APEC Currents - The Newsletter of the Australian APEC Study Centre at RMIT
March 2012


In this edition we look at:

APEC's Services Trade Access Requirements (STAR) Database: Identify the requirements to trade with and invest in other APEC economies

APEC Secretariat


Welcome to the first edition of 'APEC Currents' for 2012. This issue focusses on a number of key issues in the APEC work agenda.

APEC Study Centre Chair Alan Oxley looks at the issues facing the current negotiations for a Trans Pacific Partnership and canvasses the benefits that could flow from a successful conclusion to the negotiations. Fred Bergsten and Jeffrey Schott from the US based Peterson Institute look at where China might impact on the negotiations and review some of the interests that have been ascribed to the US in recent debate.

Mark Epper, KPMG Australia and Professor Hans Hendrischke, from the University of Sydney China Studies Centre report on a recent study of Chinese direct investment in Australia and discuss the implications and challenges for Australia as (currently) the largest destination for that investment. Australia's strong currency and domestic cost pressures have again thrust industry competitive issues into the limelight. Tim Butcher, Senior Lecturer in RMIT University's School of Management discusses research into supply chain actions that might enhance a company's competitiveness in today's market.

Two articles discuss the role of services in the Australian economy and trade. Thomas Westcott, Senior Consultant, ITS Global, reports on new research looking at the extent to which services are embedded in goods exports. The extent of this 'embedded service export' has not been appropriately recognized to date and therefore not effectively taken into account in crafting domestic policy. Steve Somogyi, Chief Operating Officer and Vice President, Resources, RMIT University reviews the significance of education exports for Australia. As with manufacturing in Australia the high value of the Australian dollar and domestic cost pressures are impacting on the attractiveness of Australia as a place to study.

I hope you enjoy this selection of articles and ideas. As always, your feedback on any of the articles would be valued.

– Errol Muir, editor

The Trans Pacific Partnership – are APEC members ready for the next step to open economies?

Alan Oxley By Alan Oxley
Chairman of the Australia APEC Study Centre at RMIT University and
Principle at ITS Glboal

Nine APEC members 1 have been negotiating a new regional agreement, the Trans Pacific Partnership (TPP) 2 . If it is to do more than just restate existing commitments to open markets and to accelerate growth, significant action to remove barriers to investment and services must result.

A lot is at stake. With growth expected to continue in the major regional economies, such as China and India, a very significant opportunity is on offer to those APEC economies engaged to gear their economies to capture that benefit. There will be big challenges.

First, they will need to look beyond current preoccupations with the global financial crisis. Then they will have to break the practice of making ringing declarations like the 1994 Bogor Declaration to remove all trade and investment within 20 years, then only partially remove barriers. Admittedly the resulting liberalization did generate faster economic growth than the rest of the developing world; but difficult problems were left untouched.

Today there is a much tougher challenge before them - to fully open their economies and see this as part of a strategy to restructure them. The economic dividend will be huge, and essential if Asian Pacific economies are to remain globally competitive.

Specifically, this requires reducing barriers to investment, deregulating services, and adopting laws to guarantee freedom of competition and protection of the right to engage in business. This for some will be large cultural step - a step back from a culture of management of national economies and a move instead towards allowing economies to adjust naturally to changes in market forces.

Stepping back from politicking over trade
This will also require a step back from the politicking over regional trade liberalization. Regional trade agreements have become so much the flavour of the day there is an orgy of poster politicking in the Asian region over who has the bigger plan for a regional agreement.

China proposed an ASEAN plus three agreement; that was trumped with an ASEAN plus six; Japan proposed a regional Asian trade agreement; an FTA for all 21 APEC members has been proposed; and last November ASEAN leaders proposed an ASEAN plus Plus model.

So where does the Trans Pacific Partnership come in? There are some notable elements. First it less ambitious in one sense - it does not aspire to be the biggest agreement ; and second there is the participation by the United States. This is a game changer. The US takes trade agreements very seriously, as anyone who has negotiated a bilateral free trade agreement would attest.

This will also be a tougher agreement than most - it will require coverage of investment and services and reach into some "beyond the border" regulation. So far its participation is limited to those economies who want to participate: it does not seek to satisfy a principle of geographical inclusion.

That said, the acid test of the success of this agreement will be the extent to which its parties reach into the new areas of liberalization without which the necessary economic "restructuring" cannot begin.

The grand ambition of its backers is to demonstrate a framework by which all members of APEC can achieve a seamless flow of trade and investment.

What does economic restructuring entail?
Modern trade agreements promote liberalization of trade and investment. APEC economies have also long understood how barriers and controls "beyond the border" need to be removed if economic growth is to be improved. These leads governments down the path of structural adjustment, the term traditionally used in international, economic bodies to describe adoption of policies to enable economies to adjust to changing economic conditions. Structural change is increasingly referred to in work in APEC bodies.

The benefits from liberalizing services and investment
Most Asian Pacific economies understand the benefits of cutting tariffs but the benefits from opening services markets and removing restrictions on investment are less well appreciated.

It is a standard feature of economic development that as economies grow, the share of GDP generated by services also increases. In industrialized economies services generate around 80 percent. In lower income developing economies, such as Indonesia and Vietnam, services generate only around 40 percent of GDP.

Economic competitiveness is highly dependent on competitively costed services. The costs of a number of services, for example, telecommunications, finance, transport and professional services, have direct bearing on the competitiveness of manufacturing.

As in manufacturing, a key strategy to secure globally competitive services is to expose suppliers to the most globally competitive businesses. This was recognized in the WTO where the most elaborated measures for liberalizing services are set out for the telecommunications and financial sectors.

Services industries as well are important generators of export income. Guest workers are important export earners in the Philippines and Indonesia. The ASEAN economies have also identified tourism and health services as priority services for expansion.

Yet, it is typical for services industries to remain heavily restricted. These include industries which governments have traditionally reserved for nationals - for example, domestic transport, retailing, education and health. APEC members see the reality of today's globalized economy. In manufacturing for instance, component production (where components are made in one country and shipped to another for further processing or integration into a completed product somewhere else) now account for about half of world trade in manufactures.

We just saw Japan's economy slump for a quarter because floods in Thailand disrupted component manufacturing. Economic growth in Thailand there has been driven to large degree by acceleration in manufacturing of IT and Communications products, the world's fastest growing manufacturing industries. While appreciated better among APEC economies than many others, the capacity to utilize foreign investment to develop these chains of manufacturing is still inhibited in key Asian economies.

A big step, not just the next step
The steps to release competitive forces in the economy described above are challenging. For some governments they present an uncomfortable idea - markets are allowed to move in the directions they seek, not those set by government. Key to these strategies are the ideas of freedom to compete and withdrawal of the state from regulation of economic activity. Despite their evident economic success in following the free market economic model, loosening fully controls on markets remains an uncomfortable idea in many Asian economies.

While the benefits of low tariffs are fully appreciated and there is a commitment to removing barriers to services and investment, the need for companion measures to guarantee freedom of competition and to loosen domestic regulation business are not on the whole equally appreciated.

Policy makers sometimes assume that cutting a tariff will automatically deliver an economic benefit. Often it will not unless domestic companion measures are in place which foster the shift to new economic environment. This is clearer when liberalizing services industries. The act of liberalization there is a change to domestic regulation to permit more competition from both domestic and foreign providers. Moving from commitment to execution is difficult, as ASEAN is now finding. Recent agreements require comprehensive liberalization of services. The focus on is now to trigger that process.

These ambitions present quite a fundamental challenges for Asian economies. The end result is withdrawal by government from most activities in the national economy. Only in a few Asian economies is it accepted that government does not have a right to intrude into all activities. Even where separation of executive power from legal institutions is constitutionally provided for, the presumption of the right to exercise executive discretion often remains in the body politic. This is not surprising. Centralized power has a very long tradition in Asian societies.

The geopolitics
The flurry of proposals for larger regional trade agreements in East Asia and the Asian Pacific region is to a degree a function of the changing balance of interests as new and stronger economies emerge.

The Trans Pacific Partnership is one of the less ambitious measured by the size and scope of the participants (including so far only 9 of the 21 APEC economies), but the ambitions of the participants is to create a model which will increase the capacity of participants to broaden the process of liberalization in their economies and to build platforms which will improve economic management and foster structural adjustment.

The measures of success of this agreement will depend on the extent to which TPP partners set new standards, and how other leading APEC economies perceive its virtues. It will also need to provide pathways that enable them to accede over time.

The attitudes of China, Japan, South Korea and the ASEAN members not participating will be critical.

China has proposed and ASEAN plus 3 (China, Korea and Japan) FTA, Japan an FTA of those states plus Australia and New Zealand, and Chile and some others of an APEC-wide FTA.
2 Australia, Brunei, Chile, Malaysia, New Zealand, Peru, Singapore, United States, Vietnam. (Canada, Korea and Japan have also expressed positive interest).


China and the Trans-Pacific Partnership

Fred Bergsten Jeffrey Schott.jpg By C. Fred Bergsten and Jeffrey J. Schott
Peterson Institute for International Economics

China is currently not participating in the negotiation of the Trans-Pacific Partnership (TPP) trade agreement, but it is an ever-present concern of those countries that are crafting the trade pact or that seek to join the TPP talks. Will the dominant economy of Asia become the economy that dominates Asia?

That question, of course, is intentionally alarmist. However, it echoes warnings that have been sounded by commentators throughout the Asia-Pacific region, who have suggested that the TPP is ultimately designed both to ensure the continuation of US engagement in the region and to contribute to an overall strategy to "contain" Chinese economic and political influence. Indeed, such commentaries allege that the United States, as the predominant economy among the nine countries currently negotiating the TPP, is the prime mover of this containment strategy and sets the terms of the TPP accord deliberately to exclude China. But the containment thesis conflates blocking access to the trade accord with bolstering competitiveness and thus the ability to contest markets against Chinese firms and investors.

China already is the leading trading partner of most of the TPP participants, and those countries expect their trade with China to increase markedly in the future. They also expect China to become involved in new trade talks with the TPP countries as they proceed toward the long-term goal set by APEC leaders at their Bogor Summit in 1994 of achieving free and open trade and investment in the Asia-Pacific region. They hope to use the TPP to spur the economic reforms needed to bolster the competitiveness of domestic industry and expand exports, including to the fastest growing economy in Asia. China, in turn, has a vested interest in maintaining good access to TPP markets that, when countries that could well join the talks in the coming year (Japan, Mexico, Canada, and South Korea) are included, account for more than 40 percent of Chinese merchandise trade. It has committed to the long-term integration strategy endorsed by APEC leaders.

As with most conspiracy theories, the containment thesis harbors a germ of truth about the linkage of economic and security considerations. Trade and foreign policy objectives have long been essential and mutually-reinforcing components of US trade policy. In fact, they drove the initial impetus for what has become the Trans-Pacific Partnership (TPP) almost two decades ago and remain critical to the success of the initiative today. George Yeo, then trade minister of Singapore, proposed an Asia-Pacific trade accord (the "P-4") in the 1990s both to maintain US strategic engagement in the region and to deepen US trade and investment ties at a time when the Chinese economy was rapidly integrating with its Asian neighbors. Similar motivations led Lee Kwan Yew to advise President Obama in November 2009 to refocus on Asia and re-engage in the TPP negotiations.

But the admixture of commercial and political goals has also created some ambiguity regarding US priorities in general and US policy toward China in particular. Some of this concern arises because of a misreading of US commercial interests in the TPP. To be sure, the commercial payoff from the TPP in the near-term seems modest: the other 8 participants have relatively small economies and the United States already has a bilateral FTA with four of them (Australia, Chile, Peru, and Singapore). The bigger trade and welfare gains come over time as the pact is extended to the major economies of the region and the partner countries integrate and harmonize their policies. However, the TPP also serves to "level the playing field" for US exporters and investors in the dynamic Asian markets by offsetting discrimination generated by the preferential trading agreements among Asian countries to which the United States is not a party. From a US perspective, the TPP addresses both offensive and defensive interests: expanding exports to Asia and confronting discrimination that could undercut US competitiveness and sales in those markets.

The Containment Fallacy
In crafting a high-standard, 21st century trade accord that is far more comprehensive than the trade arrangements forged among Asian countries, some observers have concluded that TPP participants intend to exclude China from their integration arrangement. They contend that the bar would be set too high in terms of transparency of domestic policies and the rigor of disciplines on government interventions in the marketplace. Others take this argument further and claim that the United States is not only trying to keep China out of the TPP but also trying to "contain China" in order to retard its economic and political influence in the region - or at least provide a peaceful counterweight that siphons off some of China's neighbors to a "counter-coalition."

To some observers, recalling past US opposition to Malaysian Prime Minister Mahathir's efforts to create an exclusive East Asian economic area in the late 1980s - early 1990s, the US pursuit of Asia-Pacific trade arrangements seems designed to undercut the evolution of another East Asian trading bloc - except this time led by China instead of Malaysia!

Even with China in the lead, however, we don't expect an Asian-only bloc to become important in commercial and strategic terms -- unless the United States disengages from the region. Integration among the East Asian countries is too shallow and the horizon for harmonizing domestic policies of Asian countries into a deeper integration arrangement is too distant. And China is heavily dependent on export markets outside of Asia, particularly in North America and Europe. Nonetheless, the containment theory continues to flood public discourse.

Charges that the United States seeks to "contain" or "surround" China seem to ring true to those concerned about China's strategic posture in the region as well as those accustomed to China-bashing in the US trade policy debate. US officials clearly prefer to talk about the distortive effects of China's currency manipulations and US trade enforcement actions against unfair Chinese trade practices, as President Obama did in his State of the Union speech on January 24. What US politician would talk about negotiating a free trade deal with China given the current contentious debate about Chinese exchange rate and industrial policies?

The containment argument falls flat for two specific reasons. First, US officials need a cooperative China to confront the myriad problems facing the world economy and the security challenges posed by new and aspiring nuclear nations in Asia. Both countries need to work together and therefore must manage the inevitable frictions that arise as the breadth and scope of their commercial relations expand. Second, no one else in Asia wants to contain China either. The trade and investment integration in the Asia-Pacific region achieved over the past few decades benefits all the TPP participants, even as it poses competitiveness challenges for their manufacturing industries. The proper response is to use trade arrangements, in conjunction with domestic economic reforms, to boost productivity of local industry and thereby be better positioned to compete against Chinese firms at home and abroad. Self-improvement is a critical component of any hedging strategy directed at China's growing economic presence in the regional and world economy.

"Hedging" strategies are not the same as "containment" strategies. For most countries in Asia, the TPP is about keeping the US in, rather than keeping China out. To engage the United States through a TPP, Asian countries know that the deal must be comprehensive and comparable, though not necessarily identical, to the scope and depth of liberalization of the Korea-US FTA. Otherwise, the US Congress would be unlikely to ratify the pact. TPP participants understood those conditions before the negotiations began in earnest in March 2010 and countries that subsequently joined the talks had to accept them as well before US officials (and the other charter members) would allow them to participate. They recognize that the TPP will require adjustments in their domestic policies but also will bolster their international competitiveness and help them keep pace with China at home and in global markets. That's why, for example, Vietnamese leaders implicitly agreed to a framework of economic reform - albeit over a lengthy time period - as a condition for entering the TPP negotiations. The motivation was in part due to concerns about competing with China and gaining some commercial independence from the intra-Asia production network centered on China.

China's Readiness
China has made progress regarding convergence with prospective TPP norms but still would need to implement significant trade and domestic policy reforms to be able to comply with the comprehensive set of obligations expected to be adopted by TPP signatories. Three developments bear mention in this regard.

First, China's accession to the World Trade Organization required significant reforms; as a result, its border barriers are less restrictive than most developing countries. But China is not ready to undertake TPP requirements with regard to the transparency of government policies that affect trade and investment; its opaque and often discriminatory domestic policies and regulations, its distortive production subsidies, and its manipulative exchange rate policies are clear barriers to TPP entry.

Second, China has concluded trade pacts with four of the nine TPP participants (Chile, New Zealand, Peru, and Singapore), has a broader deal with the ASEAN members, and has negotiations in progress with Australia. To be sure, these FTAs are of varying quality in terms of the scope of coverage and depth of reforms, though the recent pact with New Zealand broadened coverage in services and included disciplines on a range of domestic policies. Going forward, the prospective negotiations with South Korea, which are expected to launch in May 2012, should also propel Chinese reforms, even though the deal is unlikely to be as comprehensive as the Korean FTAs with the United States and the European Union. But this parallel initiative, as well as possible trilateral talks with Japan and South Korea, should help prepare China for more substantial ties with TPP signatories in the medium term.

Third, China's participation in the talks is not of immediate interest to Chinese officials. What Chinese official would consider undertaking such far-ranging commitments regarding domestic economic policies until their new political leaders are in place and have set Chinese commercial priorities?

In sum, China is not ready to implement and enforce the types of obligations under construction in the TPP negotiations. But the gap between China and the prospective TPP accord is not unbridgeable.

Going Forward
The TPP has been endorsed by the leaders of the Asia-Pacific Economic Cooperation (APEC) forum as one of the pathways to achieve the long-term goal of creating a Free Trade Area of the Asia-Pacific (FTAAP). The United States and China joined this consensus and thus implicitly committed to participate in an APEC-wide trade accord. It is hard to conceive of a comprehensive Asia-Pacific trade arrangement that does not eventually include China. But it is also conceivable that not all of the broad and diverse APEC membership, including China and Russia, will be able to accept and enforce obligations as comprehensive as those in the TPP. Instead, the FTAAP may emerge as a hybrid arrangement that accommodates elements of both US and Asian-style regionalism.

An early test of this thesis will come in the next few years as China negotiates new trade pacts with Japan and South Korea. Two of the three will likely be members of a high-standard TPP as well as a more modest ASEAN plus 3. China may simply settle for the less comprehensive Northeast Asian FTA and defer TPP participation. In that event, the China-Japan-Korea deal could represent the bridge between US and Asian-style regionalism that sets the course for the ultimate conclusion of the FTAAP.


China's Post-WTO Transformation

Mark Epper Hans Hendirscheke By Mark Epper, KPMG Australia and
Professor Hans Hendrischke, University of Sydney China Studies Centre

One of the trends that will most influence Australia and China's economic future is the rapidly growing inflow of Chinese capital to Australia. China is now Australia's most important bilateral trading partner and an increasingly vital source of capital. Australia is China's largest supplier of raw materials. Currently, the Heritage Foundation lists Australia as the top single country investment destination for China.

According to analysis 1 by KPMG and the University of Sydney China Studies Centre, Chinese direct investment in Australia has soared both in value and number of deals in the past few years: from September 2006 to June 2011, the value of completed deals totalled US$ 35 billion with 2009's tally alone hitting US$ 8.4 billion, roughly 5 times that of 2007's total.

This analysis notes that Chinese investment in Australia is likely to be much greater than official data suggests. Chinese statistics treat movements of capital and goods into Hong Kong as 'foreign' and do not take notice of the flow-on of funds to further destinations, such as Australia, for which Hong Kong is only a conduit. The Australian Bureau of Statistics (ABS) also treats China and Hong Kong as two independent entities.

China's growing outbound direct investment (ODI) has significant implications for Australia's economic future. A further US$1 trillion to US$2 trillion of Chinese direct investment will be dispatched overseas by 2020, according to recent estimates. Australia represents approximately 2.5 per cent of China's global ODI stock today. If a mere 3 per cent of China's expected capital outflows target Australia over the coming decade, the volume of investment will be massive.

Over the same period, Australia will require more than US$200 billion in investment in its resources and energy infrastructure. Much of this funding will have to come from overseas sources. The Australian government is currently creating the regulatory framework to attract and manage the expected inflow. The predicted rise of Chinese capital seeking investment opportunities requires a strategic response from Australia in order to realise the opportunities and maximise the benefits for the energy and resources sector and beyond. There are clear economic benefits in encouraging the Chinese to invest in Australia. A response that is poorly considered or poorly executed will drive those economic benefits to other nations.

This investment is an enormous opportunity for Australian businesses, with vast potential to sustain or lift growth in both resources and non resources industries. China's interest in acquiring assets and expertise beyond its traditional focus on natural resources creates opportunities for Australia's agriculture, financial services and infrastructure sectors. Joint ventures, partnerships and other innovative arrangements with Chinese partners should be considered. The increasing global commercial clout and financial strength of Chinese companies, as well as China's vast international business networks, could also assist the entry of Australian business partners in third-country markets.

The new reality: an influx of Chinese capital across a spectrum of industries
Investments in Australia have been concentrated in the natural resources sector in past years, reflecting Chinese investors' emphasis on fixed asset investment and the raw materials required to feed economic growth. Energy and resources will remain China's strategic priorities. More recently however, along with an acceleration of capital outflows from China, the range of investment targets and destination countries has expanded as well. This is the result of China's emphasis on domestic consumption under the current Five Year Plan which has created additional demand for financial services, agricultural products and new technologies.

Globally, Chinese companies made direct investments in 3,125 overseas companies, across 129 countries and regions in 2010. Agriculture, mining and energy experienced the most aggressive increase in Chinese interest. Notably, Chinese companies tend to prefer investing in well-developed countries with a large market size and a favourable institutional environment. Chinese companies are also making the most of the current economic slowdown to acquire technologies to improve their competitiveness - something that cannot be achieved quickly through organic growth alone. The global economic downturn has reinforced the incentive to take this approach by reducing the prices of potential acquisition targets.

The future pattern of Chinese investment in Australia is set to follow this trend. Agricultural and non-resource investments will grow, reflecting China's push to expand its domestic market and boost home-grown consumption. To grow and lift profits, Chinese companies already skilled in manufacturing must develop their distribution, marketing and innovation skills, and management expertise, among other things. These are areas in which Australian businesses could meet Chinese demand.

The diversification of Chinese ODI in Australia has already begun in earnest. From investment in one or two strategic industries in Australia, Chinese enterprises have sought increasingly diverse targets in recent years. From mid-2007 to the start of this year, deals have been completed in publishing and media, real estate, pharmaceuticals, logistic equipment and services, agriculture, and hotels and casinos, according to KPMG data. Sectors such as manufacturing, finance, business services, construction, transport and warehousing, wholesale and retailing and scientific research have also been recipients of Chinese investment money in recent years.

These deals suggest a robust potential for Chinese investment to continue spreading to other sectors of the Australian economy.

The pattern of Chinese investment in Australia
The recent pick-up in flows has been steep: between September 2006 and June 2011, a total of 77 completed deals over US$5 million are recorded in the KPMG dataset. 39 out of 77 deals are targeting WA companies. In terms of transaction value, 45 per cent of investment was registered in Victoria, 22 per cent in Queensland, 16 per cent in Western Australia and 17 per cent in New South Wales.

To understand the scope of future growth of China's investments in Australia, it's important to examine the pattern of investment to date. China's stock of ODI in Australia so far is relatively small, representing just 4.1 per cent of the total stock of ODI from all countries in 2010 and concentrated in the resources sector.

As Chinese investment is mostly concentrated in energy and resources which require high levels of capital, the average size of these deals is relatively large and a high proportion of Chinese ODI in Australia originated from state-owned enterprises (SOEs). Around 71 per cent of the completed deals are over US$ 100 million. It is therefore no surprise that the pattern of Chinese investment into Australia has been somewhat volatile.

Recently there are more deals made by provincial-level SOEs and private enterprises. Local investment is still low compared with the central level investment. The major part of local investment originates from a few provinces only. From September 2006 to July 2011, local SOEs and private enterprises provided around 20 per cent of total Chinese ODI. In particular, over 50 per cent of local investment came from Shandong Province, followed by Guangdong (14 per cent) and Hunan Province (13 per cent). Overall, a total of 15 out of 31 provincial divisions have made investments in Australia.

It is important for Australia to encourage Chinese investment from different origins and into a spectrum of non-resource industries in order to increase the potential for greater overall stability and growth in Chinese capital inflows over the long-run. There's ample potential for further growth.

The challenges of new and rapidly growing Chinese ODI
Waves of Chinese investment have, from time to time, triggered public anxieties in Australia - just as Japanese and Korean investment had in past decades. Strong media attention on a handful of prominent cases created the impression in Australia and abroad of a discriminatory attitude towards Chinese investors. There were also concerns that the investment intentions of Chinese SOE's were more geopolitically than commercially driven.

More than 90 per cent of Chinese ODI in Australia is made by either central SOEs (i.e. Shenhua Group) or provincial SOEs (i.e. Chiping Xinfa Huayu Alumina). This is notably higher than the global SOE presence of 70 per cent according to the PRC Ministry of Commerce statistics. It is also higher than 65 per cent presence of Chinese SOE investment in the USA noted by the Rodium Group. There is, however, no systematic evidence that China's SOE's, like those of other countries, are driven by more than typical commercial considerations.

And despite the occasional flare-ups on either side, Australia is rated by Chinese companies as being one of the countries most open to Chinese direct investment. In a recent survey of Chinese enterprises, Australia was seen as the second most open country after the United States, with South Africa, Germany and Korea ranking third, fourth and fifth respectively.

At the corporate level, cultural adaptation is still one of the biggest challenges for Chinese enterprises abroad. The challenge can often be greater than just differences in corporate cultures: it is coming to terms with the different interplay between corporate governance and the regulatory environment. Chinese enterprises are generally unfamiliar with by the regulatory and business cultures in economies such as Australia and require support from China-experienced Australian advisors.

Operating in Australia requires managers of Chinese companies to bridge language and cultural divides, comply with unfamiliar regulatory standards, acquire local market knowledge, manage local staff, negotiate with organised labour and other stakeholders, reach higher quality and safety standards, adhere to different tax and accounting rules and environmental guidelines, as well as develop appropriate communications and public relations strategies.

The way forward
A deeper understanding of China's ODI into Australia is needed to help governments and businesses to respond to and make use of Chinese ODI to the benefit of Australia's relations with China. Since Chinese governments play an important role in facilitating ODI, Australia needs to utilise multiple channels at all levels of government - federal, state and local - to speak to China's central, provincial and municipal governments respectively, as well as other stakeholders and businesses about investment opportunities in Australia.

The initiation of government-to-government and government-to-business arrangements for routine consultation between Australian and Chinese authorities would have the practical effect of strengthening the framework for Chinese investment over time. Australia can embrace Chinese investments in ways that will stimulate employment growth, innovation, technological advancement and infrastructure renewal. The great benefit is that this will also lead to a stronger and more comprehensively globalised Australian economy.

For full report see http://www.kpmg.com/AU/en/IssuesAndInsights/ArticlesPublications/china-insights/Pages/the-growing-tide-china-outbound-direct-investment-in-australia.aspx


Local versus Global: Australian supply chain responses to global competition
Tim Butcher by Dr Tim Butcher
Senior Lecturer at the School of Management, RMIT University

The future of Australian manufacturing, it would seem, is uncertain. For so long, Australia's remote geographic location has to some extent shielded it from the pressures of globalisation. Yet, with the current decline of the global economy, the competitive pressures felt in other corners of the globe are now knocking at Australia's door. How should its manufacturers respond?

Recently Toyota announced 350 job cuts at its Australian plant in Altona, Victoria. 1 The Federal Government response was emphatic with its Manufacturing Minister Kim Carr stating that "The company doesn't operate on the basis of asking for a handout or a bailout or any of the other words that are used." "That's not the way it works, we don't do that." 2 So instead there have been renewed calls for the Australian Reserve Bank to cut interest rates to give our manufacturers a 'fair go,' in the hope that that might enable them to compete with their counterparts in low cost economies. 3 But is this alone a viable long-term solution?

Professor Roy Green, University of Technology, Sydney knows one solution for Australia's manufacturers is innovation. Professor Green cites three components to his recommendation: cost cutting, continuous improvement, and an overhaul of the business model. 4 So doing enables the development of processes and products that differentiate products and services to offer superior value to low cost alternatives.

I don't disagree with Professor Green. I would point out though that Toyota has for the past thirty years and more been at the forefront of global manufacturing innovation due to its renowned Toyota Production System. So what more could it have done? What many scholars are now asking of the global automotive industry is whether this and other such production systems are right for these increasingly uncertain times, and does the way we produce cars and other such products require a fundamentally radical overhaul.

Focusing on the Australian context, the Managing Director of Toyo Tyres and Rubber, Australia stated that his firm foresaw this event two years ago via the decline in Toyota's sales locally. His firm's response had then been to scale back operations. 5 Indeed, employment in the manufacturing sector is 'scaling back' with a reported 44,000 manufacturing jobs lost in Australia in 2011. 6 So is downsizing of Australian manufacturing inevitable?

I believe a telling sign of the current state of Australian manufacturing is in the opening statement of the Federal Government's 2008 Review of the National Innovation System: "We have known for several generations that innovation pre-eminently determines our prosperity. Yet innovation only began its prominence as a focus for Australian policy making in the 1980s." 7 Did Australian manufacturers 'jump on the innovation bandwagon in the 1980s?' Even if they did, was it already too late?

In 2010 I interviewed senior managers of an Australian aftermarket automotive retailer and two of its Australian-based lead suppliers about their buyer-supplier relationships. The context of those interviews was a three-year project by the retailer to overhaul its supply chain strategy. Part of which was a review of its existing procurement arrangements with Australian suppliers, complemented by an initiative to source a new range of private label (own-brand) goods directly from low cost overseas manufacturers via a Chinese sourcing office. The overall aim of which was to broaden the product ranges offered in-store via three categories that the retailer terms "good, better or best" products; where private label products are the former of the three. This strategy therefore attracts new as well as existing customers by offering greater choice across different price points. The challenge set to local suppliers was to fulfill demand for the better and best categories. To do so required innovation.

What was realised early in their review, and admitted by both buyers and suppliers, was that for decades local procurement negotiations were largely dictated by suppliers. "They knew their products best" so suppliers set the terms including quality, quantities and prices. For too long both parties had rested on their laurels, with a premium being paid for the same products year in, year out. While this situation was obviously seen by the retailer as no longer sustainable, relations between the retailer and local suppliers were unsurprisingly excellent. The challenge for the retailer was to maintain good relations while encouraging its suppliers to trade on more amenable terms while offering more differentiated and competitive products. They received a mixed response.

It was not that the suppliers did not see this coming. They themselves source from South East Asia, attending various trade fairs. They could see the innovations been made in process and product technologies overseas but did not need to respond so long as the Australian market for their products lacked any notable competition. However, with the retailer and its competitors now attending the same overseas trade fairs to extend their product ranges, the pressure was on local suppliers to now respond.

Those suppliers who responded most positively to the retailer's new demands recognised two things. Firstly that if they didn't adapt, they would lose the retailer's business because overseas competitors not only offer low cost alternatives, but also add value through supply chain efficiencies and product innovation. Secondly they realised that the challenge was not theirs alone. Working with the retailer was key. In so doing they gained visibility of not only demand for their own products but also an appreciation of demand across the product ranges they serve, and thus where their products fit. Knowing in greater detail what consumers want and don't want, coupled with their knowledge of the new technologies available through trade fairs enables those suppliers to innovate and remain competitive. They are not only developing new products but also new services. For example, co-designing and commissioning bespoke display units for their products in the retailer's stores and training the retailer's staff extends their value proposition to consumers. Hence, between the supplier and the retailer they not only offer choice but also a superior experience. If that is a good experience, consumers will return to their brand.

The de-industrialisation of the Australian economy is inevitable, as has been the case in other developed economies.8 My aim in writing this has been to offer a post-capitalist call to arms as a response to globalisation. After all, it's here to stay; so we'd better get used to it. At a macro-level a nation or region must enable innovation but as Mr Carr points out they cannot support firms in maintaining commitments to unsustainable ventures. Meanwhile, at the micro-level, firms must face up to globalisation, but recognise that they are not alone.

While I have only had the chance to provide a glimpse into this case study, our research reveals an opportunity for Australian manufacturers. We live in an era of choice. As consumers, we now demand it. Hence there will always be room for premium products on the retailers' shelves with private label items alongside them. Premium products sell provided consumers can distinguish between them and the low cost alternatives and gain as a minimum the value they expect.

To be viably manufactured in Australia, premium products must be sold at premium prices to overcome the high costs of production. So to justify high prices, products (and services) should not merely meet customer expectations but exceed them. Firstly firms must offer innovative technological solutions to their products, and the services 'wrapped around' them. Secondly those products and services must be perpetually improved upon. For manufacturers, this means innovation, continuous improvement, small batch production and shorter product lifecycles to focus on product variety, not volume. Unfortunately this implies downsizing. Large-scale production systems cannot economically meet these demands.

Neither can manufacturers achieve these demands alone. This is something Toyota has long recognized, employing a Keiretsu model of collaboration with its suppliers to filter best practice through its global network to maintain quality standards. So the third take away is that firms must collaborate with their supply chain partners to achieve the necessary agility to respond to an ever-changing market and gain the differentiation to stay ahead of their competition. These are sentiments echoed by Ian Campbell, Managing Director of GUD Holdings. 9

The days of adversarial buyer-supplier dealings are gone. Contemporary procurement must viewed more holistically as sustainable longitudinal supply chain relationships. While Australian manufacturers and retailers are now beginning to recognise this, so too are Government bodies. 10 Support of innovation must be provided not just to firms but instead to extended enterprises. Collaboration is key.

Dr Tim Butcher is a Senior Lecturer at the School of Management, RMIT University. This research was funded by a seed fund grant, awarded by the College of Business at RMIT. You can connect with Tim via email at tim.butcher@rmit.edu.au via LinkedIn at http://au.linkedin.com/in/timbutcher or via Twitter at @tim_butcher.

1 The Australian, "350 jobs to go as Toyota swings the axe"
2 774 ABC Melbourne Radio, "Government couldn't stop Toyota job losses: Carr
3 Herald Sun, "Manufacturing industry turns to Reserve Bank"
4The Conversation, "Death by the dollar? How innovation can save manufacturing
5 The Sydney Morning Herald, "Supplier saw Toyota job cuts coming two years ago"
6 Herald Sun, op cit.
7 Australian Government Department of Industry, Innovation, Science, Research and Tertiary Education, "Review of the National Innovation System"
8 Mangan J, Lalwani C, Butcher T & Javadpour R (2012) Global Logistics and Supply Chain Management, 2nd Edition, London, Wiley, p356.
9The Australian, "GUD fights high dollar and own brands with reliability",
10Business Victoria, Collaborative Networks Pilot Program


The role of intermediate services inputs in trade and investment
Tom Westcott by Thomas Westcott,
Senior Consultant, ITS Global

A forthcoming services trade policy forum builds on work undertaken in a capacity building training course convened by the Australian APEC Study Centre at RMIT University in Melbourne from 21-25 November 2011. This forum will help develop a greater understanding of the role and scope of services, their importance to economic growth and increased productivity in the region's economies and policies that will promote better regulation of services industries.

The economic importance of services is generally understated. Services industries play a critical role in sustaining and growing other parts of the economy, such as manufacturing, construction, and primary industries including agriculture and mining. A myriad of services are intermediate inputs in these sectors. Manufacturing exports, for example, include an array of services used in the manufacturing process.

These services are said to be embodied in manufactured goods. The value of 'embodied services' is typically substantial, though not measured by statistical agencies. The extent of this interconnectedness between services and manufacturing is not well understood, but new research into the value and distribution of embodied services across manufacturing industries sheds more light on the issue. The conclusion is that services regulation has important implications for policymakers concerned with creating a vibrant manufacturing sector.

Understanding the often burdensome impact of regulation on the pricing and delivery of services is complicated by the heterogeneity of the services that make up the sector. This is compounded by relatively poor data on services trade. In comparison with merchandise, which can only be traded internationally by physically crossing an international border, the non-material nature of many services means that they can be traded internationally in a wide variety of ways. This makes data collection problematic.

A more detailed understanding of services exports comes from the analysis of national accounts input-output tables. These can be used to calculate the value of a country's embodied services exports, including which service sectors are embodied in the production of goods and services, and which goods contain more intermediate services inputs.

For example, research in the Australian context conducted by ITS Global for the Australian government in 2010 has revealed these services are far more significant than is commonly recognised. In Australia, cross-border services exports were worth around $55 billion in 2008-09. It has been estimated that services embodied in merchandise exports were worth a further $30-35 billion in that year. That is, services were found to be 1.7 times as important to the Australian economy in terms of export performance as the level of recorded cross-border exports of services would suggest. This finding also holds important implications for other APEC economies and is worthy of further analysis across the region.

The intensity of the use of intermediate services in production is measured by the proportion of a dollar's worth of output that is accounted for by intermediate services used to make it. In the case of coal produced in Australia (the category comprising most embodied services per dollar of output) to extract $100 worth of coal in 2005-06, the Australian Bureau of Statistics Input-Output Tables indicate that the average mining company would have spent $11.40 on labour costs, $30.50 on intermediate inputs, leaving $58.10 as the gross return that the company earned on its capital investment in that year.

For coal, intermediate inputs are the materials and services that mining companies buy to enable its miners to extract coal with the company's plant and equipment. On average, a coal mining company spent a total of $6.10 on materials – construction materials, diesel fuel for mobile plant, explosives, prefabricated buildings, and new machinery – and a total of $24.40 on services. Services included electricity to power the fixed plant and equipment, geotechnical and mining engineering services, tradesmen to construct and maintain the plant, rail transport to take the coal to port, and property and business services such as legal and accounting.

This makes coal mining a relatively intensive user of services inputs. Over 80 per cent of the intermediate inputs used to extract coal were services. Put another way, intermediate services accounted for 24.4 per cent of the final value of the cost of the coal produced in 2005-06. This is the measure of the intensity of their use in the productive process.

The challenge of reforming intermediate services regulation –which can be costly and lead to inefficiencies – requires taking account of the varying nature of services industries. Network services – electricity, water, telecommunications, transport, etc. – require major infrastructure investment which in turn requires large economies of scale. These are typically the most important intermediate services inputs and should be accorded priority by policymakers. They are also most sensitive to regulatory restrictions making them a priority for liberalisation efforts.

Business services such as accounting, IT and banking rely on a skilled labour force. Policies should enable effective competition. FDI in the business service sector has been found to stimulate specialization and therefore increase the productivity in sectors using these services.

Domestic services, for example construction or cleaning services, differ again. These are fast growing labour intensive sectors where policymakers should promote flexibility, easy entry and keep industry-specific regulations to a minimum.


The Outlook for Australian Trade in Education Services
Steve by Steve Somogyi,
Chief Operating Officer and Vice President, Resources, RMIT University

In his post-budget speech to the Australian Press Club in May, 2011, the Australian Treasurer noted that Asia is driving Australia's future. Asia's impact on the minerals industry is well known. However, there are a wider set of opportunities in which many Australian services companies are participating. One of these is education. Globally, education services is a fast-growing and attractive sector in terms of trade and the potential for longer term value and benefit.

Figure 1 shows that the number of international students studying outside their domestic country has been growing at around 5% per annum for just over 35 years. That continues at a reasonably steady pace. Over the last 10 years it has picked up pace to nearly 6.5% p.a. So it is not only fast-growing but an accelerating area. There are a number of good reasons why it has continued to grow and why, if you look at the next 20 years, it should continue to grow at least the same rate if not faster. There are many more people movements, particularly from the developing world. The ability to connect both electronically as well as physically has brought the world closer together, and driven by the globalisation of business, people want to learn about each other more than they used to. Education has come into the modern age.

Figure 1
Source: UNESCO

Movement of people internationally seems to be driven in part by growth in the global economy. Figure 2 shows the Australian Treasury's modelling of the growth in GDP that we can expect over the next 20 years for major regions of the world. China and India are accelerating in importance in comparison with the developed world of the European Community and the United States. As economies grow, so does the demand, and ability to pay, for education, as well as the interest in international education opportunities. China and India represent nearly 40% of international student numbers in Australia and given the anticipated economic growth of these two countries, one would expect continued growth in the number of Chinese and Indian students seeking international education opportunities.

Figure 2
Source: Australian Government Budget Papers 2011

Figure 3 shows foreign students by country of destination and illustrates the importance of education services to Australia as a source of export income.

Figure 3: Country of study for foreign students in tertiary education
Source: OECD

The United States is dominant as the preferred source of education, with nearly 19% market share. The UK is number two by a significant margin at 10% market share. However, Australia punches well above its weight: if we were to represent its share of global economy or economic activity, population or number of universities, Australia would be around 1-1.5%. Yet Australia attracts nearly 7% of student numbers with this market share growing over the last 10 years. This growth is likely to continue for some time.

In terms of individual sectors, education has become a critical export for Australia, at a little under $18.4 billion dollars for 2009/2010 (Figure 4). In 2005 the education sector overtook tourism as the major services export sector and exports are now about one and a half times the figure for tourism in terms of gross revenue, and well above business services, the third service sector shown in Figure 4. For the State of Victoria, education is the largest export industry.

Figure 4: Australia's top exports 2009/10 (A$Million)
Source: ABS

Figure 5 below shows the number of international student enrolments in Australia in all parts of the education sector, including higher education, English-language programs, foundation courses and high school. The 2010/2011 figure shows a decline in the number of students, though in revenue terms this has been offset to some degree by the rise in the value of the Australian dollar.

Figure 5:International student enrolments in Australia: 1988-2010
Source: Austrade

There are a number of short-term and long-term issues that we need to take into account in looking at future trends. When deciding where to study, students are driven to choose a country by a number of key factors (Figure 6).

Figure 6. Factors influencing student choice of study location

The most important factor in students' minds is employment prospects after study, not necessarily in the country of study, but at home also. Most students, after working in Australia for a couple of years, return home and become important cogs in their own economy, whether it be in commerce, government or politics. Clearly, scholarships, safety, liveability are all important.

RMIT's market research globally but particularly in Asia, indicates Australia has a number of advantages. First, we are a multicultural society. When students come to Australia they are not just dealing with Australians. Particularlyin multicultural cities like Sydney and Melbourne, nearly half the population has a background in a non-English-speaking community. That is an attractor. Second, we have an existing large pool of international students who are advocates for what happens in Australia. Third, there is a demand for skilled workers in Australia and, subject to visa conditions, which have recently been made less welcoming, that is a key attractor for students andtheir families. Fourth, we have a welcome climate and lifestyle, particularly compared to the other three main attractors of international students in English language. And finally, it has proven to be the case over the last 15 years that Australian education institutions have been very adaptable to change and have made offerings that take into account the needs of the international student.

However, there are a number of disadvantages that need to be taken into account. Clearly, competition is increasing. With the downturn in numbers over the last 12 months, mainly because of changes to student visa conditions, and partly because of the higher Australian dollar, a number of institutions from other countries, including Canada, have stepped in and filled some gaps. The financial attractiveness of living and studying in Australia has become more strained in the last 12 months. Tuition fees represent only 40% of all of the costs of study in Australia so rises in non-education costs adversely impact attractiveness. This, together with the increasing strength of the Australian dollar has reduced the attractiveness of Australia. In addition, in 2011, Australia's 'safety' reputation also suffered some damage – something that most institutions have taken steps to address.

It is worth recalling that it is not just the number of students who come to Australia that represent our export strength. The number of students who study Australian programs that are taught by Australian institutions offshore is also an important growth area with 76,500 higher education students enrolling in 2010 (Source: DEEWR). Just as Australian industry has responded to exchange rate and cost pressures by moving part of their operations offshore, it may be that we will see increased overseas activity by universities.

However, in addition to competition from other developed country education suppliers, Australia also faces competition from increasing education provision in students' home countries and from China and India. Figure 7 shows growth in university enrolments in China, India and the US.

Figure 7
Source: UNESCO, US Dept of Education

China and India continue to grow strongly and are forecast to prosper more in the future. So is the number of students who are forecast to want to study in China and India.

China currently hosts 260,000 overseas students and is aiming for 500,000 by 2020. Figure 7 shows the strong growth that has already occurred in China and that will continue to rise as parents become more financially capable of sending their children to university. However, despite the strong rate of university construction in China (there are a hundred major universities being constructed at present), China can still only meet, on current projections, 40% of demand domestically and less in postgraduate study.

In India there is a strong demand for education, particularly postgraduate, and many Indian students are currently going offshore. India aims to increase the proportion of young people in higher education from 12% to 25% by 2025 and is undertaking a massive spending programme to achieve this. The 2010-2015 higher education budget is nine times larger than that of the previous 5 years. It is difficult for non-Indian universities to become involved in this growth as, at present, a bill to govern establishment of foreign educational institutions in India is blocked in the Indian Parliament.

There are important benefits flowing from international education, and these are not just financial. Many students who have come to study in Australia are now in key positions of influence in their home countries. This can be a major factor influencing future exports and trade, and not just in the education sector. International students have improved our campuses because of the financial wherewithal that they bring. It has made our academic staff mix more international, because we have had to become more international in our recruitment both to meet demand and to cater for international student needs. The diversity of cultures within universities has assisted all students in developing cultural understanding and a network of international contacts together with increased opportunities for international student exchanges. And international research collaboration opportunities have increased with the internationalisation of staff and the establishment of overseas campuses.

In summary, the education services sector is growing quickly with significant benefits being realised for the Australian economy and the education sector. Australia is currently punching above its weight in this area and is expected to continue to do so both on and off-shore. However there are some key challenges which governments and higher education institutions will need to address to ensure that student visa conditions, the higher Australian dollar and cost pressures in Australia do not adversely affect our competitiveness.

This paper is based on a presentation to the 'APEC Conference 2011 - Is Australia managing?' held in Melbourne in November, 2011.


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