Welcome to the second edition of APEC Currents for 2012. In this edition Ken Waller, Director of the Centre outlines recent business proposals to establish an Asia Pacific Finance Forum to advance and coordinate regional discussions on improving the region's financial frameworks to facilitate capital movement for businesses and households. Ken discusses the key issues to be resolved before such a Forum can be established. Sustainability is of on-going priority for APEC member countries and Centre Chairman, Alan Oxley, reports on the June meeting of the UN Sustainable Development Conference (Rio+20) held in June where countries reaffirmed the importance of development and open markets in the pursuit of sustainability.

Regional supply chain issues were highlighted by Ministers at the last APEC Ministerial meeting in Hawaii (November 2011) as a critical issue for the region. In this issue, Professor of Economics, Rajeev Anantaram, from the International Management Institute, New Delhi, India discusses China's central role in many companies South East and East Asian supply chains and foreshadows significant changes as China's National Investment Strategy seeks to increase production of goods with much higher levels of embedded technology.

The OECD's Policy Framework for Investment has been used by many Asia Pacific governments as a means of enhancing their approach to investment attraction and governance. Mike Pfister, Senior Policy Officer Investment at the OECD explains how the Framework can be used to foster supply chain links between local Small, Medium Enterprises and multinational companies.

The impact and effectiveness of port operations have been a mainstay on the agenda of APEC member governments. Dr Victor Gekara from RMIT's School of Business IT and Logistics, reviews the range of threats facing port managements, whether public, private or mixed, and asks if there is sufficient recognition of the full range of threats being faced and whether the various arms of port administration and government need to better coordinate their understanding of these issues to ensure an holistic approach to risk mitigation.

As always, feedback on the articles is most welcome.

Errol Muir
Editor

Timely moves to form the Asia Pacific Finance Forum

By Ken Waller, Director, Australian APEC Study Centre

The APEC Business Advisory Council is proposing to APEC Leaders and Finance Ministers the formation of the Asia Pacific Finance Forum (APFF). The proposal is timely and it is important.It is timely because financial markets of the Asia Pacific region members of APEC do need to prepare themselves to support the momentous economic and social challenges that face the region.The economic challenges reflect growing trade and economic integration within the region requiring efficient and linked financial markets to realize the full potential of the region.

Social challenges arise from the rise in middle classes across the region and the aspirations of those groups for financial services to meet their pension, health and retirement needs, as well as the needs for younger families in providing for high quality education, housing and health services. A critical social challenge is that of increasing the reach of financial services to the millions of people in the region who do not have access to minimal services where they can save and deposit monies or access credit facilities. Enhancing financial inclusion in the many facets of services - is a major development issue and its attainment on a scale that will help people move out of the poverty trap remains largely unfulfilled at this juncture.

There have been rapid achievements in improving financial services in the region over the last two decades or more. In part, regional economies moved to strengthen the prudential standards over financial service providers as a response to the Asian financial crisis. The regulatory reform process continues in all economies, intensified by the global financial crisis with calls from the G20, the Financial Stability Board leading to specific regulatory requirements proposed by international standard setting bodies.

While initiatives are on-going within the Asia Pacific region to address regulatory and market deficiencies to promote system stability and financial strengthening, it is important to supplement and to go beyond present arrangements.The APFF is a realistic proposal to do that.Much more effort is needed to improve financial market efficiencies, particularly in developing markets and to better link financial services so that they are more easily accessible and with less costs to businesses and individuals in the region.

Financial institutions face different regulatory laws and regulations across the region and they also face different market entry conditions. There needs to be a consistent approach in the region to reducing or eliminating those differences. Companies and small businesses that may wish to raise funds to develop their operations in regional economies either through equity or bond markets face different regulatory conditions.Savers in one economy cannot easily invest in other markets in the region and their choice of investment options is severely constrained. There are unnecessary costs involved in overcoming these various activities.

In effect the regional economies impose unnecessary cost structures on their companies and on individuals by not promoting financial market integration. The present financial structures in Asia by constraining investment opportunities in the region contribute, in part at least, to the imbalances (and volatility) of the global financial system. Asian savings are heavily invested in US Treasury paper and are a counterpart to the massive current account deficit of the US economy. There are advantages in financing the US deficit but part of the root cause of that process is the limited opportunities for debt raising in the Asian region as a consequence of illiquid and small capital markets.

Continuation of this form of underdevelopment of financial markets is not an option for the future of the Asia Pacific region and this is the fundamental point of ABAC's proposal to establish the APFF.

The proposal does raise some serious questions that APEC Leaders and Finance Ministers will need to consider.The first is what will APFF achieve that is not possible through existing attempts to promote regional financial integration, such as the work being undertaken by regional central banks or the regional bond market initiative by the Asian Development Bank or the multilateralisaion of the Chiang Mai Initiative to enhance the foreign reserve resources of economies that face threats to their external balances.

In response, the APFF would embrace and encourage the work that is ongoing in the region. By creating an open and inclusive forum and involving business, policy and regulatory agencies, regional and international organizations and academics and think tanks, a key purpose of the Forum would be to facilitate discussions on the work of existing groupings.This would be within a framework in which the work of those groups can be discussed in the context of sharpened focus on regional financial market integration and connectivity.This would require a holistic approach to financial markets banking, capital and equity markets with the purpose of discerning what is required to improve linkages within individual markets in the region and across regional markets.

It would be a mistake to see this as a call for a single financial market. Rather it should be seen as call to reduce or eliminate impediments that prevent the efficient linkages of markets so that they provide consistency and harmonization of key principles of policy and regulatory approaches. The APFF could report its work to APEC Finance Ministers and Leaders on a regular basis through the ABAC advisory framework and this process would provide an overarching political framework that is currently not available in Asia Pacific regional financial affairs.

A second question is what would APFF seek to achieve? An early objective of the APFF would be to establish a road map of the primary factors that would need to be addressed to promote consistency in market structures and linkages in regional economies and across the region. It would encourage public and private sector agencies, academics and think tanks on how they could contribute to the attainment of those ends.There would need to be clear recognition on the non-binding principles that apply under APEC in the work of APFF and that the analysis and work that would be undertaken would be objective, empirically based and to accord with general objectives discussed above.

A third question is how would APFF contribute to international regulatory financial standards?It is anticipated that APFF would encourage discussion on emerging regulatory standards by the Financial Stability Board and relevant standard setting bodies.The focus would be on evaluating the impact on regional financial systems and on economic development and system capacities. The process would identify regulatory approaches that may better relate to the financial and economic needs of the region's economies in expectation that this process and its outcomes would contribute an Asian regional perspective to the work of international standard setting bodies. The regional outreach work of the Financial Stability Board is highly important. By encouraging Asian regional perspectives on emerging international regulatory standards and approaches, the work of APFF would enhance the relevance of regional interests in the international standard setting processes. Such an outcome would reflect the economic and financial weight of the region in global financial standards and practices.

ABAC's proposal to establish the APFF is far reaching. If implemented it would be a Forum to discuss, analyse and to equip regional economies shape financial markets to better meet the needs of their business groups and the needs of households and individuals so that they can attain their full potential during and beyond the Asian century.

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Lessons from RIO+20 - Open Markets are essential for Sustainable Development

By Alan Oxley, Chairman, Australian APEC Study Centre

The UN Sustainable Development Conference in Rio de Janeiro in June resulted in a restatement of the UN orthodoxy on how to achieve sustainable development (in essence improvement of the environment had to go hand in hand with economic growth), to the dismay of some key European Environmental Ministers.   The European Commission had proposed that the United Nations should commit to building a global "green economy" and that the UN should adopt ecological principles, such as measuring natural capital, as part of its sustainable development program.  This was rejected by most members of the UN.

The first sustainable development conference was held in Rio de Janeiro 20 years before. Dubbed 'The Earth Summit', it elevated the environment as one of the leading subject areas of the United Nations, but not without a major condition. The formal title of the meeting was the 'UN Conference on Environment and Development'. This was demanded by developing countries which insisted that environmental issues should not take precedence over economic development.

The program adopted at the 1992 Conference was entitled 'Agenda 21'. The Declaration covering it stated that 'Sustainable Development' rested equally on three pillars - economic growth, improvement of the social condition and environmental protection.

The 1992 Conference also adopted three new conventions - the UN Framework Convention on Climate Change, the UN Convention on Biodiversity and a Convention to halt desertification in Africa.

Not much has been added to international agreements on environment since then. The Kyoto Protocol to the Framework Convention on Climate Change was negotiated, but its key legal commitment - a small and limited commitment to reduce greenhouse gas emissions - looks set to lapse at the end of this year. Negotiations over new global measures to reduce emissions of greenhouse gases remain stalled after the failed Copenhagen conference in 2010. Two protocols have been added to the UN Biodiversity Convention, each with rather limited reach, and little action has been taken to address desertification in Africa.

With the memories of the failure at the Copenhagen climate change conference still fresh, no one sought to propose new global environmental conventions at the RiO+20 conference. Developing economies, lead by the BRICS (Brazil, Russia, India, China and South Africa), firmly restated the position that environmental protection needed to go hand in hand with economic growth. They also rejected proposals, again principally from the Europeans that the UN Environment Program be converted into a specialized agency of the United Nations.

Somewhat surprisingly, the BRICS economies strongly asserted that global markets must be kept open to foster economic growth. These governments are not usually front-line advocates of free trade, but this was clearly a reaction to recent actions by the EU, and in the US, to impose trade restrictions to advance environmental goals.

The EU has imposed such restrictions on imports of biofuel (penalizing biodiesel imports from Indonesia and Malaysia and ethanol imports from Brazil and the US). As well, the EU is imposing carbon taxes on aircraft flying to EU destinations. Several countries have foreshadowed they will challenge these measures in the WTO.

In the United States, the Environment Protection Agency has foreshadowed restrictions on biofuel imports into the US similar to those in the EU. Now US labor and environmental groups are pressuring the Obama Administration to include environmental provisions into the Trans Pacific Partnership Agreement (TPP) which will connect compliance with trade obligations with environmental standards.

In most bilateral FTAs with other Asian Pacific economies, US Administrations have usually kept environment provisions in Agreements delinked from trade obligations, keeping faith with the fundamental principles of WTO Agreements not to restrict trade on non-trade grounds. Since one key purpose of the TPP Agreement is to serve as a framework in the future for an APEC-wide free market agreement, it can be expected other TTP parties will press the Administration to keep environment and trade issues in the TPP de-linked. This would keep the TPP Agreement attractive to the other ten APEC economies not negotiating the TPP.

It has been disappointing that the EU has gone along with green trade barriers. So too has been the dismissal by a number of European Environmental officials of the result at Rio last June. The communique from the Rio meeting is extensive and the ambit of the UN's environmental agenda was expanded, for example on protection of marine biodiversity.

Developing countries well understand the importance of open markets to promote the growth they need to raise living standards. They also understand an economic fundamental which has been lost sight of in a number of capitals in developed economies. A prerequisite for creating a sustainable economy where environmental protection standards are high is prosperity. While ecologists argue to the contrary, the leadership of every developing country understands full well that protecting the environment is expensive and wealth is required to pay for it.

Twenty years of global experience of trying to negotiate new international environmental provisions while at the same time experiencing success in raising living standards in developing countries has simply reconfirmed the wisdom of this proposition in developing country capitals - hence the rather firm restatement at RIO+20 of what is necessary to achieve sustainable development.

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China and the Evolving Dynamics of the Regional Production System in Asia

By Rajeev Anantaram, Professor of Economics, International Management Institute, New Delhi, India

Despite the economic downturn that began in 2007-08, the Asia-Pacific region remains the most economically dynamic geography in the world. Three of the world's ten largest economies measured in market exchange rates - China, Japan and India - belong to the region.The distribution is even more impressive when economic output is measured in terms of Purchasing Power Parity (PPP). By this yardstick, these economies are included in the world's top five economies. More significantly, the global footprint of the region is expected to be even more dominant in the years to come and it is estimated that the countries of the Asia-Pacific would contribute close to half of global output by the year 2050.

The East Asian miracle, which transformed war-devastated Japan and other post-colonial economic backwaters such as Korea, Taiwan and Singapore into economic powerhouses within a generation, has been well documented. The economic paradigm that drove growth in the region, at least in the early stages of economic transformation -export-oriented mass manufacturing, high levels of public and private investment, and a corpus of cheap labor - has been sought to be replicated globally, with limited success.

Economic growth in the erstwhile miracle economies has expectedly slowed down (at least in comparison to the breathless economic expansion experienced between 1960 and 1985) due to a combination of a high base effect and the relative inability to effect structural changes in their economies, but their technological capabilities and human capital endowment remain world class. Critiques of the miracle model by Krugman, Lau and Young in the mid1990s has taken some sheen off, but its fundamental role in transforming the countries where it was applied is indisputable. ¹

China, a relatively late entrant to the region's economic boom has witnessed what is arguably the greatest spurt in economic growth in human history. The most conspicuous feature of this expansion is that it has been sustained for over two decades (barring temporary dips due to the Asian Financial Crisis (1997) and during the early days of the current economic slowdown in 2007-08).  The results of this growth have transformed China unrecognizably. Poverty has declined sharply (the World Bank has estimated that the number of people living on less than a dollar a day declined by 170 million between 1990 and 2000, a trend that has continued since). It is arguably the premier trading nation in the world, with exports and imports each in excess of $ 1 trillion! Domestic demand in China is the biggest driver of global commodity prices. China has leveraged its economic power to gain a seat at the economic high-table and is being increasingly called upon to help resolve pressing global economic issues, such as the economic crisis that threatens to overwhelm the Eurozone.  This is a remarkable transformation for a country that three decades ago was one of the poorest countries in the world.

Facets of China's Economic Policy: 1985-2008
A pithy phrase to describe China's economic paradigm since 1985 is "Foreign Direct Investment (FDI) driven, labor-intensive, mass- manufacturing".  The Chinese paradigm of growth replicated the dominant strategy in East Asia, which relied on labor-intensive, mass manufacturing growth, with one major difference.  FDI played an increasingly important role in developing China's manufacturing sector, as opposed to East Asia, where technology was purchased outright or obtained through technology licensing. FDI has played an especially vital role in transforming the economies of the regions in China where it was employed, namely the Eastern seaboard and the Pearl River Delta.

The importance of FDI in China's economy since the turn of the century is lower compared to a decade ago.  FDI as a share of GDP in 2010 is around 1 per cent of GDP compared to almost 3 per cent in the mid 1990s.  FDI's main contribution to China has been in enabling it to overcome a balance of payments crisis in the mid-1980s, while simultaneously opening channels to export markets.  There is still an open debate in the literature on its contribution to domestic technological deepening, though much of the failure of foreign firms to be fully integrated with China's economy could be ascribed to the peculiar features of China's National Innovation System (NIS), which by its very structure discourages inter-institutional linkages.   China's new technology policy seeks to radically alter the NIS, by focusing more on greater inter-institutional harmonization, a tougher markets-for-technology policy in dealing with foreign firms and developing greater indigenous manufacturing capabilities, as discussed below.

China's growth model retained the main features of the East Asian growth model, namely, high levels of public and private investment and external trade.  The country has traditionally enjoyed high savings and investment rates, even during the pre-reform era (1949-1978).  As early as 1954, when it was still a very poor country, its investment-to-GDP ratio was 26 per cent (the corresponding figure for India was 12 per cent). Contemporary savings and investment rates in China are of the order of 45 per cent of GDP, among the highest in the world. The downside of such high investment rates has been the choice of a number of sub-optimal projects, whose output has only added to costly inventory build-ups.  It has also encouraged a resource-intensive model of growth, which creates a high demand for resources, both domestic and foreign, and has serious repercussions for the environment. The Chinese government is seized of these problems, which were openly articulated in the 17th plenary session of the Communist Party in October 2007.

The growth of trade, dominated by manufacturing imports and exports has led to the enlargement of China's global footprint, by embedding it in global supply chains. The conventional image of China as a supplier of low value-added products or as a country that assembles intermediates imported from developing countries into finished products is only partially true. Over the years, China has emerged as the nucleus of a sophisticated regional supply system, which includes the countries of East and South East Asia. Typically, primary products have been imported into China from South East Asia, while Japan, Korea and Taiwan have been sources of more sophisticated intermediates, which are assembled in China. The finished products are then exported back to the home countries or globally, as part of a vertically integrated supply change.

Such a vertically integrated regional production system is particularly well-developed in industries such as electronics and over a quarter of intra-East Asian trade is in products categorized as parts & components'. China's import policies have encouraged a 'dual' structure, whereby intermediates that are imported to be assembled as finished goods for exports have a lower duty than "ordinary" items. The trade in finished goods also follows a similar pattern, where China exports (mostly) low-end manufactured goods to countries without an indigenous manufacturing industry, while importing advanced products from developed markets. This system has worked remarkably well and has been in harmony for the most part, besides providing China's trading partners a stake in China's growth. However, the continuation of these arrangements is based on a continued expansion of the global economy. A drastic change in global economic conditions for the worse and/or an increase in techno-economic nationalism within China could lead to an uncomfortable change in existing supply chains.

The Way Forward:
There is little evidence to conclude that the rapid growth of China has adversely impacted its Asian trading partners. As a matter of fact, China runs a trade deficit with most of its major trading partners in East and South East Asia. While the trade deficit with East Asia can be understood as a function of the adverse terms of trade, the corresponding deficit with countries of South East Asia is counter-intuitive, but nonetheless true.

However, there are reasons to believe that the current arrangements may undergo a significant change over the future.  China is investing heavily in upper end manufacturing including sophisticated intermediates, both as a way of deepening its indigenous manufacturing capability and reducing its external dependence. If such an arrangement is accompanied, by abandoning 'lower end' manufacturing, characterized by low value addition and wage levels, as Japan, Korea and Taiwan did, it could provide opportunities for countries of South East Asia like Vietnam, the Philippines, Thailand and even some countries in South Asia, particularly India.

At the same time, China could emerge as a competitor to Japan, Korea and Taiwan in high technology goods.  China's policy framers have made little secret of their desire to emerge as a hi-tech economy, driven by innovation as opposed to routine manufacturing. This has led to a revamp of the National Innovation System, by making it more tightly integrated. Several Government Research Institutes have been shut down, but the outcome has been a more compact and productive system. Funding for Research & Development has increased sharply and government venture capital has started funding early-stage research. At the same time, an aggressive 'Technology for Markets' policy has resulted in foreign firms having to work more closely with Chinese partners and manufacture an increasing share of their components locally as part of Local Component Requirement policies. The impact of these policies is best manifested in the manufacture of renewable energy equipment, where China has fast emerged as a world-leader largely as a result of inorganic growth. In short, FDI is expected to make a qualitatively more significant contribution to China's growth in the future.

It would be an error of judgment to misconstrue an increase techno-nationalism for xenophobia.  China's policy makers are fully aware of their dependence on the global market. An expansion of China's economy will certainly create reverberations in the neighborhood, though the impacts need not be necessarily negative. The movement towards the aggressive inking of Free and Preferential Trade Agreements all over the region, with China as an enthusiastic supporter is seen as an effort to consolidate the gains of free trade. Technology forecasting is a risky activity at the best of times, which makes the future of economic relations in developed East Asia hard to predict. Will China occupy the space that Japan, Taiwan and Korea currently do, while they move up further up the technology ladder? Will a growing Chinese economy emerge as a source of increasingly advanced intermediates from South East Asia (as opposed to mostly primary products and lower end intermediates today)? These are vexing and significant questions for governments and business.

The fundamental critique of the East Asian model was that it was driven by relentlessly increasing the supply of labor and capital in the economy, with little attention to how productively they were used.  This automatically led to a process of compulsive investment, with little regard for downstream use.  The result often was huge inventory build ups and the choice of projects with sub-optimal returns.

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Port Vulnerability and Economic Resilience and the Gap in Comprehensive Research

Dr. Victor O Gekara Senior Lecturer, RMIT School of Business IT and Logistics

As gateways to a country's trade and therefore critical economic institutions, ports must be safeguarded from any situations which threaten their effective, efficient and productive performance. The value of ports lies not just in the transfer of cargoes to/from and within the national economy but also in their role as revenue generators, job creators and key catalysts for many related business sectors. However, in order to fortify their position a broad appreciation of the sources of vulnerability is essential. The task is to identify the broad range of threats facing the industry in order to devise versatile resilience management approaches.

The ports industry worldwide has undergone significant restructuring and growth over the past three decades in keeping with the huge increase in international trade volumes, expanding global logistics chains and technological advancements in the shipping industry. At the heart of these changes has been the opening up of the industry to private sector investment in many countries where, hitherto, ports were controlled by the state through, often inefficient and politically smothered, port authorities. The increased deregulation of port management around the world has increased private sector participation leading to the growth of global terminal operators (GTO), twelve of which now control close to 42% of the total world container throughput. Being commercially focused, unlike port authorities, whose priorities are often divided between commercial and trade facilitation' objectives, private terminal operators have invested heavily in port infrastructure, equipment and rationalised processes as they compete for profitability. In this respect, the industry has been at the forefront in the innovation of workplace technologies including advanced information management technologies, sophisticated operations equipment, including increasing automation. Ultimately, one could say that ports are critical pillars of global trade.

However, being so critical and essential to the global economy and highly prized at the national level, ports are increasingly exposed to a wide range of threats, deriving from natural, organizational, technological and human factors. The critical question is: does port management, whether public, private or mixed, and do governments recognize the full range of threats and adopt risk management systems that are sufficiently sophisticated to ensure adaptation to changing circumstances and adequate resilience?

Some of the natural events that have affected port operations in recent years and continue to present significant future threat include earthquakes and/or tsunamis, flash floods, storms and heat waves. In 2005, Hurricane Katarina devastated the entire New Orleans economy including its ports, which suffered about $100 million worth of damage and untold damage to US – Latin America trade. In 2011 tsunami floods washed across Japan's northeast coast, causing great destruction to key port towns. Not all these events have to directly hit port structures in order to disrupt operations. Because ports are key nodes in international business, they are highly sensitive to events occurring remotely both locally and internationally. Thus adverse natural phenomena such as the Europe freeze in the winter of 2010 and the Iceland volcanic ashes in 2011 caused logistic disruptions, which created enormous problems for ports and businesses globally. The recent global financial crisis has created significant challenges for ports around the world, both in the reduction in the flow of cargoes and capital investment in some parts. Security is a constant threat to port businesses and, by extension, operations. Associated threats include piracy which has converted ports in certain regions into high risk or no go shipping zones. In 2011 Somali pirates attacked a total of 163 vessels in the Gulf of Eden, making ports such as Mombasa, Dar-es-salaam and Djibouti very risky and thus undermining their attractiveness to international shipping. The politics of a country or region could also threaten the existence, effective performance and profitability of ports. Ports operating in more politically volatile regions such as Middle East and Africa face a high risk of disruption to business. Even when the risk is not direct to the port infrastructure, security related disruptions along the hinterland logistics corridors impact upon the port in terms of lost and/or damaged cargo, prohibitive insurance costs, port congestions, high cargo dwell times and general costly inefficiencies. Even in non-politically volatile regions, politics could present problems for port developers and operators. The 2006 Dubai Ports World controversy in the US is a good case of where bad politics undermined investment and business operations.

The rapidly changing technologies of operations mean that ports have to constantly update their hardware and software in order to maintain high productivity and competitiveness. The difficulty, however, is that it is an expensive undertaking, particularly updating heavy equipment. Furthermore, a lot of the port technology is intimately linked with, and influenced by, shipping technology. A currently developing situation involves the order, by Maersk and MSC, of the post-Emma generation of super container carriers. These vessels, reaching 18,000 TEU carrying capacity, will require enhanced port space and updated reception facilities and cargo handling equipment. The upward scaling of ship-sizes over the past few decades has put significant financial pressure on many ports, some of which have been relegated to feeder roles as they cannot afford the cost of updates or are in locations that require deviations from key shipping routes. Furthermore, ecological concerns prevent extensive dredging in many countries thus making expansion difficult for ports in naturally restricted harbours. Often less highlighted is the human factor category of threats. Human factor threats mainly manifest themselves in the form of industrial action at the docks, skills lag and workforce shortages. Whereas continuous discourse on workers' terms, conditions and general rights is of mutual benefit, constant workplace militancy and work stoppage can be costly and disruptive to operations and productivity. Skill lags come about in a situation of rapid changes in workplace systems and technologies without an up-to-pace program of retraining. Furthermore, changing social demographics often affect the supply of workforces by creating outright workforce shortages and/or a misalignment between new workplace processes and workforce attitudes.  

Recent studies in Australia have indicated a dearth of qualified and experienced port pilots, port engineers and generally across port management. These jobs are critical to the safe operations of the port yet, due to a complex mix of socio-economic factors under globalisation, the supply of people with the right technical skills and attitudes has been declining drastically over the past three decades. The difficulty lies in the port's historical reliance on the seafaring sector to supply the technical skills. Unfortunately seafaring labour, particularly in industrialised economies has been on the downward trend since mid-1970s. Whereas previously advanced maritime economies dominated the shipping industry, including the ownership of ships, their registration, management and crewing, the tables have progressively turned with the advent of a new international division of labour, under globalisation. With the shift of the various aspects of the industry to low-cost economies, the seafaring sector gradually exhibited all the indications of a declining labour force, i.e., increasing wastage, increasing age profile and reduced numbers. Consequently, shore-based maritime operations like ports, which relied on seafarers to supply certain critical skills currently experience recruitment difficulties.   The problem lies in the tendency to 'maritimise' port operations when a large proportion of port work is non-maritime and the solution lies in adopting more efficient and tailored skills pathways.       Considering the wide range of potential threats there is strong need for comprehensive, independent, inter-industry research to develop a pool of knowledge for the common industry good. The current situation is mostly characterised by individual terminals undertaking individual in-house or outsourced research in areas of perceived interest. With the distancing of the state from port management there is a gap in the policy and funding for broad-based industry-wide independent research leading to a situation where different industry stakeholders, including operators, government and unions, see only a part of the picture, creating a their-problem-is-not-my-business attitude. Ultimately, what is required is a comprehensive strategy, at the national level, for building the resilience of ports.

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Promoting MNE-SME linkages through integrated policies: Business linkages as an avenue for knowledge and technology transfer

Mike Pfister, Senior Policy Officer Investment, Directorate for Financial and Enterprise Affairs, OECD

Fostering business linkages between multinational enterprises (MNEs) and small and medium sized enterprises (SMEs) is an effective avenue for promoting knowledge and technology transfer from foreign investors to a host economy. Such linkages can take various forms, but one of the most efficient for transferring knowledge and technology is backward linkages – i.e. where small domestic enterprises supply larger MNEs.

As suppliers to MNEs, and hence as integrated actors in global value chains, domestic suppliers have to adhere to global quality standards, including environmental standards. These are not reached automatically, often requiring significant training, and hence transfer of skills and tacit knowledge from MNEs acting as the lead companies in the value chain and their suppliers.

MNEs need a consistent and reliable supplier base, thereby reducing risks and costs associated with poor quality products and services. It is in this spirit that MNEs enter into strategic partnerships with a select number of suppliers, maintaining a certain degree of control, while transferring specific propriety information on production and even management methods. Only suppliers with the necessary competence and the adequate absorptive capacity for new technology and knowledge are able to cater to the needs of demanding MNEs.

There is compelling evidence that SME-MNE linkages contribute to enhanced competitiveness of the involved SMEs. An example from Brazil, where 3 MNEs upgraded 27 of their suppliers in the Northeastern State of Pernambuco, illustrated that partner SMEs improved performance indicators by a total of 210% in less than one year. The highest scores were made in the areas of safety, health and environment.¹

From a policy perspective, promoting SME MNE linkages is complex, involving numerous policy areas, from investment policy and promotion, to innovation, financial sector development and small business development measures. It is against this backdrop that the Policy Framework for Investment (PFI), developed by the OECD, can offer a useful analytical framework for assessing linkages policies.

The Policy Framework for Investment (PFI)
The PFI was developed to help governments "mobilise private investment that supports steady economic growth and sustainable development and thus contribute to the prosperity of countries and their citizens and the fight against poverty" (PFI Preamble). The PFI represents the most comprehensive multilaterally-backed approach to date for improving investment conditions. It addresses some 82 questions to governments in 10 policy areas to help them design and implement good policy practices for attracting and maximizing the benefits of investment. The PFI is a practical tool that has been used by governments to undertake investment policy reviews (IPRs).

Table 1. Main policy areas of the OECD PFI

• Public Governance
• Investment policy
• Investment promotion and facilitation
• Trade policy
• Competition policy
• Tax Policy
• Corporate governance
• Responsible business conduct
• Human resource development
• Infrastructure and financial sector development

The PFI offers an integrated policy analysis framework, recognising that various policy areas, beyond investment policy per se, can influence a country's or a region's investment climate. Table 1 below illustrates the main areas of the PFI.

Many countries participated in developing the PFI, including some 30 OECD and 30 non-OECD governments. Business, labour, civil society, and other international organizations, such as the World Bank, also played an active role. Already, Morocco, Indonesia, China, India and Zambia are some of the countries that have undertaken an assessment of their investment framework based on the PFI. Moreover the Association of Southeast Asian Nations (ASEAN) and the Southern African Development Community (SADC) are using the PFI to promote investment policy harmonisation among their Member States.

One of the main benefits of this framework is the flexibility it offers. While some governments can decide to focus more a select number of policy areas others have chosen to use apply to a specific sector (see table 2 below). Also, some have used the PFI for specific sectoral work as a follow-up to a more general PFI-based investment policy review. For example, as was the case with Indonesia and its follow-up work on agricultural investment

Table 2. Examples of recent PFI-based Investment Policy Reviews and areas of focus

Country; Chapters/sector focus
China; Responsible Business Conduct
Egypt; Trade,competition
India; All chapters
Indonesia; Competition,infrastructure, finance, governance
Peru; Trade,competition
Russia; Energy sector
Vietnam; Trade, competition, finance
Zambia; All chapters
Burkina Faso; Agriculture sector

Addressing policies in an integrated manner
A whole set of policy measures needs to be synchronised in order to foster SME-MNE linkages, favouring a PFI approach. Linkages policies cannot be designed, nor implemented, in isolation. It is the interplay and the fine-tuning of different policy areas identified in the PFI that can contribute to an environment conducive to creation of linkages.

In particular, policies that contribute to strategic investment attraction on one hand, and strengthening the absorptive capacity of suppliers on the other should be addressed jointly if SME-MNE linkages are to be fostered effectively. Governments and their agencies, in particular investment promotion agencies (IPAs), tend to underestimate the link between these two policy areas.

Only a limited number of investment promotion agencies actually consider business linkages promotion as one of their main functions.  For example, an UNCTAD study found that only 51 out of 123 surveyed IPAs reported having a linkages programme. Among others, the lack of a specific mandate and the in-house competence to implement such programmes were cited as the most important reasons behind their inactiveness in direct linkage promotion. ²

One may argue that investment promotion agencies are probably the best placed to promote linkages as they are, in many cases, the gateways to a host economy for foreign investors. For example, they could include potential suppliers in their strategies when targeting certain investors. IPAs would also be well placed to channel investor demands and expectations to SME promotion agencies so that appropriate measures can be developed, including targeted capacity building. The latter would obviously require significant co-ordination and effective implemention. In particular, R&D and vocational training institutes need to be involved.

Practical applications of the PFI as an analytical framework
Recent and on-going PFI-based investment policy reviews have highlighted some integrated policy processes that have contributed to linkages promotion.

The OECD Investment Policy Review of Mozambique (forthcoming in 2012) included an analysis of the MozLink programme, a local supplier development program jointly created by Mozal Aluminium Smelter, IFC and CPI, Mozambique's IPA, in 2003. The programme is a follow-on from the initial SME development project that began during the construction phase of Mozal (the SME Empowerment and Linkages Programme). As the first major commercial development after the end of the war in Mozambique there was a need to create technical and business capacity to allow local companies to become more competitive and participate in this development by supplying quality goods and services, increasing local purchasing power and promoting job creation.

The impact of the programme has been significant: from 2002-2005, Mozal increased purchase from local SMEs from $5m to $17m per month, the number of SMEs involved grew from 45 to 250, over 2,000  jobs were created, and over US$50 million in revenues were generated  for participating SMEs. ³

Another example clearly illustrating the benefits of effective co-ordination across different policy areas for linkages formation can be seen in Malaysia's Penang Skills Development Centre (PSDC). This case was analysed in the OECD Investment Policy Review of Malaysia (forthcoming in 2012). The PSDC was established in May 1989 as a not-for-profit training and development centre. At initial start-up, the PSDC received support from the Penang State Government in the form of subsidised rental of premises, and an annual training grant for the centre.

As it grew in relevance it attracted the attention of the federal government. Starting from 1993, the PSDC received capital grants to assist with its capacity building expenditure such as equipment and machinery. The PSDC invites membership from the manufacturing and related industries and to-date has a member base of 130 companies. With strong support from the government and industry, the PSDC undertook the facilitation of effective resource utilisation amongst the manufacturing and service industries. In its first year of operation, the PSDC offered a total of 16 courses with 309 participants.

The PSDC does not target any specific group and is accessible to all who wish to pursue lifelong learning. However, its staple programmes such as those conducted on behalf of the government and the degree and diploma programmes offered under continuous education tend to attract:

• secondary school (high school) leavers;
• unemployed graduates; and
• the existing workforce which requires re-skilling and skills upgrading.

The success of the PSDC is also attributable to its tripartite business model involving three key stakeholders: industry, academia and government. The PSDC is managed and led by the industry and is supported by national academic bodies and the government. The PSDC is managed by a Management Council which is comprised of elected members from the existing member base.
Six government agencies are involved with the PSDC:

• the Ministry of Entrepreneur & Cooperative Development
• the SME Corp
• the Standard and Industrial Research Institute of Malaysia
• the Penang Regional Development Authority
• the Penang Development Corporation
• the Penang State Secretariat

These agencies represent the various interests of the government such as local enterprise development, research and development and both state and national level development initiatives. More importantly, their involvement in the PSDC council enables the centre to understand the policy directions of the government and therefore, to implement and introduce new human resource development initiatives which complement national policies ⁴

Also, the OECD Investment Policy Review of Botswana identified some interesting institutional reforms aimed at streamlining investment promotion and SME development. The Local Enterprise Authority was recently put under the supervision of the Ministry of Trade and Industry, which also oversees the Botswana Export Development and Investment Authority. This re-organisation aims precisely to strengthen the link between the two organisations.

Strengthening the PFI to better address business linkages policies
While the PFI provides a useful baseline framework for assessing investment-related policies, it could benefit from some adjustments to better address business linkages policies. The OECD hosts a number of instruments that squarely address SMEs and their capacity constraints and could be usefully applied through the PFI.

In particular, the PFI could integrate elements of relevant instruments such as the OECD SME Index, and its work on SMEs and innovation ⁵. The flexible nature of the PFI could lend itself to developing a specific framework for promoting business linkages.

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¹P.17, "Creating Business Linkages, a Policy Perspective", United Nations Conference on Trade and Development, Geneva, 2010
² P.vii, "A Survey of Support by Investment Promotion Agencies to Linkages", United Nations Conference on Trade and Development, Geneva, 2006
³ Esteves, Ana Maria, David Brereton, Daniel Samson and Mary-Anne Barclay, 2010, Procuring from SMEs in Local Communities: A Good Practice Guide for the Australian Mining, Oil and Gas Sectors, University of Queensland; Jenkins, Beth, Anna Akhalkatsi, Brad Roberts and Amanda Gardiner, 2007, Business Linkages: Lessons, Opportunities and Challenges, International Finance Corporation, International Business Leaders Forum and Kennedy School of Government, Harvard University. Jaspers, Frans-Jozef, Ishira Mehta, 2007, Developing SMEs through Business Linkages: The MozLink Experience – A Manual for Companies, NGOs and Government Entities, International Finance Corporation.
⁴OECD, LEED Programme
⁵www.oecd.org/innovation/strategy.

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