power and infrastructure.
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Illustrative Examples of Japanese Companies in Asia ITOCHU The Japanese sogo shosha (trading companies) are global operators and have been refashioning themselves as investors in numerous sectors, effectively becoming giant conglomerates. All of the Japanese sogo shosha have extensive operations throughout Asia, in many sectors and all of them have been longstanding commercial partners of Australian companies. ITOCHU is presented here due to its recent investments in Australia that may have an impact in the Asian region. In 2009 ITOCHU bought a share in Burra Foods, a Victorian dairy manufacturer. Both companies have agreed to establish a new milk powder facility, and ITOCHU will jointly operate the milk powder business with Burra in Australia. Demand for dairy products in the Chinese and Asian markets is rising, with their growing population and improving income levels, and there is a growing need for new production initiatives, especially in light of the attention given to safety and confidence in food following the food poisoning problems of recent years. ITOCHU believes this company is capable of supplying products suitable to the Chinese, Asian and Japanese markets targeted by ITOCHU. Also in 2009, ITOCHU became part of the Aquasure Consortium, which won the bid to provide a desalination plant for the Victorian Government in a Public Private Partnership (PPP). Australian engineering and financial firms have joined Japanese banks and ITOCHU for this project. ITOCHU is placing a strategic emphasis on the water sector, and has been very active in the Middle East, including Saudi Arabia. ITOCHU will accelerate and expand its activities in the water sector for countries in the Middle East, Australia, and Asia, where stress on the water supply is soaring.
RAKUTEN Rakuten is one of the worlds largest internet service companies. It provides numerous online services, from retail, credit and payment services, travel services, securities broking and banking. Rakutens official company language is English. Over the past few years, Rakuten has invested in several joint ventures in online commerce in China, Indonesia, Taiwan and Thailand. 76
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Rakuten is an example of the new wave of Japanese firms in the services sectors, expanding there presence in overseas markets in new ways.
DENSO DENSO is a high technology automotive component and technology provider, including climate control, driving control, safety, automotive information systems and others. For Denso, global growth in the auto market is being driven by emerging markets like China, India, and Brazil. DENSO is focusing on the development of low-cost components and its manufacturing development structure to gain business growth in emerging markets. Understanding local customer needs and market characteristics, procurement of local raw materials and parts procurement and local product design and manufacturing using local facilities are also crucial to product competitiveness. In emerging markets, DESNO is looking at halving costs compared with existing products. DENSO has a Shanghai technical center and has established a joint venture in India with the local company Subros Limited to design air conditioning systems. DESNO intends to establish new centers in India by the end of 2011 and in Brazil in early 2012. By the end of fiscal 2013, DENSO aims to have a fully global development and design structure. DENSO has also established a plant to produce car air conditioners in Changchun, China Singapore-based DENSO INTERNATIONAL ASIA PTE. LTD. (DIAS) serves as the headquarters of DENSOs operations in Asia and Oceania. DIAS has a wholly owned subsidiary in Thailand, DENSO INTERNATIONAL ASIA CO., LTD. (DIAT), which operates a technical center. DENSOs main customers are Japanese carmakers but it also supplies local and European and U.S. manufacturers as a result of recent free trade agreements (FTAs) in the region. DENSO in Australia manufactures engine cooling systems, air conditioning, air intake systems, fuel pump modules and instrument clusters. It has extensive relationships with Australian components suppliers. - ends -
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Manuel Panagiotopoulos

East Asian Economic Integration

EAST ASIAN ECONOMIC INTEGRATION BY MANUEL PANAGIOTOPOULOS

A REPORT FOR THE AUSTRALIAN TRADE COMMISSION

East Asian Economic Integration

East Asian Economic Integration

Conclusions and Recommendations

East Asian Economic Integration

Section 2 Chapter 10 Chapter 11

Chapter 12 Chapter 13 Chapter 14 Section 3

East Asian Economic Integration

East Asian Economic Integration

Examples Australian and Japanese companies strategies in Asia.

East Asian Economic Integration

Chapter 1. Economic Integration

East Asian Economic Integration

East Asian Economic Integration

East Asian Economic Integration

East Asian Economic Integration

East Asian Economic Integration

East Asian Economic Integration

East Asian Economic Integration

East Asian Economic Integration

East Asian Economic Integration

East Asian Economic Integration

East Asian Economic Integration

East Asian Economic Integration

East Asian Economic Integration

East Asian Economic Integration

East Asian Economic Integration

East Asian Economic Integration

East Asian Economic Integration

East Asian Economic Integration

East Asian Economic Integration

East Asian Economic Integration

East Asian Economic Integration

East Asian Economic Integration

East Asian Economic Integration

East Asian Economic Integration

East Asian Economic Integration

East Asian Economic Integration

Multinational Enterprise (MNE) Perspectives, Inter-firm and Intra-firm Transactions

East Asian Economic Integration

East Asian Economic Integration

East Asian Economic Integration

East Asian Economic Integration

East Asian Economic Integration

East Asian Economic Integration

East Asian Economic Integration

East Asian Economic Integration

East Asian Economic Integration

East Asian Economic Integration

East Asian Economic Integration

East Asian Economic Integration

East Asian Economic Integration

(Gereffi and Frederick, 2010)

East Asian Economic Integration

East Asian Economic Integration

(Fernandez-Stark et al, 2011)

Another value-chain map for pharmaceuticals is presented on the next page.

East Asian Economic Integration

East Asian Economic Integration

East Asian Economic Integration