Benchmarking the Canadian Business Presence in East Asia [1 ed.] 9781442671249, 9780969969105

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Hongkong Bank of Canada Papers on Asia Editor A.E. Safarian University of Toronto Managing Editor Wendy Dobson University of Toronto

Editorial Advisory Board David Bond, Hongkong Bank of Canada, Vancouver Edward K.Y. Chen, University of Hong Kong Chia Siow Yue, National University of Singapore Farid Harianto, University of Indonesia & Institute for Management Education and Development, Jakarta Ralph W. Huenemann, University of Victoria Lawrence B. Krause, University of California, San Diego Karen Minden, Asia Pacific Foundation, Vancouver Eleanor Westney, Massachussetts Institute of Technology, Cambridge, Mass. Ippei Yamazawa, Hitotsubashi University, Tokyo Soo Gil Young, Korean Transport Institute, Seoul

Centre for International Business University of Toronto

Hongkong Bankof Canada

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Hongkong Bank of Canada Papers on Asia, Volume 1

Benchmarking the Canadian Business Presence in East Asia A.E. S afar tan and Wendy Dobson, Editors

ISBN: 0-9699691-0-4 www.utppublishing.com Centre for International Business Faculty of Management University of Toronto 246 Bloor Street West, Toronto, Ontario M5S 1V4 Printed and bound in Canada

Canadian Cataloguing in Publication Data Main entry under title: Benchmarking the Canadian business presence in East Asia (Hongkong Bank of Canada papers on Asia ; v. 1) Includes bibliographical references. ISBN 0-9699691-0-4 1. Canada - Commerce - East Asia. 2. East Asia Commerce - Canada. 3. Canada - Commercial policy. 4. East Asia - Commercial policy. 5. Canada Foreign economic relations - East Asia. 6. East Asia Foreign economic relations - Canada. I. Safarian, A.E., 1924- . II. Dobson, Wendy. III. University of Toronto. Centre for International Business. IV. Series. HF3228.E37B45 1995

382.097105 C95-931635-3

Preface This volume is the first in a series that examines Canada's economic relationships with the countries of East Asia. Canada faces a paradox— while the East Asian economies have emerged as the world's most dynamic, Canada's economic presence has declined. Some of the reasons relate to the fact that Canada's trade policies in recent years have stressed linkages with our southern neighbours. But a significant factor is the relative costs businesses face when they enter unfamiliar and distant markets. Helping to reduce information costs is something the academic community can address. The Hongkong Bank of Canada Papers on Asia has been created with this purpose in mind. The series will feature timely and readable scholarly work in the fields of business and the social sciences, aimed initially at the Canadian business community. Future publications are also intended to become an authoritative source of research, in Canada and beyond, on the rapidly-evolving Asian economies. With the generous sponsorship of the Hongkong Bank of Canada, A. E. Safarian has become Editor of the series and leads a distinguished international Editorial Advisory Board that provides peer review and editorial advice. The Papers are published by the Centre for International Business, Faculty of Management, University of Toronto. The Papers are more than a vehicle of dissemination; they are proactive. The first volume establishes a benchmark of Canada's performance against which future progress can be measured. In the last chapter, Professor Safarian sets out a research agenda suggested by these initial studies.

To stimulate high-quality research, the Editorial Advisory Board seeks out top researchers and encourages them to write on subjects that are central to the Papers' mission. Manuscripts have been commissioned and symposium and conference contributions will be solicited. In addition, events are specifically organized to stimulate research in this area and to ensure its timely dissemination to interested audiences. In effect, the Papers are a catalyst in the development of a cadre of scholars. The project is fortunate to have the strong support of Heather Munro-Blum, Vice-President, Research and International Relations, and Hugh Arnold, Dean, Faculty of Management, University of Toronto. This volume was prepared with the research assistance of Walid Hejazi, the meticulous editing and desktop publishing skills of Catherine Gordon and the outstanding organizational skills of Vivien Choy. Wendy Dobson Managing Editor May 1995

ii

Contents Preface

Introduction

I

1

Wendy Dobson

Canada's business presence in East Asia: Overview and strategic options Keith Head and John Ries

Introduction 9 Statistical overview 11 How do trade and investment in East Asia benefit Canadians? . .22 Infrastructure opportunities in East Asia 34 Conclusion 37 Capturing Japan's attention: Canada's evolving economic relationship with Japan William V Rapp Introduction The emerging motivations of Japanese MNCs in a global context FBI's place in the product cycle The changing Canadian-Japanese paradigm Innovation and competition in Japanese high technology industries The pattern of competition in Japan Foreign firms and the paradigm Summary and conclusions

41 45 50 57 59 60 63 66 iii

The China market: Dancing with a giant Victor C. Falkenheim Introduction Canada's position in the China market China's changing trade and investment regime China's business environment and business systems Canada and the China challenge Canadian readiness

75 77 82 93 97 100

Southeast Asian perceptions of Canadian business Lorna L. Wright Introduction 107 The Canadian presence in Southeast Asia 108 Business environment and business systems 110 Southeast Asian perceptions of Canadian business 124 Canadian companies in Southeast Asia: Three case studies . . . .130 Implications for Canadian business 135 Conclusion 141 Where to from here? A.E. Safarian

149

About the authors

159

Centre for International Business

161

iv

Introduction Wendy Dobson

This volume is a benchmark that provides a basis against which future progress can be measured. It establishes in a systematic way how Canadian business is doing—and how it is perceived to be doing—in the rapidly-growing economies of East Asia.1 The studies in this volume identify and address a paradox: East Asian economies are booming but Canada's economic presence has been declining. By objective measures, Canada is selling less to East Asia than East Asia is selling to Canada, and this deficit is growing in spite of growth in Canadian exports overall, and in spite of rapid import growth in the East Asian economies. The composition of Canada's exports to East Asia is dominated by natural resources, even though machinery, transport and electrical goods account for 40 percent of Canada's total exports. William Rapp's analysis is that Canada's interface with Japan appears to be stuck in a "rocks, food and materials" export ratio that typified the 1960s and 1970s. Victor Falkenheim, in his analysis of the China market, notes that, while there is no a priori reason to define an appropriate "share" of the market for Canada, it is possible to identify sectors, such as auto parts, machine tools, banking and insurance, in which Canada's global revealed comparative advantage is not reflected in commensurate success in China. Lorna Wright notes a remarkable congruence that is not being fully exploited: Canada's strengths in

1

Countries studied in particular depth include the Peoples Republic of China, Indonesia, Japan, Malaysia and Thailand. 1

infrastructure development, telecommunications and transportation are also the investment priorities of Southeast Asian governments. By subjective measures, although there are notable exceptions in all markets, these studies find that Canadian firms pursuing business opportunities in the region are perceived to be ill-prepared and unfocused. Falkenheim cites weaknesses of Canadian firms noted by Chinese sources, including an inadequate allocation of market research and resources to business development and technical and decision making contacts, inflexibility, impatience, inadequate after-sales networks and a lack of market presence. Wright's survey of Thai and Indonesian business people revealed additional perceptions such as inadequate understanding of the importance of long-term relationships, lack of business focus, unsuitable products and an unwillingness to take chances. Are these assessments cause for alarm? How much do they matter? Although the East Asian economies are growing rapidly and their imports from the rest of the world are increasing, Canada's performance may not matter for reasons Keith Head and John Ries point out. Rents—higher-than-normal profits—may not be available to Canadian producers in this dynamic market, but they can be found in trade and investment relations with our rich and closer neighbour, the United States, even if the US economy is growing at a slower rate. Under normal market conditions the absence of Canadian firms in East Asia may make sense because of fierce competition and a paucity of high-profit opportunities. Falkenheim notes that the erosion of Canada's market position in China can be explained in part by the proximity to China of East Asian competitors, as well as by the marketing and production strengths of competing American and Japanese companies. Head and Ries point out, however, that market failures, in the form of inadequate market information, may also be part of the problem—in which case Canadians may be foregoing significant economic opportunities in the region. Each of the authors identifies significant information and strategic obstacles. Four factors in particular should be understood by Canadian governments and businesses conducting business in the region. The first factor, identified by the title of William Rapp's paper, Capturing Japan's attention: Canada's evolving economic relationship with Japan, is the 2

Wendy Dobson

need to understand the evolving global strategies of Japanese multinationals if successful cooperation or competition is to develop. Japanese raw materials processing firms, Canada's traditional business partners, are no longer growing. To identify future business partners, Canadian firms must understand the role of the product cycle in Japan's industrial development. Such an understanding will indicate where the strengths of Canadian companies will fit in Japan's domestic market, and where Canadians will find potential partners for joint initiatives in East Asia. Historically, Japanese firms have been imitators and followers. Products were first imported from advanced countries, and as domestic demand developed the industry was protected. When the local market was saturated, the industry exported its products, reduced its production costs and increased product quality. Price competition was a good entry strategy because many of the targeted industries in the importing countries were mature. As production costs rose in Japan, producers would move standard technology labour-intensive production offshore to East Asian developing countries and import the products to Japan. Later this technique was also used to maintain exports to advanced countries. Such export competition caused political pressures and created incentives to invest in production facilities in the target markets as well. At the same time, Japan was changing its ability to produce and use advanced technologies. As a result, the Japanese economy has been characterized by a mix of industries at different stages of the product cycle. The second factor is to understand the strategies of other East Asian firms and governments. To an important degree, other East Asians also use follower strategies. Japanese investors, for example, initially exported to third world countries from their low-cost labourintensive Southeast Asian plants. They are increasingly targeting local markets as well as importing components and consumer goods from the region into Japan. Understanding the role of host governments is critical to success. In general, the government's role in the follower economies in the region is to speed modernization and raise per capita incomes through industrialization, infrastructure development, deregulation and privatization of state-owned enterprises. Falkenheim stresses the extent to which the state sector remains dominant in the Introduction

3

Chinese economy. Trade policy is essentially mercantilist and the economy highly-protected. Priority has been given to exports, and investment policy has favoured export-oriented ventures capable of generating foreign exchange to pay for imports. Even so, many sectors remain closed to foreign participation. The Chinese authorities envisage the role of the outside world in China's development as providing production inputs and international markets for Chinese processed goods, reducing import competition in the domestic market, maximizing foreign exchange for priority sectors, and rationally exploiting China's comparative advantage in low-wage labour in international markets. The Chinese government's requirement for joint ventures between foreign and local partners raises the cost and reduces the longterm return on investment in China. In Southeast Asia, governments are taking advantage of economic diversity to develop a regional division of labour based on differing comparative advantages. Market forces are beginning to take over and governments are moving back to allow the private sector to move in. Yet years of rapid growth have brought congestion; infrastructure is over-burdened and huge investments are contemplated in the years ahead. These are areas where Canadian firms have competitive strengths, but their clients in many cases will be governments. The third factor, which is closely related, is to understand the linkages between trade and investment. Rapp outlines how Japanese firms have used direct investment to gain and retain access to foreign markets. Falkenheim notes that it is possible to sell into a foreign market without establishing a formal business presence. Indeed, turnkey plants and licensing arrangements are quite common. But FDI may be necessary as an entry strategy when government policy encourages direct investment including joint ventures with local partners and retains high import barriers. This is the case in China, and has been the case in certain industries like autos in Southeast Asia. In addition, in China, the growing importance of foreign-invested enterprises (FIEs) as channels for imports means that investment will increasingly affect Canada's export performance, yet Canada's overall direct investment in the region accounts for only 6 percent of its total. The fourth factor is to understand business systems and how 4

Wendy Dobson

to work with them, especially since some governments encourage joint ventures with local partners. Falkenheim stresses the role of state entities in a more liberalized, but increasingly fragmented, Chinese business environment. The players are many and turf wars frequently delay project permits. Some of the key actors include state trading companies and state-owned enterprises, ministries that have created production enterprises and trading companies of their own (as has the military), and provincial and local governments with project approval powers up to certain limits that are critical in some infrastructure projects. In her analysis of business systems in Southeast Asia, Wright also identifies a number of players, including state enterprises, royalty and government leaders, and the traditional family-owned Chinese conglomerates. She emphasizes the importance of relationships with and among these players, and identifies them as major factors in business practices. All of these issues and obstacles are addressed in the four papers in this volume. In the first paper, Head and Ries, both Professors at the University of British Columbia, provide an overview of how we are doing. They document the paradox between Canada's performance and the region's growth, and examine the arguments for actively pursuing a greater business presence in the region. They examine with particular care the advantages first-mover firms have in the large market, and examine the huge projected demand for infrastructure. They note that barriers to entry and intense competition will reduce available rents. In the next three papers, the focus shifts to analysis of leading East Asian economies including Japan, the People's Republic of China, and three countries in Southeast Asia. In his paper on Japan, William V. Rapp, Professor of International Business at the University of Victoria, characterizes Canada's economic relationship with Japan as focusing on Japan's economic past rather than on its future. To help them understand that future, and to capture Japan's attention, Canadians need to understand how Japanese strategies are driven by the product cycle. Rapp emphasizes that Canada is no longer at the leading edge of Japan's global strategic thinking. Recapturing their attention will require "aggressively proactive" strategies, which he outlines in detail. In his paper on China, Victor Falkenheim, Professor of Political Science at the University of Toronto, focuses on China's market. He Introduction

5

assesses obstacles to expanded trade and investment ties and possible strategies to address them. Canada's share of China's imports fell from 3.4 percent in 1988 to less than 2 percent in 1994. Wheat accounted for nearly half of exports during this period; non-cereal exports rose modestly. Falkenheim stresses the need to understand the central roles in decision-making and priority-setting played by China's central government ministries, planning agencies, and provincial and municipal governments. Further liberalization of the economy will bring more intense competitive pressures from both international and local players. In her paper on Southeast Asia, Lorna Wright, Professor of International Management and Organizational Behaviour at the School of Business, Queen's University, focuses on perceptions of Canadian business in Indonesia, Malaysia and Thailand, putting special emphasis on the shifting business environment. Governments are relying increasingly on the private sector as the engine of growth, and shifting their focus to infrastructure development and regional ties to take advantage of Southeast Asia's economic diversity. Business systems differ among the three countries, although the family-owned conglomerate favoured by the Chinese is a common feature. Wright presents three case studies of successful Canadian firms that illustrate factors for success in the region, including cultivation of relationships, prior experience, knowledge of the cultures and joint ventures with other foreign firms. Where to from here? Professor A.E. Safarian, Editor of The Hongkong Bank of Canada Papers on Asia, draws out some of the reasons why Canadian public policy and business strategy should focus more fully on the East Asian market. He then proposes a research agenda for future Papers in this series. He notes the importance of high and variable entry costs to these dynamic markets, and identifies the challenge government, businesses and researchers are facing to reduce these costs. He also notes the emphasis the authors have placed on understanding the political and private sector priorities and organizations within which business activity takes place. Clearly, a high priority for future research lies in gaining a better understanding of the various business systems in the region. It is also important to understand the way governments in Canada support trade and investment by 6

Wendy Dobson

Canadian firms, and the role of Canadian fiscal systems. A number of research issues deal with the characteristics of the key organizational forms, including the contribution these organizations make to economic growth and competitiveness, the direction in which these forms are evolving, and such closely-related topics as the internal adjustment processes in Asian economies that assist in smooth adjustments to rapid growth and evolution. Professor Safarian also considers how research can find a potential role for Canada's immigrant community in reducing entry costs—an issue that is often discussed but not well understood.

Introduction

7

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Canada's business presence in East Asia: Overview and strategic options Keith Head and John Ries

Introduction The world economic map is changing rapidly, altering prospects for Canada's position in it. One of the drivers of change is growth of the East Asian economies. As the Economist recently reported, if current economic growth rates are projected forward 25 years to the year 2020, six of the world's ten largest economies will be in East Asia. Such a prospect implies a huge market potential for Canadian goods and services. Yet, surprisingly, despite Canada's advantageous geographic proximity to East Asia relative to most other Western nations, and despite its large East Asian ethnic population, Canada's trade with the region has been shrinking. Direct investment has been rising, but mainly in Japan, and from a small base. To the extent this situation has been noticed, it has been defined as a missed opportunity with alarming long-term consequences for Canada's economic future. Upon closer scrutiny, however, it is less obvious why Canadians should prefer to trade with or invest in some countries rather than others. For this to be the case, returns from these efforts must be greater than the returns (known as economic rents) normally associated with trade or investment in particular countries. In the next section we profile Canada's current economic relations with ten East Asian economies: the five relatively industrialized economies (Japan, South Korea, Hong Kong, Taiwan and Singapore),

9

and the five rapidly industrializing ones (China, Indonesia, Malaysia, Thailand and the Philippines). By any measure, Canada's economic relations with the region have not kept pace with the growth of these economies. In the third section, we investigate the reasons why Canada should be concerned about its economic presence in the region. The case that having a presence in Asia makes a big difference for Canada (as opposed to having a presence in the rest of the Americas or in Europe) must rest on arguments that the destination of Canada's exports and outward investment matters. We consider mechanisms that relate economic presence in Asia to improvements in the future standard of living of Canadians. Specifically, we examine whether exports to Asia are likely to give sustained, above normal, rates of return to the successful exporter. One of the main sources of such superior rates of return would come from first-mover advantages that give sustained market share and profitability to early entrants to the market. These advantages come from network externalities (the benefits from a large base of consumers) and from consumer brand recognition, relationship-specific investments and scale economies. None of these sources of sustained advantage, however, characterize the predominately resource-based products Canada sells to East Asia. This finding implies that increased trade with Asia will require a shift in activity towards business services and infrastructure projects that are more likely to generate superior returns. Positive "spillovers" between Canadian firms doing business in East Asia imply that additional Canadian activity there will lower the costs and risks of future ventures in the region. We explore potential sources of positive spillovers associated with economic activity in new markets. If spillovers are important, Canada's relative absence in East Asia may be the outcome of a vicious circle where Canadian firms stay away because there are few Canadians there. Positive spillovers, however, may also be the source of a virtuous circle, where increasing Canadian presence in the region spurs future Canadian business there. The third section also discusses how immigrants to Canada from East Asia can enhance business links with their countries of origin. Another area of particular opportunity for Canadian firms in East Asia lies in the infrastructure investment boom in the region. In the 10

Keith Head and John Rtes

fourth section, we examine recent Canadian success in securing infrastructure contracts and consider whether these contracts are likely to confer above-average returns. In the concluding section, we summarize our findings and focus on information and market intelligence as areas where government and the academic community can contribute to lowering the risks and costs associated with doing business in the region.

Statistical overview We begin with a profile of the East Asian economies and Canada's economic relations in the region. First, we describe the current level of economic development in these economies and their rapid economic growth. Next, we explore Canadian exports to the region to see how important these countries are as markets for Canadian goods. We pay particular attention to East Asia's share of Canadian exports and to Canada's share of East Asian imports to see whether Canada's trade to the region is keeping pace with overall trade growth. To the extent the limited data allow, we describe Canada's sale of business services in the region as well as the amount of Canadian direct investment there. We also compare Canada's performance in East Asia to that of Australia and the United States to gauge whether Canada is doing as well as other Western nations who have similar characteristics to Canada. Growth of the East Asian economies The East Asian economies have been among the most dynamic in the world in terms of GDP and trade growth. Table 1 lists some important economic characteristics. With the exception of the Philippines, each nation has enjoyed annual per capita GDP growth of at least 3.5 percent during the 1989-1993 period.1 As a group, per capita GDP in the 10 countries grew at an average rate of 4.4 percent over this period, a much higher rate than the 1.8 percent growth of OECD countries during the corresponding time span. Growth was generally highest among countries that were relatively behind 1

Calculations of these growth figures are based on current exchange rates. Trends in real exchange rates will cause differences between the growth rates listed here and growth rates calculated using purchasing power parity exchange rates.

Canada's business presence in East Asia

11

in economic development. China, the country with the lowest per capita GDP of $3702 in 1991, grew at 6.1 percent, while the highest growth was achieved by Thailand (7.5 percent), and Malaysia (6.2 percent), which had intermediate per capita GDP levels of $1,580 and $2,490. More developed countries—Japan, Hong Kong and Singapore—grew at lower rates. Growth in this region is not expected to taper off in the future. The World Bank forecasts per capita GDP in East Asia to average 5.9 percent growth from 1992 to 2002, with China, Korea, Malaysia and Thailand expected to achieve growth rates of 7 to 8 percent (Global Economic Prospects and the Developing Countries, 1993: 66).

Table 1: Economic characteristics of East Asian economies

Population Japan Hong Kong Singapore Taiwan Korea Malaysia Thailand

Annual Trade Growth Average Annual GDP/Capita 1989-93, %p.a. FDI Inflows (current exchange rates) 1991 Level Annual Growth Imports Exports 1989-93 (US$ millions) 1989-93 (US$)

123.9

27.087

3.7

5.3

6.5

978.0

5.8

13,200

3.5

18.5

17.9

n/a

11.5

5,831.8

2.8

12,890

5.0

11.4

20.4

9,070

5.3

10.4

7.7

n/a

43.2

6,340

5.8

11.5

6.5

731

18.2

2,490

6.2

21.6

15.5

3,363.6

57.5

1,580

7.5

20.2

20.1

1,989.8

Philippines Indonesia China

14.3

8.9

525.6

186.0

610

4.5

16.9

14.2

1407.6

1,148.2

370

6.1

12.3

14.3

9,640.4

East Asia

1,668.1

7,438

4.4

11.5

10.2

24,017.0

62.1

740

-0.1

Source: International Financial Statistics Yearbook; Asian Development Outlook (Asian Development Bank); Balance of Payments Yearbook 2

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Dollar amounts listed in the paper are US dollars unless otherwise noted.

Keith Head and John Ries

GDP growth in East Asia was exceeded by growth of trade. As illustrated in the table, annual import growth averaged 11.5 percent and export growth averaged 10.2 percent from 1989 to 1993. Thailand and Malaysia each increased imports by over 20 percent a year during this period. These increasing import levels indicate the growing market for foreign products in these economies, and potential markets for Canadian exporters. The East Asian economies also became favoured host sites to foreign direct investment (FDI) due to more favourable policies towards foreign investment and low unit labour costs. Many countries lifted restrictions on foreign investments or encouraged investment by offering tax and import duty exemptions. For instance, China initiated an "Open Door" policy and created Special Economic Zones which featured a wide array of economic incentives. Figure 1 shows the steady increase in FDI flows into the region, rising from just over Figure 1: Inflows of foreign direct investment to East Asia 1988-1993

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$10 billion in 1988 to $40 billion in 1993. As shown, China has become a favourite site, particularly in the past few years. The last column of Table 1 shows that China received the largest annual flows among the 10 countries during this period ($9-6 billion or 40.2 percent of the total), with Singapore a distant second at $5.8 billion (23 percent share). Malaysia ($3.4 billion) and Thailand ($2.0 billion) also received significant annual flows of foreign direct investment over this period.

Canadian trade with East Asia In 1993, Canada exported merchandise valued at C$187.3 billion while importing C$170.0 billion, generating a C$27.3 overall trade surplus. Canada had a C$36.7 billion surplus with the United States that year. On the other side of the ledger, Canada posted C$7.8 billion and C$5.1 trade deficits with East Asia and Europe. The 10 East Asian economies purchased C$ 15.3 billion worth of Canadian goods while exporting C$23.1 billion to Canada. Two features of these trade levels stand out: first, East Asia plays a small role in overall Canadian trade (accounting for 8.2 percent of Canadian exports and 13.6 percent of Canadian imports); and second, in contrast to its large trade surplus with the US, Canada runs a trade deficit with East Asia. Figure 2 shows trade flows between Canada and the ten East Asian countries in 1993. As the figure illustrates, Japan was Canada's most important Asian trading partner, accounting for nearly 50 percent of Canada's East Asian trade. Trade with China is rapidly growing, but Canada is importing almost twice as much as it is exporting. Overall, it is clear that the East Asian economies have greater success selling to Canada than Canada has selling to them. Canada was a net importer from every country except Indonesia, with which Canada ran a slightly positive trade balance of C$17 million. Canada's trade deficit with East Asia is not simply a case of export growth being outstripped by import growth. Rather, Canada's exports to East Asia have actually fallen in absolute terms since 1988,3 3

14

A decline in wheat exports largely accounts for the decline in total exports. Wheat exports to China alone fell by $850 million from 1988 to 1992. Subsidies from the US Export Enhancement Program may have been a key factor in this decline.

Keith Head and John Ries

while imports from East Asia have continued to grow. Figure 3 illustrates this phenomenon. Exports to East Asia peaked in 1988 at C$16.0 billion, at which time imports stood at C$17.4 billion. By 1993, Canadian exports were slightly lower, at C$15.3 billion, while imports had increased by 33 percent to reach C$23-1 billion. Moreover, this decrease in exports to the region occurred during a period when Canadian exports to the rest of the world and imports from East Asia were growing rapidly. The East Asian share of total Canadian exports, therefore, shrank significantly, from 11.6 percent in 1988 to 8.2 percent by 1993. The fall in Canadan exports destined for Asia as a share of Canada's overall exports is partly a consequence of expanded exports to the United States. The Canada-US Free Trade Agreement, economic recovery in the United States and depreciation of the Canadian dollar all combined to spur exports southwards. The proportion of Canadian Figure 2: Trade flows between Canada and the ten East Asian economies, 1993

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shipments to East Asia of all Canadian exports, except for those to the United States, fell only slightly from 1988 to 1993 (declining from 42.6 percent to 41.7 percent). However, one must keep in mind that total East Asian imports were rising rapidly over this period, growing by 58 percent from 1988 to 1992. Consequently, Canada's shares in the imports of those countries almost halved, declining from 2.9 percent to 1.7 percent. Figure 4 compares Canada's share of each of the ten economies' imports in 1988 and 1992. It fell for every economy except the Philippines. The absolute decline in the share was greatest in the two largest markets for Canadian goods—Japan and China. Examination of the composition of Canada's exports to East Asia reveals that Canada is selling mostly resource-based goods. Figure 5 provides the breakdown in 1992 according to industrial categories.

Figure 3: Canadian trade with East Asia, 1993

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Keith Head and John Ries

The largest export item was wheat (12.6 percent), followed by wood (10.0 percent), coal (9-3 percent) and pulp (7.5 percent). Adding the next six biggest export items—ore, soy and seeds, paper, gold and aluminum—accounted for 60 percent of all Canadian exports to the region. Since Canada is a net exporter of resource-based products, it is not surprising that it would also specialize in the export of these goods to East Asia. The relatively poor performance of exports of manufactured goods such as machinery, electrical and transport equipment, however, is disappointing. Trade statistics show that machinery and transport equipment (which includes electrical goods such as office equipment and televisions according to the SITC at the one-digit level), constitute over 40 percent of Canada's worldwide exports but only 9-9 percent of its exports to East Asia. Moreover, Canada manages

Figure 4: Canada's share of East Asian imports by economy

Canada's business presence in East Asia

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roughly to balance its trade in these industries with the United States, but runs a deficit with East Asia. This brief review of Canadian trade with East Asia paints a rather bleak picture in terms of trade balances, export growth and export composition. Canada is not selling as much to East Asia as East Asia is selling to Canada, and the trend is negative. This is in spite of growth in overall Canadian exports and rapid increases in imports in East Asian economies. Moreover, Canada primarily exports commodities to East Asia that appear unlikely to develop worker skills or create positive spillovers for other industries. While they may generate large profits, the sustainability of advantages tied to nonrenewable resources is a serious concern. Figure 5: The composition of Canada's exports to East Asia, 1992

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Keith Head and John Ries

Trade in business services While the Asian market has been a relatively unimportant destination for Canadian merchandise exports, there are reasons to believe that Canada can succeed in supplying business services to Asian markets. Canada's high levels of educational attainment relative to most East Asian economies will tend to give it a comparative advantage in human-capital intensive industries like business services. The service sector dominates the Canadian economy and trade in services has occupied a growing role in international trade. The largest category of non-merchandise trade is interest and dividend payments for capital services. Canada runs a substantial deficit (C$27.6 billion in 1993), in this component of services because it is a net debtor nation. We focus here on business services, a smaller component of nonmerchandise trade, which includes consulting, professional and transportation-related services as well as royalties, patents and trademarks. Canada runs a global deficit in business services of C$4 billion which is mostly attributable to trade with the United States. It generates, however, a small business services surplus with East Asia (excluding China, for which data are unavailable), with C$892 million in exports and C$744 million in imports. While business services numbers are modest in comparison to other trade flows, Canada has managed to increase its services exports and net surplus to East Asia by 50 percent since 1988. The largest single category of service exports from Canada is insurance. Between 1982 and 1992, Canada's insurance exports tripled to C$1.4 billion. Manufacturers Life (Manulife) is now the largest Canadian-based employer in Hong Kong with 400 employees. Since Manulife obtains 70 percent of its revenues outside Canada and opportunities for expansion in the US market are limited, the prospect of major growth in Asia is quite alluring. Canadian direct investment in East Asia There has been a rapid infusion of foreign direct investment into East Asia economies, prompted by their economic growth and receptive public policies. Foreign capital is welcomed in the developing East Asian countries since it is seen to lead to job increases, export growth and technology transfer. From the point of view of the investing Canada's business presence in East Asia

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country, foreign investment allows firms to take advantage of inexpensive factors of production and facilitates sales in host economies. Canada had the world's seventh largest stock of direct investment abroad (DIA) in 1992 (UNCTAD, 1994). This, like most Canadian international economic transactions, is directed largely towards the United States. At year end in 1992, of a total stock of C$106.5 billion, C$65.1 billion (61 percent), was located in the United States. Europe was host to another C$22.1 billion (21 percent), while the total in Japan, Korea, Hong Kong, Singapore, Taiwan, Malaysia and Indonesia was C$6.6 billion (6.2 percent).4 The seven countries' share of Canada's stock of DIA has increased of late: it fell from 5.4 percent in 1987 to 4.4 percent in 1989, and then rose substantially to 6.2 percent by 1992. Japan is the recipient of most Canadian direct investment abroad (CDIA), accumulating C$2.6 billion by 1992. It has also realized substantial increases—the stock in 1989 was only C$507 million. It should be noted that this increase was in the form of retained, rather than new, capital flows. The next largest East Asian hosts to CDIA are Singapore (C$2.0 billion), and Hong Kong and Indonesia (C$0.8 billion each). Taiwan, Malaysia and South Korea have received limited CDIA, which has not increased from 1989 to 1992. Still, stocks of CDIA are a very small proportion of the total stocks in East Asia.5 Canada's share of the stock of FDI in Japan is 1.8 percent (1992), while it is was only 1.3 percent in China (1987), 1.2 percent in Malaysia (1987), 1.1 percent in the Philippines (1989), 0.7 percent in Hong Kong (1989) and a negligible amount of the stock of FDI in Korea (1988).6 These shares are somewhat lower than Canada's share of trade with these economies (Canada's import shares ranged from 2.9 percent in 1988 to 1.7 percent in 1992).

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4

Data for China, Thailand and the Philippines are unavailable.

5

The following statistics are calculated from data published by the United Nations Centre for Transnational Corporations which are compiled from host country sources. The data do not necessarily match Canadian FDI stocks reported by Statistics Canada referred to above.

6

Data are unavailable for other countries.

Keith Head and John Ries

Comparative performance with the United States and Australia in East Asia Canadian exports and direct investment into East Asia do not appear to be keeping up with growth there, and the exports are concentrated in resource-based products. Is that record poor relative to other Western countries? It helps to examine this issue by comparing Canada's performance with that of the United States and Australia. The exports of both Australia and the United States are more oriented towards East Asian markets than those of Canada. Fifty-six percent of Australian exports and 27 percent of US exports went to East Asia in 1992, compared to 8.1 percent of Canadian exports. These numbers have remained stable since 1988, although Hill (1994) notes a remarkable reorientation of Australian trade towards East Asia and away from Western Europe that has occurred since the 1950s. US firms had 17.0 percent and Australian firms had 3.4 percent shares of the East Asian import markets in 1992, compared to Canada's 1.7 percent. Since the US economy is ten times larger than Canada's, we might expect higher shares for the United States, but we would not necessarily expect a higher share for Australia, which has a smaller economy than Canada's. Like Canadian exports, however, Australian and US exports have not been increasing as much as the demand for exports in the ten East Asian economies: both the US share and Australian imports share of East Asian markets have fallen from their 1988 levels.7 Frankel (1993) pointed out, however, that it is not surprising that the rapidly expanding East Asian economies would import relatively more from each other than they would from slower growing economies.8 What is notable is that both the United States and Australia seem to have maintained their market share much better than Canada has. 7

The US import share was 18.8 percent in 1988 while it was 3.8 percent for Australia.

8

To see this, suppose exports and imports were in direct proportion to GDP and there were no preferential trading between countries. Canada, the United States and Australia would therefore have import shares of East Asian markets reflecting their economic size. As the economies of Western countries fell relative to those of East Asia, however, so would their share of East Asian import markets.

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The product composition of United States exports to East Asia differs dramatically from Canada's, while Australia's composition is less distinct. Leading US exports in 1992 were aircraft and parts (10.6 percent), semiconductors (8.1 percent) and computers (3.4 percent). The SITC one-digit machinery and transport equipment industry accounted for 44 percent of US exports to the region. For Australia, leading exports in 1992 were gold (14.6 percent), coal (14.6 percent) and iron ore (6.7 percent). The share of machinery and transport equipment in Australia's exports was 5.6 percent. This share lies below Canada's level of 9-9 percent, although Australia was ahead in absolute dollar amount of exports due to its higher overall level of exports to the region. The patterns of US and Australian direct investment in East Asia are not distinct from Canada's. Direct investment by all three countries in Asia is small and primarily targeted towards the industrialized economies of East Asia (Japan, Hong Kong and Singapore). In 1992, US direct investment in Japan, Korea, Hong Kong, Singapore, Taiwan, Indonesia and Malaysia (the countries for which Canadian data are available) totalled $53.9 billion in 1992, or 10.8 percent of the US total. The 1991 figure for Australia was AUS$4.5 billion, or 12.5 percent of its world total. Denominated in a common currency, US direct investment in Asia is ten times Canada's total, while Australia's is two-thirds Canada's total. These figures indicate that the amount of the three countries' direct investment in East Asia is roughly in line with the relative size of their economies. Like Canada, the United States primarily targets Japan ($31.4 billion), with Singapore and Hong Kong being the next largest recipients. In contrast, Australia has little investment in Japan, while Hong Kong and Singapore receive 87 percent of the total going to Asia. Overall, Canadian direct investment in East Asia, while small, is not significantly different from US and Australian direct investment in the region.

How do trade and investment in East Asia benefit Canadians? Canada has an economic stake in strong trade and investment ties with East Asian economies because those economies are growing very fast. While growth may be very good for East Asia, what will it do for 22

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Canada? One is tempted to reply that if our exports to Asia grow at the same pace as the East Asian economies, we may see a rising trade surplus and surge in employment in Canada. A skeptic may also point to the strong likelihood that Asian exports to Canada will rise as well. At a more fundamental level, the trade balance and employment levels in Canada are determined by macroeconomic factors such as Canada's patterns of international borrowing, its exchange rate policy and the rate of population growth. As long as Canada spends more on private investment and government expenditures than it saves or pays in taxes, it will be forced to run a capital account surplus. This implies a current account deficit of equal size and constitutes a limit on the growth of net exports. The case for a strong East Asian trade presence ultimately relies on arguments that it is the destination, and not just the total volume, of Canada's exports that matters. There is a political argument in favour of increased East Asian trade orientation. The large share of Canada's exports that are bound for the United States puts Canada in a vulnerable position whenever trade agreements are negotiated or trade disputes arise. Marjorie Bowker, a retired judge, first popularized the over-dependence argument during the debate on the Free Trade Agreement (FTA) with the United States. After the agreement took effect, she argued, "Canadian industries would begin 'gearing up' and restructuring in anticipation of greater exports to the US" (Bowker, 1988). UBC economist, Brian Copeland, developed the argument further, pointing out that "because of the difference in relative importance of the FTA to the two countries, Canada becomes vulnerable to threats by the US to abrogate the agreement—the major investments made by firms to reap the benefits of free trade would significantly decline in value upon abrogation." (Copeland, 1988) If Canadian industries become "locked in" to trading relationships with the United States, then Canada will lack bargaining power in future disputes.9 While the Bowker-Copeland argument seems reasonable in principle, it does not present a particularly compelling argument for reori9

This argument was formalized in a paper by John McLaren (1994).

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enting Canadian trade towards Asia. Canada has access to the dispute resolution institutions embedded in NAFTA (North American Free Trade Agreement), and GATT (General Agreement of Tariffs and Trade, now known as the World Trade Organization (WTO)). The use of dispute resolution panels, however imperfect, seems markedly superior to the use of sanction threats which, given Canada's small size, would impose significant costs with little or no prospect of influencing policy. The reason Canada trades so much with the United States is related to its geographical and cultural proximity which lower trade impediments. Other markets are not, and probably never will be, close substitutes for the US market. In any case, the political argument does not explain why East Asian trade would be preferable to European trade, for example. The increasing reliance on the United States as a market for Canadian exports also elicits concern about excessive vulnerability to business downturns in the United States. Exports constitute roughly one-quarter of Canadian GNP. In 1993, Canada exported 80.4 percent of its goods to the United States, up from an average of 74.8 percent in 1986-1990. A recession in the United States would obviously have a profound effect on production in Canada. If business cycles in East Asia are imperfectly correlated with those in North America, diversifying Canadian trade towards East Asia will lower the variance in aggregate demand for Canadian goods and services. Most economic justifications of trade intervention rely on the presence of either economic rents or externalities. For instance, the theories known as "strategic trade policy" have shown that, under certain conditions, an export subsidy may raise the subsidizing nation's economic welfare by shifting rents from producers based in other nations. Recent trade theory has also formalized the idea that scale economies, which are external to the firm, may lead to a failure of a nation to exploit its latent comparative advantages. In the rest of this section, we consider how such arguments might apply to the issue of whether Canada should attempt to redirect its trade towards Asia. The rents argument works as follows. If exports to Asia generate greater rents per unit than exports to other regions, Canada could increase total rents accruing to Canadian producers by reorienting its trade towards the Pacific markets. To evaluate this argument, we need 24

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to examine likely sources of rents. Economic rents are closely associated with barriers to entry. This is because producers cannot hope to earn supernormal returns for a sustained period unless there is some way to bar competitors from imitating the source of their success. Perhaps the most well-known entry barriers arise from government actions to prevent new competitors from entering a market. Prominent examples include patents and trademarks for particular products. Governments also occasionally grant monopolies for whole industries, as was the former practice in telecommunications. Rents derived from patents and trademarks seem, on the whole, reasons to avoid the Asian market. For instance, Chrysler, angered by unauthorized replicas of Jeep Cherokees produced in small Chinese auto shops, announced that it might scuttle the plan to manufacture Minivans in China. While China is the most newsworthy case, the region as a whole is not known for strong enforcement of intellectual property rights. Even Japan has been criticized in the area of patent protection for institutional practices which foreign firms have claimed put them at a disadvantage.10 On the other hand, East Asian middleclass consumers are generally considered to be highly brand-conscious and companies such as Apple Computer and Harley Davidson have found some success exploiting their logos and brand names in Japan (see, for instance, the Business Week article on Harley, May 24, 1993). Given the political pressures, government-granted monopolies to foreign firms appear to be an unlikely possibility. Recent events in the East Asian auto industry suggest, however, that opportunities may be on the increase. For instance, China recently closed its market to new foreign auto assembly investment for three years. After this period, entrants must adhere to strict local content requirements. Incumbent companies such as Volkswagen and Peugot-Citroen appear likely to benefit from being among the first companies to establish a manufacturing presence in China (Economist, April 16, 1994:71). 10

As an example, Fusion Systems has been engaged in a lengthy battle with Japan's Mitsubishi Electric Company over alleged patent piracy by the Japanese company. Whether the source of the problem is patent piracy or Fusion's ignorance of the Japanese patent system is immaterial to the broader point. Foreign firms need to safeguard technology when doing business in Asia. (For details, see Harvard Business School case #9-390-021.)

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In general, we may expect to see governments allowing limited FDI to develop an industry and then protecting those firms from import competition, and even from subsequent competitive investment. This pattern would suggest there are advantages to establishing an early manufacturing presence. Since such policies run strongly against WTO rules, which China has indicated a strong desire to join, we do not expect such policies to be rampant in the future. In fact, GATT and its WTO successor are insisting on more open and even-handed government procurement rules. These rules will make it harder in the future for firms to obtain preferential relationships with the host government—even for those firms that have become "local" by engaging in joint ventures with host-country partners. A second source of rents stems not from government policies, but from actions by firms themselves. In many industries, the first few firms to enter a new market or to provide a new product can erect their own barriers to the successful entry of other firms. These first-mover advantages include a number of mechanisms through which early entry leads to sustained market share and profitability. We describe four examples below: network externalities, consumer brand recognition/loyalty, corporate relationship-specific investment and static and dynamic scale economies. Network externalities

Network externalities exist when the value a consumer obtains from consuming a good depends on the number of other consumers that use the product. While the obvious examples come from the computer industry where compatibility between machines and software systems is extremely valuable to users, network externalities are pervasive in other consumer electronics products, telecommunications equipment, interactive and high definition media. Once a particular design has become the industry standard and network externalities are present, new entrants will find it difficult to compete, even if they offer an intrinsically superior product.11 A single industry standard may 11

26

Examples include numerous computer operating systems that have failed to gain much market share from Windows despite their superior characteristics. We drafted this paper using Wordperfect 5.1 in large part because it is the standard in our faculty and many other places.

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survive in equilibrium, forcing alternative standards to exit, as was the case when VHS videotape cassette forced the Betamax technology out of the market. Network externalities will matter for Northern Telecom which is already battling with AT&T and Alcatel for the China market. It could also matter for Ottawa's fledgling software industry. Consumer brand recognition and loyalty Firms that establish themselves as industry leaders benefit from the permanent advantages associated with brand reputation. More consistent with economic theory is the idea of switching costs that tie consumers to the first product variety they choose to consume. For instance, computer makers often provide equipment to university computer laboratories at an extremely low cost. Once students familiarize themselves with the computer maker's technology, they are likely to become loyal customers in the future because switching to a competitor's product would impose the cost of learning a new system. In the context of East Asian trade, when consumer switching costs are present, first-movers may establish a customer base that is difficult for later entrants to erode. Corporate relationship-specific investment Similarly, firms may become tied to each other when the cost of switching business partners is high, which may occur when they make substantial relationship-specific investments. Japanese inter-firm relationships are characterized by their longevity and by a prolonged period of "getting to know each other" prior to conducting any transactions (Lifson, 1983). Rather than engage in short-term spot contracting, Japanese firms prefer to expend substantial time and money to develop close communication and trust. These relationship-specific investments pay off in the long run by lowering the cost of future business transactions. They also imply that incumbent relationships are preferable to potential ones with outside parties because the upfront costs of developing close communication have already been incurred. Relationship-specific investment may be quite tangible in business relationships among vertically-related firms. Aoki (1988), a noted economist and expert on the Japanese firm, characterizes major Canada's business presence in East Asia

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Japanese manufacturers and their parts suppliers as each investing in equipment and devising management practices which are tailored to the needs of their current business partners. An auto parts company may tool machines to the requirements of a particular assembler who, in turn, may invest resources in the supplier. These investments bind the firms to one another and make it difficult for outside firms to compete for available profits in the industry.12 Although the importance of relationship-specific investment has been extensively documented in the Japanese case, there is reason to believe that these types of inter-firm relationships are pervasive in East Asia. For example, the emphasis Chinese business places on connections (known as guangxi in Mandarin) derives, in part, from the need to establish trust in business relationships. This implies that the cost of switching relationships is high and serves as an advantage to firms that initially establish business partnerships there. In general, firstmovers are at an advantage whenever there are irreversible costs to establishing business, regardless of whether they are costs to build trust, distribution networks or local knowledge. If these upfront costs are large, only a limited number of firms may be able to conduct business successfully in the market. Furthermore, reforms in China and Vietnam may have created a brief window of opportunity for outsider firms to establish long-run relationships with local enterprises who have not yet found adequate suppliers or distributors. Economies of scale Economies of scale also have the potential to generate long-run rents to first-movers. Static scale economies exist when average costs fall as volume increases. High fixed costs, such as those for research and development, plant and equipment or distribution networks, are often the source of static scale economies. In his paper later in this volume, Rapp identifies software and biotechnology, two industries 12

28

Ries (1993) shows that the voluntary export restraints on Japanese passenge cars instituted in 1981 increased the profits of Japanese auto makers and many of their parts suppliers. The relationship-specific investments that char acterized the industry arguably prevented the auto makers from expropriating the full amount of the windfall profits.

Keith Head and John Ries

where Canadian firms are arguably internationally competitive, as characterized by static scale economies because they have high development costs and low reproduction costs. Infrastructure projects are also subject to economies of scale.13 When learning effects are present, average costs fall as experience accumulates. These are called dynamic scale economies. They confer advantages on first-movers because they have a head start over rivals in the race to move down the learning curve.14 Some people argue that companies cannot be world competitors if they do not sell into important emerging markets. For instance, the chairman of AT&T China, William Warwick, declared, "The choices of US companies are stark. Either we establish a major presence in the China market or we forget about being a global player, forget even about being able to defend our home market." (Asian Business, September 1994) Both high volume and experience may translate into low costs for firms. And large-scale entry by Canadian firms may be less difficult in growth markets than in mature markets. There would appear, however, to be limited opportunities to achieve dramatic static or dynamic scale economies through expansion into East Asian markets. To start, plant-level static scale economies in most industries would appear to be exhausted at relatively low levels of output. Any Canadian firms that sell to the North American market are likely to be operating at an efficient scale already. Moreover, expansion into East Asia likely means replicating fixed investments in advertising, distribution and customer service, thereby dissipating static scale effects. Research and development appear to be the most likely fixed costs to be prorated over greater volume with expansion to East Asian markets. Even so, it might be necessary to replicate these costs to some extent to tailor products to local market conditions. As for dynamic 13

In a later section, we examine the opportunities for Canadian firms presented by infrastructure investment in Asia.

14

For an empirical examination of an industry where import protection was used to make up for a late start down the learning curve, see Head (1994).

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learning economies, production for the North American market would achieve most available learning economies, while the learning derived from producing in Asia would tend to yield region-specific lessons. Even if barriers to entry are imperfect, temporary rents to "pioneers" may still yield significant economic gains. East Asian economies, as reflected by economic growth, are extremely dynamic, with constantly increasing demand for goods and services. This implies that new market opportunities continuously arise for entrepreneurial firms. While long-run entry may eventually reduce profits to zero, short-run rents may be substantial, resulting in gain for firms positioned to sell into Asian growth markets. Each of these arguments supports early entry into East Asian markets as a means to secure economic rents. This entry might necessitate foreign direct investment which is not a strategy frequently employed by Canadian companies in East Asia. Firms invest abroad when local production offers more advantages than serving markets through export or licensing arrangements.15 These advantages may include lowering transportation costs, circumventing trade barriers or accessing low-cost inputs of production. Since import barriers remain high in many East Asian countries while labour is relatively inexpensive, there may be a strong case for local production in the region. A local presence may also enhance a firm's ability to adapt its product and business practices to rapidly changing local demand conditions and government regulations. Company performance shows some evidence that direct investment is an effective strategy for reaching foreign markets. First, researchers have identified a positive correlation between direct investment flows abroad and export levels.16 If, for reasons suggested above, rents are earned on exports to East Asia, then this correlation is consistent with direct investment abroad conferring welfare gains to

30

13

These remarks reflect a large literature on why firms invest abroad rather than simply exporting or licensing to foreign companies. For details see, for example, Dunning (1993).

16

This relationship is established for Canadian firms by Rao, Legault and Ahmad (1994), for US firms by Encarnation (1992) and Bergsten and Graham (1994), and for Swedish firms by Blomstrom, Lipsey and Kulchyck (1988). Keith Head and John Ries

home country firms. Research has shown that firms that engage in direct investment tend to have better performance in terms of returns on sales.17 However, there is an important caveat. Firms that invest likely have high levels of exports and strong economic performances simply because they are strong firms. Thus, it may be incorrect to interpret the correlations noted above as indicating that direct investment generates additional exports and profits. When rents are available, Canadian firms should recognize opportunities to profit from engaging in business in East Asia. Thus the relative lack of Canadian business presence points to the absence of profitable opportunities. The homogeneous, resource-based products that Canada sells to East Asia are unlikely sources of rents. Nor is it probable that Canadian firms would need to establish a local market presence in Asia to better sell these kinds of goods. The existence of externalities from positive spillovers of the business activities of Canadian firms in East Asia, however, may offer additional motivation for redirecting trade towards Asia. At first glance, such an argument seems doubtful. Many, but not all, East Asian economies lack natural resources and are likely to import them from countries like Canada. In addition, we tend not to think of natural resources industries as externality generators. Yet it is possible to see some potential for spillovers. For example, bilateral trade and investment linkages, such as local market knowledge, may lower transaction costs of future market entry by other Canadian firms in East Asia. Thus trade linkages or the local presence of Canadian firms in Asian markets resulting from direct investment may serve as a conduit through which other Canadian firms learn about local market conditions and opportunities. Second, one Canadian firm's successful entry into an East Asian market will enhance the reputation of Canadian firms in general as providers of high quality goods. 17

Ries and Head (1994) establish this for Japanese companies while an earlier work of Daniels and Bracker (1989) detects this relationship for US firms.

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In the presence of externalities, associated with either direct investment or trade, Canada may fail to realize latent competitive advantages in selling to Asia. The idea is similar to the "coordination game" referred to by theorists. If many Canadian firms reorient themselves towards Asia, their costs of trading with Asia could collectively fall below the levels that prevail when only a small percent of Canada's firms do so. When spillover benefits are large, it is worth the government's while to subsidize the pioneering investors. The problem with applying that argument to this situation is that many spillovers will be difficult to confine to Canadian firms. Correspondingly, spillovers from pioneering activity by US firms may benefit Canadians as, for example, Head and Ries (1995) identify in relation to foreign investment in China. Articles in Business China (June 1990, October 1989) and East Asian Executive Reports (May 1990) had identified component supply problems as one of the chief headaches of foreign joint ventures in that country. The articles explained that local firms were unwilling to make the effort to upgrade quality to the levels required by foreign firms as long as there were few foreign firms in an area. Some firms had responded by pooling orders for parts or by accepting higher land and labour costs to be closer to Shanghai- or Hong Kong-based parts suppliers. Based on this anecdotal information, we proposed that, as foreign firms enter China, they stimulate the development of local suppliers of high quality intermediate inputs. Firms arriving later in a city benefit from the strong base of Chinese suppliers already established there by the early entrants. Our hypothesis was supported in the statistical analysis. For a given set of economic attributes (wages, taxes, etc.), investors were much more likely to choose cities with large amounts of prior foreign investment over other locations. When investors cannot appropriate all the returns, it may be preferable to let other countries develop the linkages necessary for trading and investing in a region and then free ride on their investments. We refer to cases such as this as "second-mover" advantages. When these advantages exceed first-mover advantages, "follower" strategies may reflect good business sense, rather than some irrational fear of new environments. One final consideration is the business implications of Canada's 32

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large population of Asian immigrants. They represent a valuable asset for establishing trade and investment links in Asia because of their knowledge of home country markets, language skills and business contacts. Gould (1994) shows that the pattern of immigration in the United States exerts a strong influence on US bilateral trade flows, with immigrant populations accounting for greater increases in exports than imports. This finding implies that they contribute to trade surpluses. For example, Gould estimated that an additional immigrant from Singapore over time would increase US exports to Singapore by $47,708, while increasing imports by only $29,395. Figure 6 portrays the ethnic composition of Canadian immigration flows from 1989-1993. Immigrants from Asian countries represent almost half of the 1.1 million immigrants coming to Canada over this period. Since Canadian exports to East Asia were stagnant during this .

Figure 6: Immigration to Canada, by country of origin 1989-93

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period, it appears that, in contrast with the US experience, immigrant links have not generated additional exports. One important implication is that Canada may be underutilizing this asset.18

Infrastructure opportunities in East Asia A recent prediction of East Asia's infrastructure requirements estimates expenditures of as much as $1.9 trillion by the year 2000. This prediction, cited in Business Week (November 28, 1994), is based on data from the Peregrine Asian Infrastructure Fund. The major component, especially in China, will be transportation infrastructure ($1.3 trillion), with power ($206 billion) and telecom ($89 billion) investment as the other major categories. Among the biggest projects are nuclear power plants to be constructed in Korea, Taiwan and China. Major new airports in Hong Kong and Bangkok will cost billions of dollars. Whatever the validity of these estimates, Asia's infrastructure boom is significant for Canada in two ways. First, some of Canada's largest multinationals, such as Northern Telecom and Bombardier (rail cars, small aircraft), are primarily infrastructure suppliers. If the number of phone lines per person in China rose to just half the ratio in Canada, it would mean sales of over 300 million new lines. As the Chinese population continues to migrate into the major cities, congestion problems will require massive investment in urban transit. Cities that are barely known in the West, such as Chongqing and Chengdu, have populations of over 10 million. One Canadian company, Dominion Bridge, has already signed contracts to provide Chengdu with a subway and an expressway. The second attractive aspect of the Asian infrastructure boom is that the local suppliers (with the exception of Japan) are significantly

18

34

One may expect skilled immigrants to contribute more to trade flows than unskilled immigrants since they are likely to have the human capital necessary to conduct trade in Asia. Since Canadian immigration policy has recently been changed to increase the business class category, this may be a benefit in the long run. Gould, however, did not find a statistical relationship between trade and the skill mix of immigrants.

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less advanced than Canadian-based firms. Since foreign firms are often at a disadvantage in competing with domestic firms for infrastructure contracts, the absence of strong domestic incumbents may level the playing field. But will Canadian firms be able to obtain rents (as we have defined them) from infrastructure contracts in Asia? Arguments in favour of this include the scale economies that characterize a large power or city transit project and make it a natural monopoly. Further, there is an asymmetry of information. Canadian firms know how much it costs them to provide the project. The Asian government at best only knows the cost of doing the project with domestic contractors. This may leave room for a substantial margin. Unfortunately, these advantages may be undermined. As the saying goes, "there's many a slip between the cup and the lip." The first problem is that the negotiations prior to the signing of contracts are long and delicate. Dominion Bridge's (DB) deal nearly collapsed, according to the Globe and Mail, because of an oversight in the invitation list for a final meeting between the company and Chengdu city officials. The mistake was caught in time because DB had employed two business agents as facilitators. Nevertheless, the incident points to the extra costs of doing business in an unfamiliar environment where special rules of business etiquette apply.19 The second problem is that competitors from Japan, Europe and the US are all equally eager to win major contracts. For instance, while the Chinese government awarded contracts worth $2.4 billion to Atomic Energy of Canada for two Candu nuclear reactors, the French company Framatone secured a $5 billion contract around the same time. China has also sought out multiple suppliers in the telecommunications area. While this action is probably a deliberate bargaining 19

The business press is replete with stories about the importance of connections in Asian and particularly Chinese business transactions. Another point made in several articles is that one of the costs of doing business in China is stress on the liver. Drinking at banquets and karaoke bars—where it is essential to match the host's speed and volume—establishes "bonds" that facilitate agreements between the Western firm and the Chinese purchaser.

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strategy, it also reflects the increasing decentralization of infrastructure investment decisions in China. The third obstacle in the pursuit of rents has been a recent Chinese policy to limit foreign investors' rates of returns to 12 percent. The justification offered is that this return is equivalent to that offered in the United States and Europe. This ignores the pre-contract business costs and the post-contract uncertainties. As an example of the latter, Gordon Wu, a Hong Kongbased contractor, was promised a substantial bonus for early completion of a highway between Shenzhen and Guangzhou. Due to delays that he claimed were caused by the refusal of local officials to turn over land, the deadline was not met and the bonus reportedly was lost (Economist, July 23, 1994). Other types of uncertainty, that raise the risk for the infrastructure contractor, include high and variable inflation rates, exchange rate volatility, political risk and the difficulty of enforcing contracts in a country with a relatively undeveloped legal framework. While all of these sources of risk are most prominent in China, they are also present in other developing East Asian economies. If the infrastructure provider can find a way to insure against worstcase scenarios, 12 percent might still be an attractive rate of return for a large project. Otherwise, the foreign firm might be better off holding out for a risk-adjusted return. A final barrier to sustained rents in East Asia arises from domestic learning. While the Chinese allow foreign firms to own a majority of the stock in infrastructure ventures, a local Chinese partner is an almost inevitable requirement. In the short run, local expertise and connections are extremely valuable. However, as many foreign firms have realized, joint ventures tend to create future competitors. As Don Hackl, a Chicago architect working in Shenzhen, commented in Business Week, "All of us working in China realize we are probably working ourselves out of future opportunities as the Chinese obtain the experience." This threat arises in association with the Candu nuclear reactor deal. In addition to installing 40 gigawatts of new nuclear power over next two decades, China would like to become a major exporter of nuclear technology to other developing nations (Globe and Mail, November 28, 1994). A 1993 Sino-US agreement inhibits China from exporting US technology to countries like Iran

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and North Korea. Perhaps for this reason, China has sought out non-US sources such as Canada. Although this may yield a short-run benefit, in the long run Canada may gain a competitor in selling to other developing countries.

Conclusion In this paper we have examined Canada's economic activities and reviewed economic arguments for increasing the Canadian business presence in East Asia. The data reveal that East Asian economies currently import small amounts of Canadian goods. Canadian merchandise exports to East Asia comprise only 8.2 percent of Canada's total exports and account for just 1.7 percent of the region's total imports. Since peaking in 1988, Canadian exports to East Asia have fallen in spite of overall Canadian export growth and large increases in total imports by those countries. Canadian direct investment in the region is also small, generally no more than 1 percent of total foreign direct investment in the East Asian countries. Canadian sales of business services to the region, while small relative to merchandise trade, have been increasing in the past few years and may be an important source of increased Canadian business activity in East Asia in the future. Canada's potential gain from redirecting its economic activities towards East Asian markets depends on the existence of economic rents associated with business there. High rent industries are those where barriers to entry limit competition. These barriers may be a result of government regulation or may emerge as an outcome of firm strategies. Network externalities, consumer brand recognition, relationship-specific investments and scale economies can give rise to first-mover advantages allowing early entrants to enjoy sustained market share and profitability. Canadian exports to the region, however, are largely homogeneous, resource-based products which are not generally associated with above average returns. Thus, it seems unlikely that increasing existing Canadian-East Asian business activities will improve Canadian welfare. Canada may, of course, alter the commodity composition of its exports to the region. In particular, it may emphasize the export of business services. Canada's strength in many infrastructure industries, combined with the boom in Asian investment in transport, power and telecom Canada's business presence in East Asia

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equipment, presents an attractive opportunity. Canadian firms must overcome many obstacles, however, before they can reap sustained rents from infrastructure projects in Asia. Unfortunately, the cost of surmounting such problems appears highest in China, the country with the largest market potential. Many commentators presume that Canada's lack of significant presence in Asia reflects fear or laziness on the part of Canadian firms. One message of this paper, therefore, is that true economic rents may simply be scarce in Asian markets because of strong competition and significant impediments to the sale of foreign goods. If profitable opportunities in East Asia were plentiful, it is probable that Canadian firms—which export successfully to the United States and Europe— would be exploiting them already. Thus, limited Canadian activity in East Asia might simply reflect a scarcity of opportunities. It seems likely that the costs of doing business in Asia will fall as those economies develop and become more similar to the industrialized economies in which Canadian firms are more accustomed to selling. One crucial question, therefore, is whether it is important for Canadian firms to establish themselves in Asia now, or whether they can afford to wait for business costs to decline. The answer undoubtedly varies across countries and industries, depending on the magnitude of first- and second-mover advantages. Despite all the caveats, there are at least two reasons why current levels of Canadian business in Asia may be too small even if, individually, Canadian firms are making the correct decision by avoiding these markets. First, if there are positive externalities associated with either trade or investment in East Asia, these advantages will be under-provided by the free market and the Canadian government may want to intervene to redirect business activity there. Second, Canadian firms may lack sufficient information about profitable opportunities. This deficiency would provide the scope for developing mechanisms to furnish such information. The other papers in this volume, as well as those in future volumes, will serve to bridge this information gap.

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References Aoki, M. 1988. Information, Incentives and Bargaining in the Japanese Economy. Cambridge: Cambridge University Press. Bergsten, C. Fred and Edward M. Graham. 1995. Global Corporations and National Governments: Are Changes Needed in the International Economic and Political Order in Light of the Globalization of Business. Washington DC: Institute for International Economies. Blomstrom, M., R.E. Lipsey and K. Kulchyk. 1988. "US and Swedish Direct Investment and Exports". In Robert E. Baldwin, ed. Trade Policy Issues and Empirical Analysis. Chicago: University of Chicago Press for the National Bureau of Economic Research. Bowker, Marjorie. 1988. "What Will the Free Trade Agreement Mean to You and to Canada? An independent analysis based on the Actual Text of the Canada/US Free Trade Agreement." Ottawa: PRINT 2000: mimeo. Copeland, Brian. 1988. "Of Mice and Elephants: The Canada-US Free Trade Agreement." University of British Columbia Department of Economics Discussion Paper No. 88-16. Daniels, J.D. and J. Bracker. 1989. "Profit Performance: Do Foreign Operations Make a Difference?" Management International Review. 29:46-55. Dunning, John. 1993. Multinational Enterprises and the Global Economy. Workingham, England: Addison-Wesley Publishing Company. Encarnation, Dennis. 1992. Rivals Beyond Trade: America vs Japan in Global Competition. Ithaca and London: Cornell University Press. Frankel, Jeffrey A. 1993- "Is Japan Creating a Yen Bloc in East Asia and the Pacific?" In Jeffrey A. Frankel and Miles Kahler, eds. Regionalism and Rivalry: Japan and the United States in Pacific Asia, A National Bureau of Economic Research Conference Report. Chicago: University of Chicago Press.

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Gomez-Cassares, Benjamin. 1993. Harvard Business School case #9390-021. Cambridge: Harvard Business School. Gould, David M. 1994. "Immigration Links to the Home Country: Empirical Implications for US Bilateral Trade Flows." Review of Economics and Statistics. 302-316. Head, Keith. 1994. "Infant Industry Protection in the Steel Rail Industry." Journal of International Economics. V: 37 and John C. Ries. 1995. Forthcoming. "Inter-City Competition for Foreign Investment: Dynamic and Static Effects of China's Incentive Areas." Journal of Urban Economics. Hill, Hal. 1994. "Australia's Asia-Pacific Connection." Paper presented at the conference Pacific Trade and Investment: Options for the 1990s. June 6-8, Toronto. Lifson, Thomas. 1983. "What Do Japanese Corporate Customers Want? A Guide to American Firms Selling to Japan." In Annual Review. Cambridge, MA: Program in US Japan Relations. Cambridge: Harvard University. McLaren, John. 1994. "Size, Sunk Costs, and Judge Bowker's Objection to Free Trade." New York: Columbia University: mimeo. Rao, Someshwar, Marc Legault and Ashfaq Ahmad. 1994. "CanadianBased Multinationals: An Analysis of Activities and Performance." In S. Globerman, ed. Canadian-Based Multinationals. Calgary: University of Calgary Press. Ries, John. 1993. "Windfall Profits and Vertical Relationships: Who Gained in the Japanese Auto Industry From VERs?" Journal of Industrial Economics. XLI: 259-276. and Keith Head. 1994. "Causes and Consequences of Japanese Direct Investment Abroad." In S. Globerman, ed. CanadianBased Multinationals. Calgary: University of Calgary Press. United Nations Conference on Trade and Development. 1994. World Investment Report. New York and Geneva: United Nations. World Bank. 1993. Global Economic Prospects and the Developing Countries. 66. Washington DC: The World Bank.

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Keith Head and John Ries

Capturing Japan's attention: Canada's evolving economic relationship with Japan William V. Rapp

Introduction In this paper, we place Canada's evolving relationship with Japan in the context of the strategic development of large Japanese firms and their changing interest in the Canadian economy. Understanding this strategic development helps to explain why even very early reports on the Canada-Japan economic relationship (Hay, 1972) strongly reflected the nature of Canada's raw material, food and energy bias, but only noted the potential opportunities in areas like software. We look at why this situation has not changed, and discuss some of the options available to Canadians to alter the structure of the relationship, given current and future Japanese corporate goals and strategies and Canada's economic strengths and weaknesses. In 1965, approximately 98 percent of Canada's exports to Japan were food, energy or raw materials. Many Canadian observers and policy makers expected this export share to drop over time as Canada added more value and shifted to new industries and services. But almost thirty years later, the "rocks, food and materials" export ratio to Japan had only declined to about 93 percent (Canada-Japan Trade Council, 1994), compared to a comparable share of raw materials in US exports to Japan of only 48 percent. Although both the Japanese and Canadian economies had advanced significantly, Canada's interface with Japan by the early 1990s appeared to be stuck in the 1960s and 41

70s. In 1993, exports of energy and raw materials accounted for only 44 percent of Canada's total exports; the comparable US ratio was 30 percent. While US-Japanese exports have been somewhat skewed towards food, raw materials and intermediate products, Canadian exports to Japan have been overwhelmingly so, even though more than 15 percent of Canada's total exports are high technology products (Smith, 1991), up from 10 percent in 1987 (Statistics Canada, 1988). In examining this situation from a Japanese perspective, these results are not so surprising. Japanese energy, raw material and food processing firms are not growing. If 1990 is 100, an index measuring growth in the steel industry would have dropped by 1993 to 89, in non-ferrous metals to 98, in fabricated metal products to 93, in non-metallic minerals to 91, and in pulp and paper to 99- Food and tobacco would have remained at 100 (JEI, 1994). The primary goal of Japanese firms is continued corporate existence and employment. They therefore will not increase value-added in Canada when this would mean unemployment in Japan. Since Japanese plants are fully depreciated, they can maintain competitiveness through additional investment even though the returns are only marginal in these negative-growth industries. In addition, experience indicates that raw material resources over time are subject to depletion and increased cost. Japanese firms are seeking to maintain the flexibility to shift the sources of procurement. Without legal compulsion, there is little likelihood Japanese firms will increase their value-added processing in these sectors despite Canadian exhortations (McMillan, 1989; CanadaJapan Trade Council, 1990). Because these Japanese industries are under continued economic pressure, there is little incentive for them to shift the nature of their relationship from long-term trading contracts to foreign direct investment (FDI). This is probably one reason why Japanese FDI in Canada has remained quite low compared to investment in the United States or Europe, even though Japanese firms have expanded their activities in the United States (Rugman, 1990). Indeed, as of March 31, 1994, total Japanese FDI in the United States was US$177 billion compared to $7.8 billion in Canada and $2.2 billion in Mexico (JEI, 1994). Total FDI in the United States was about equal to Japan's total US trade in 1993 of $160 billion, while Canada's two-way trade of about 42

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US$14 billion was roughly twice the value of investment received from Japan. There appears to be some statistical basis for the claim that Canada is not receiving its share of Japan's investment and economic attention (Canada-Japan Trade Council, 1990). Economic considerations, rather than fairness, ultimately determine inward investment flows. Canadian policy makers should therefore think seriously about the relative disparity in economic attention indicated by these data, especially in light of Japan's current and evolving economic structure. Japanese trade and FDI are actually extensions of the competitive behaviour and strategic orientation of Japanese firms. These rarely have any relationship to the desires of a host country like Canada. It therefore appears that more direct investment will be destined for Canada only if Canada's policies shift in a direction that is more congruent with the business interests of Japanese firms. Japanese multinationals (MNCs) have three major international business interests. First, they seek to develop low-cost manufacturing of labour-intensive standard technology products in Asian countries. This will help to improve their global competitiveness and ensure access to these emerging high-growth markets. Second, they seek to retain and improve market share in autos, auto parts and consumer electronics in their major North American and European markets, building on existing investments (Rapp, 1993). Third, they seek access to new technologies and products that enhance competitiveness or can be introduced as shinhatsubai (new products) either in Japan or the global market (Rapp, 1993). These interests include software and biotechnology—areas in which Japanese firms are relatively weak. Understanding these strategic motivations is critical to influencing Canada's current economic interaction with Japan. Without any shared security interests or larger global connection, the relationship between the two countries is determined primarily by two-way trade and direct investment. Canadian investment in Japan is small and Japanese portfolio investment, which was fully hedged after 1985 to avoid large exchange losses, subsequently declined sharply after the asset bubble burst in 1990 (Wright, 1994). Portfolio investment is in any case inherently transitory and subject to the vagaries of the market and investor preferences, so it does not represent a long-term Capturing Japan's attention

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commitment to Canada and does little to define the relationship over the longer term. The same reasoning applies to contractual relationships which have a finite life. The strategic relationship revolves instead around flows of more permanent trade relationships and direct investment. These have been largely driven by three major influences: Japan's level of economic development when Canada's relationship with Japan was most dynamic; Japan's constantly evolving economic structure and relationships with the United States and other nations, especially Asian; and, perhaps least recognized, Canada's experience in managing relationships with economically powerful nations like the United States and Britain. Gaining an understanding of the first two influences requires some appreciation of Japan's competitive development and the emerging global strategies of its multinational corporations (MNCs). MNCs are responsible for most trade and investment, and are the organizations with which Canadian companies and policy makers chiefly interact. The trade and FDI strategies of MNCs reflect both their administrative heritage and their current competitive environment, which is global rather than bilateral. The global strategic behaviour of Japanese MNCs in Canada and other countries is a logical consequence of their experience managing the interaction of product cycles, their lower cost expectations based on continuous improvement, and their industry's evolutionary and competitive development. It is true that the direct investments of Japanese MNCs have grown rapidly over the last fifteen years (Komiya, 1987; Okumura, 1989; Komiya and Wakasugi, 1991). However, so did their international trade in the years before that, and one is a direct extension of the other. Once the domestic market was saturated with a product, they began to export it (Porter, 1990). Then, having established an international presence, they started servicing customers better, hedging exchange risks, and extending sales opportunities. Finally, they invested in productive capacity or acquired foreign companies, in response to actual or potential import barriers or the need to acquire new skills and technologies. Throughout this evolutionary process, MNCs were constantly aware of their administrative heritage and long-term strategic objectives. Sony's acquisition of CBS Records and Columbia Pictures, for example, was driven by its earlier experience with Betamax, where the 44

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system was ultimately rejected in favour of the VHS format because of insufficient software support. Sony could not afford a similar experience in 1 3/4" CD or 8mm video, so it purchased major software producers with extensive libraries and cross-licensing arrangements. Then Matsushita responded with an acquisition of MCA, and Toshiba tied up Time-Warner, since neither company wanted Sony to have a market advantage they could not match. Matsushita has only recently perceived Sony's strategy as less of a threat, and this, combined with MCA's management difficulties, has prompted them to divest 80 percent of MCA. Some of the reasons for this competitive compulsion are analyzed in this paper and are covered in more detail in other studies (Ohmae, 1991; Rapp, 1992; Yoshino, 1968). Situations like these make it clear that the trade and FDI of Japanese MNCs have been heavily influenced by domestic competitors. The motivations of MNCs often have less to do with extending profit opportunities for new technologies than with a concern for protecting global market share, maintaining low cost production, and ensuring firm survival (Porter, 1992; Rapp, 1992). As Japanese MNCs continue to adapt to pressures and changes in their economic and political environment, it is expected that their future decisions will represent similar responses. Their behaviour toward Canada will be determined by how they perceive Canada's contribution to the achievement of their strategic objectives within this dynamic context. If Canada or Canadian firms wish to participate in and benefit from this evolving situation, they must position themselves to capture the attention of Japanese firms. This is a radically new situation for Canada. In the past, Canada has been courted by offshore interests. Now, because of the growing weakness of the Japanese government relative to its corporate giants, Canada can rely less on diplomatic ties.

The emerging motivations of Japanese MNCs in a global context Canadian firms and policy makers who wish to position themselves competitively relative to Japan's evolving economic structure must understand the pressures and considerations that will affect the decision-making of Japanese MNCs in the future.

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Corporate existence Corporate existence remains the primary organizational goal. Companies must ensure the survival and benefits of their senior executives, and their lifelong commitment to the firm, customers, employees, suppliers, and banks. Alternative employment for top managers is limited, so they are more concerned with ensuring the firm's continuous wage stream than with maximizing corporate profits (Rapp, 1992; Porter, 1992; Fruin, 1992). To achieve this goal, managers must protect the firm against the effects of further yen appreciation, and prevent shifts in production of major products towards developing countries. They must also offset persistent US protectionist pressures by reducing the bilateral deficit. For most companies, the task of maintaining corporate competitiveness will be complicated as an aging labour force and low birth rates, combined with continued corporate growth, will make Japanese labour shortages acute, especially for technical personnel. At the same time, in many raw material processing industries, where slow or no growth is limiting productivity improvement, maintaining employment will be difficult. Technology upgrading Constant upgrading of technology within industries (intra-industry technology) will be necessary to meet competitive pressures from Japanese and foreign competitors, and to meet customer demand for quality improvement (Imai, 1986; Abegglen and Stalk, 1985). Some upgrading will depend, as it has throughout the post-war period, on continued access to more advanced global technology. Upgrading is also a way to counter the shift in competitiveness towards developing countries, and to deal with cost pressures due to labour shortages, slow growth and a stronger yen. Intense domestic competition leading to "band wagons" Japanese producers within each industry face similar external environments, and managers have similar backgrounds. There is a tendency, therefore, for most competitors to follow the leading Japanese firm. For FDI in mature markets like raw materials processing, autos or consumer electronics in the United States and Europe, this can lead to 46

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overcapacity and "excessive competition" (Ohmae, 1991). But since government action usually preserves market share, being the most aggressive investor domestically and overseas, as well as the lowest cost producer, remain the best strategies (Rapp, 1992). Overcapacity and excessive competition in these global markets are likely, which will force Japanese firms to increase productivity and remain low cost producers. Controlling technology transfers Controlling technology transfers to the industrializing economies is one way to achieve these objectives. The industrializing economies in turn will try to emulate Japan and develop global competitors who will evolve with the product cycle. This process is a logical outcome of Vernon's original product cycle model (1966), which describes the systematic shift in comparative advantage for a new product from its introduction by a developed country, such as the United States, to a first-follower such as Japan, to subsequent followers like Taiwan, Korea or China. The model was extended by Krugman (1979) to show that the original innovator can maintain its trade advantage by constant, rather than one-shot, innovation. The Vernon-Krugman argument stresses constant product innovation as the driving and dynamic motivation for shifts in the comparative advantage and in the product cycles of western firms. Japan and other followers become competitive through technology transfer and lower labour costs. In their models, however, there is no mention of the role of process innovation. Japan's improved terms of trade, yen appreciation, and Japan's ability to remain competitive despite wages that are now higher than many Western competitors cannot be explained without considering process innovation. Controlling the transfer of process innovation though FDI is central to Japan's management of the product cycle. This ability, which relies heavily on tacit knowledge and improvements in organizational structure (Nelson and Winter, 1982; Florida and Kenney, 1991) provides the key to both the strategic intent and global competitiveness of Japanese firms. Unlike product technology, which can be copied by a follower country once it is seen, process technology requires the active participation of the developer. And since process Capturing Japan's attention

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innovation can usually proceed at a more rapid pace than product innovation, a logical extension of the Krugman hypothesis is that successful process innovators will attract capital and improve their terms of trade, leading by extension to currency appreciation. These theoretical outcomes are all consistent with Japan's actual development. Saturated markets The Japanese market is fairly well saturated for many established products, but Japan's demanding customers make it a large and important market to control for companies introducing product innovations from abroad. By supplying this market, Japanese firms are able to apply and develop the process innovations that give them their competitive advantage before transferring this expertise to their foreign affiliates. To maintain a competitive position, however, the Japanese market in such mature industries must always be supplemented by overseas sales. Maintaining or growing market share domestically and abroad therefore remains an important strategic objective, especially as European and North American markets become more closely integrated. Japanese MNCs must participate in these large, wealthy, advanced markets to be globally competitive, especially if their customers and competitors are moving in this direction. FDI, therefore, is a key element in their corporate strategies, along with strategic alliances. Little political interference Japanese MNCs pursue their strategies with little domestic political interference because the Japanese government has no clear economic goals and has been hurt by various recent political and financial scandals. The government's ability to exercise authority over the MNCs outside Japan is weak. Managing the trade and FDI process, therefore, is likely to be left to the companies, competitors and foreign governments. Lack of policy congruence Japan's major challenge is to meet growing transfer payments to an aging population. The government wants to develop successful 48

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advanced industries like software, aerospace, supercomputers, biotechnology and telecommunications, through continual "inter-industry" rather than "intra-industry" development. The MNCs, however, have little desire to phase out their existing businesses since this could threaten their corporate existence. They will resist policies that transfer resources from established industries like consumer electronics, automobiles and steel, to fields like aerospace. This lack of policy congruence is new, and will lead to more independent action by the MNCs that may affect trade and FDI. Their actions will be reinforced by the competitive advantage Japanese firms have in process innovation, since this advantage is dependent on their unique productspecific organizations and production systems—things that are not always easily adapted to totally new product areas. Given these considerations, it is logical for large Japanese MNCs to try to manage the product cycle. Since FDI and trade will become increasingly important strategic activities within the cycle, Japanese FDI must be seen as part of a total corporate system for creating and maintaining competitive advantage that will ensure corporate existence through constant investment and productivity improvements. The steel industry is one example of such a strategy. Japanese steel producers have invested in US steel companies and upgraded their process technology and capital stock to supply Japanese auto companies. This has made them and the US firms less vulnerable to other offshore competition. And since Japanese auto companies use higher quality steels, such as very thin light weight one-sided zinc coated sheets, this forces US auto producers to improve quality, too. But the product is only available from Japanese-affiliated US firms, so offshore producers are denied markets they might otherwise have captured through the traditional product cycle evolution, as the US industry matured and its firms became less competitive. This strategy has obvious implications for Canadian steel producers. It also illustrates the impact of process innovation: the firm was able to control its transfer of technology by modifying the traditional product cycle, instead of waiting for competitive advantage to evolve to the second- and third-level followers. It is not necessary to review Japan's entire postwar economic performance to fully appreciate the reasons for and motivations behind Capturing Japan's attention

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these strategies. It is important, however, to recognize the role that product cycles have played within Japan's industrial development, and to appreciate direct investment's place within these cycles. Historically, Japanese industries and firms have been followers and imitators. Japan first produced and exported simple manufactures and primary commodities such as copper and raw silk. Then growth and development improved technical production capabilities and generated demand for more advanced products, initially cotton textiles and then machinery, steel, shipbuilding, automobiles, integrated circuits and computers. Since more advanced industries were frequently capital intensive, growth and capital accumulation created conditions that shifted factors of production in directions that improved Japan's economic development, even though, overall, Japan lagged behind similar developments in advanced industrial countries (Akamatsu, 1962; Vernon, 1966; Rapp, 1967).

FDI's place in the product cycle In this follower pattern of industrial development, products were first imported from the more advanced countries where they originated. When domestic demand developed further, the government protected the industry. As the local market became saturated, the industry grew and began to export (Porter, 1990), and producers became more efficient. Japan was assisted in this evolution, because firms in the more advanced countries simultaneously became less competitive in these follower industries as their economies grew, capital increased and wages rose. At the same time, they were moving into more advanced industries and into products that were more in demand, for which they had the production factors, and that justified higher wages. Since their industries were usually more technically sophisticated and capital intensive, their economies were innovating and creating the demand, technology, and capital required to competitively develop these higher value-added industries. This growth and development, generated by the creative destruction of old industries and the introduction of new ones (Schumpeter, 1947) is entirely consistent with the Vernon-Krugman model. Once the new technology was known, the cost of transfer declined, which helped followers like Japan. Once they become globally 50

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competitive, Japan exported first to developing countries that wanted to develop a specific industry, and where they were likely to face relatively equal competition from advanced countries. These markets also tended to be price sensitive, so aggressive pricing strategies by followers like Japan could overcome quality or service problems. After they built their export experience, reduced their costs even further and increased quality, Japanese firms began to export to the more advanced markets. The industries were usually mature in these markets, and many of the targeted products were produced in high volumes. Price competition was again a good entry strategy. As the Japanese economy developed, its own labour-intensive, lower value-added industries became subject to similar competitive pressures from followers like Taiwan and Korea who, in turn, have experienced their own shifts in competitive advantage to countries like China and India. This classic international product cycle was first observed in an analysis of Japan's cotton textile industry and the corresponding decline of the industry in countries like the United States and the United Kingdom (Akamatsu, 1962). This industrial and trade development pattern involved several stages: building domestic markets by importing from advanced countries; producing domestically to substitute for those imports; exporting to developing countries; exporting to more advanced markets; and, finally, importing from less developed countries. FDI usually emerged in the later stages, when exporting to advanced countries or when importing from the developing countries where producers were often Japanese-owned. This situation appeared in the 1970s in the textiles industry, when FDI was used to maintain export competitiveness to advanced markets, and for imports back to Japan (Ozawa, 1979). The import substitution stage has usually been the high-growth period. By the initial export stage, domestic growth was often declining, motivating firms to export. By the later export stage, the demand from Japan and the advanced country was usually mature, so that gains in global market share became more of a zero sum game. Yet exports also became a larger part of total production (Abegglen and Rapp, 1972; JEI, 1991). This meant that burgeoning Japanese export competition would cause political pressures from the affected Capturing Japan's attention

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countries— stimulating Japanese FDI to leap protectionist barriers and preserve their market presence. For this reason, Japan's MNCs have used direct investment at a much later stage in the product cycle than US producers. The latter have sought primarily to capture new markets and profits for their innovations. For the Japanese, the markets exist and the products are not new. Once these FDI infrastructures were in place, Japanese firms, like the US producers (Vernon and Wells, 1991), could then introduce or produce products in those locations as well as in Japan, collapsing the evolutionary process and changing the nature of global competition. Depending on the industry and Japan's domestic growth rate, this industrial development sequence could take twenty to forty years. But because Japan has been changing its ability to produce and use advanced technologies, at any given time the industry mix has been at different stages. For example, while the cotton textile industry was declining, the synthetic textile industry could be investing abroad, the steel industry exporting successfully to several countries, the auto industry starting to export, semiconductors beginning production, and the aerospace industry importing. This profile would, for example, describe Japan's structure in the late 1960s fairly well. That was also the period in which Japan started to become interested in Canada as a major raw material supplier to its growing raw material processing industries. World War II played a role in this evolutionary process by determining Japan's administrative heritage as a leading process technology innovator. The war set Japan's economy back about twenty years, so that even existing industries repeated the evolutionary pattern in a short interval during the period immediately after the war. Managers in all industries—even in traditional ones like textiles and steel—became aware of the effect of product cycle forces in their industry, and of the cost reductions generated by high growth, market expansion and the introduction of new technologies through rapid investment (Abegglen and Stalk, 1985). At the same time, Japanese firms were importing product and process technologies developed by others and, to encourage competition, the Ministry of International Trade and Industry (MITI) was not permitting exclusive licensing agreements. The ability of Japanese firms to differentiate themselves 52

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and to succeed competitively was therefore dependent on their process innovation adaptations to reduce costs and improve quality. The firms that became globally competitive, such as Toyota and Matsushita, did this extremely well. In managing this process during the postwar period, a divergence emerged between the firms' goals to maintain their existence and global competitiveness in areas of core competence, and the government's industrial development goal to promote new industries. This divergence helps explain Japan's trade and FDI patterns. For example, based on its industrial vision, MITI moved in the 1960s to phase out the domestic cotton textile industry while promoting semiconductors through projects like the Very Highly Integrated Semiconductor (VHIS) project. This approach persisted into the 1990s, but government protection and support shifted to supercomputers and satellites. With each shift, Japanese FDI increased in the sector being "officially" phased out, as firms in those industries resisted the implications of the phaseout. Managers have not accepted such competitive shifts as inevitable, especially where the shift would have an adverse effect on the firm's results. Managers could not simply move production (e.g., capital and labour), from the production of textiles, steel, and automobiles to the production of computers and airplanes, since this would mean selling or scrapping their major assets or dismissing their employees. In addition, their competitive advantages lay in their industry-specific organizational structures and innovative production processes, so they pursued a mixed strategy, combining resistance with the pursuit of shifting competitive advantage, while generally remaining in their basic businesses. This strategy contrasted somewhat with the one followed by American firms. Through the political process, managers of US firms sought and often received protection in response to similar competitive developments. Indeed, over twenty years, a series of "Voluntary" Restraint Agreements (VRAs) in textiles, steel, television, machine tools, autos, and semiconductors were negotiated in an evolution that both confirmed product cycles and Japan's successful entry into more advanced industries. US firms also lobbied for a dollar devaluation with some success in the 1971-73 and 1985-87 periods, while investing offshore, to reduce production costs and maintain manufacturing competitiveness. Capturing Japan's attention

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The textile industry was the first to be subject to these forces. It led the way with this strategy in the early 1970s by investing in developing nations. Then, in the 1980s, Japanese MNCs changed their strategic use of FDI by successfully investing in advanced countries like the United States and Europe to preserve market share. The key to their success was their ability to successfully transfer their organizational and innovative process advantages without losing control of their competitive advantage. In contrast, US innovators transferred their product innovations to potential competitors through licensing or other arrangements (Vernon, 1966; Vernon and Wells, 1991; Krugman, 1979). One example was Matsushita's successful transfer of its global air conditioning operation to Malaysia in the late 1980s (Craig, 1995). This medium-technology product was by then uncompetitive in Japan (as textiles had been in the early 1970s). FDI in developing countries clearly had benefits for both Japanese and Western MNCs. It captured market growth in the developing countries, frustrated the development of local competition, and kept support, sales, and managerial people employed in Japan. Nike's migrating global production strategy is a good example. Nike showed that FDI could extend and manage the international product cycle by increasing imports from the developing countries—imports that were produced in plants owned by the importers. Meanwhile at home, American, European, and Japanese firms expanded into new, more advanced areas that were either related to their existing businesses or were completely different (i.e., they upgraded and diversified). Many Japanese companies followed this pattern of protection, offshore sourcing, diversification, acquisition and technical improvement after the 1985 yen revaluation and the automobile and semiconductor VRAs. They also made large gains in manufacturing productivity in Japan through massive investments. These improvements were then incorporated into their FDI in the United States and United Kingdom, expanding their competitiveness worldwide. This confirmed their emphasis on process innovation as the primary industrial development strategy. Of course, the potential to upgrade or expand an existing product line through R&D and technical change or intra-industry development has always been an important aspect of the classic product cycle 54

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(Rapp, 1975). Synthetic textiles emerge after cotton textiles; high grade alloy steels follow carbon steel; colour television follows black and white. As Japanese firms have advanced through these stages of intra-industry development and acquired the available pool of existing foreign technology, they have ceased to be followers and have become product innovators. Additional intra-industry development then required more invention along the lines of Krugman's basic model. Still, such innovators were constantly subject to competitive pressures from fast imitators that had excellent process innovation capabilities. Thus, by the mid-1970s, as Baba (1989) argued, the fast imitators had to become more innovative while the innovators had to become more cost-oriented or conscious of process innovation possibilities in their new and established products. Those who could not make this shift fell behind competitively and became vulnerable to foreign or domestic acquisition, as happened with GM-Isuzu, Merck-Banyu, and NissanFuji Heavy Industries. Japanese firms have differed from many of their Western counterparts by not abandoning production of the simpler technological products for which there was still large global demand (Vernon and Wells, 1991). For example, Fuji continued to dominate the commercial print film market after it drove Kodak out through intense price competition in the early 1970s. Instead, as part of their logical strategic behaviour to maintain corporate existence and employment, they used FDI to move the older products offshore while producing the newer ones at home. Honda is another example. It first produced its Civic in North America, then introduced the Accord, and recently announced the migration to Ohio of its low-end Acura, the Integra. Similarly, Toyota's production in China is based on a subsubcompact built by its affiliate Daihatsu, a vehicle size not even manufactured by the US Big Three. This strategy keeps the non-production people associated with those products employed, while exploiting their advantages in organizational and process innovation. Intra-industry product cycles have affected Japanese FDI by having an impact on the motivations behind particular offshore investments. While inter-industry evolution can stimulate FDI to acquire new technologies for introduction into Japan, intra-industry evolution stimulates FDI to protect global market share. Firms have not had to Capturing Japan's attention

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give up sales and earnings, but they have denied potential competitors from developing countries a production platform from which to enter the industry and do to the Japanese what the Japanese did to the Americans. This FDI pattern also shows up as investments in offshore assembly operations to leap trade barriers, as Japanese auto investments have done in the United States, Canada and Europe, and synthetic textile investments have done in Indonesia. Similarly, investments in manufacturing facilities in developing countries have been used to source less expensive parts for assembly in Japan (Rapp, 1993), and to create export platforms to remain competitive in products previously supplied from Japan (Ozawa, 1979). High quality and technologically advanced parts production is retained in Japan and exported in place of assembled products. In the automobiles industry, for example, US auto parts imported from Japan rose from $7.5 billion in 1987 to $12.7 billion in 1993, while auto imports remained virtually unchanged at $21 billion. This unbundling of production in an industry using offshore investment seems to dominate Japanese corporate behaviour patterns—a pattern that is consistent with the evolutionary theory of Nelson and Winter (1982)—since firms normally innovate close to existing areas of experience. FDI is initially an innovation, so firms will invest first in existing areas of expertise. When they diversify into new products through FDI, it is usually to gain access to foreign technologies or expertise only available through an ownership interest. Otherwise, long-term contracts are sufficient since they involve less capital and commitment. Long-term contracts were the preferred strategy for obtaining secure raw material and energy resources when Japanese firms had little mining, oil and gas, or large scale agricultural expertise. Canadian companies were major beneficiaries of these strategies during the 1960s and 70s, but those industries are now mature. And, after two oil crises, increased environmental concerns and three major yen revaluations, such energy-intensive Japanese raw material processing industries are not really globally competitive. We have described the way Japanese firms use offshore investment to respond to changing economic forces that shift competitive 56

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advantage. This has a number of impacts. Workers and managers in various countries experience constant shifts in employment. Host country competitiveness is also affected. The differential effect on corporate and national competitiveness is important since it explains the influence of product cycle analysis on the strategic thinking and competitive behaviour, including offshore investment, of Japanese MNCs. It also explains why, despite excellent diplomatic relations, Japanese firms have been reluctant to increase the value-added processing of Canadian raw materials, why Canadian exports to Japan continue to be mostly raw materials, and why the Canadian share of Japanese FDI appears modest. The reality is that Canada is no longer at the leading edge of the global strategic thinking of Japanese firms, and getting there will require a significant policy shift.

The changing Canadian-Japanese paradigm Canada's economic relationship with Japan, dominated by raw materials, is somewhat stuck in the past. Since Japanese raw materials processing firms are not growing and are focused on corporate existence and employment, they will not increase value-added in Canada when this would mean unemployment in Japan. Industries are under continued economic pressure, so there is little incentive for them to shift the nature of their relationship from long-term trade contracts to FDI. This is one reason why Japanese FDI in Canada has remained low compared to the United States or Europe, as was indicated earlier. While these results can be explained in terms of Canada's existing Japanese customers, it is less apparent why Canadians are not doing more in other areas, since they have been able to sell advanced manufactured products and software to US customers. The answer lies in the fact that Japanese trade and FDI remain extensions of their firms' competitive behaviour and strategic orientation, which often has little to do with a host country's desires. Canadian firms fit into the three objectives of Japanese MNCs in the following ways. First, has has been noted, Japanese MNCs seek to develop low-cost manufacturing in Asian countries for standard technology products. These investments use advanced Japanese manufacturing methods to supply high quality parts and finished goods at competitive costs to Capturing Japan's attention

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both the local market and global supply chains. They help Japanese firms maintain global market share despite a rising yen, while impeding the development of new competitors. Canadian firms can participate in this activity by helping Japanese firms supply infrastructure needs and develop their natural resources. New raw material or energy supplies could come from any low-cost global producer, including Canada. The activities of firms like Ontario and Quebec Hydro that work with Japanese electrical equipment suppliers to increase local power supplies fall into this category. Among advanced countries, Australia seems to be doing well in this regard. Second, Japanese MNCs also seek to retain and improve market share in their major North American and European markets. Attracted by the FTA and NAFTA, Canada participates in this trend through Japanese investments in Canadian autos, auto parts and consumer electronics (Rugman, 1990). Canada has little control, however, over the timing, location, nature, size and scope of these investments since they are driven by the strategic perception of market and competitive developments of Japanese firms. Third, Japanese MCNs seek access to new technologies that enhance corporate competitiveness, or that they can introduce as shinhatsubai (new products) into the domestic or global market (Rapp, 1993). This area includes software and biotechnology, where Japanese firms are relatively weak. Access to the Japanese market, however, could improve Canadian competitiveness globally and help create a sustainable advantage for some Canadian businesses, not only in Japan but worldwide. There are complementary interests in this area that clearly have potential, as the recently announced Fujitsu-Delrina strategic alliance to produce a new facsimile software product illustrates. But there is also frustration, since there are few of these alliances. Several Canadian commentators seem puzzled that more business has not been conducted (Donnelly and Kirton, 1988; McMillan, 1989) in these sectors, especially in light of numerous strategic alliances with US technology firms. Perhaps part of the issue could be better addressed if Canadian firms had a better appreciation of the interaction between the economics of these industries and Japan's competitive paradigm. This paradigm, which is driven by innovation, differs sharply from the model with which Canadians have 58

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had the most experience. Canadians are more used to Japanese firms emphasizing low cost and the reliable supply of energy, food and raw materials.

Innovation and competition in Japanese high technology industries To understand the Japanese paradigm, it is necessary to understand that in Japan, as in most other developed countries, the high development cost and low reproduction cost for software and biotechnology products means that the user base, rather than the cost of production, drives the cost structure. In software, this situation can also combine with the increased utility to the user resulting from a larger user base. That is to say, some software is like public goods, where increased use enhances utility and value. This characteristic results in strong firstmover advantages and a tendency towards oligopoly or even monopoly, as larger user bases lead to falling prices by software market segment (e.g., word processing, spread sheet, netware, operating system, or graphics program). In turn, prices tend towards equilibrium where the cost of adding a user (reproducing the program), equals the increased utility to the user. The latter becomes relatively constant once a large user base exists. There is also an incentive for mergers and for large developers to have their programs manage and handle the systems of their largest competitors. These economics mean the cost per unit for a successful program drops rapidly, establishing a large competitive barrier (to non-infringers) from the standpoint of cost and user experience. After initial development, most software or biomedical improvements are evolutionary rather than revolutionary, facilitating the "upgrade" marketing approach to the existing user base given low incremental development costs per unit. Since an expanded user base lowers the average initial development cost and the unit cost of improved versions on both a local and global basis, this characteristic also promotes globalization based on localization and adaptation of existing programs or biological formulations. Patents using Patent Convention Treaty (PCT) filings in major markets are generally a good way to protect biotechnology inventions, but copyright is an even better method for protecting software in the Capturing Japan's attention

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long term, since protection in global markets is automatically 50 years in duration. Copyright protects only the expression of an idea, however, and not the idea itself (e.g., the style of a spread sheet rather than the concept of a spread sheet), so it is normally considered weaker than a patent. But for most users, the expression ties them to the program as they learn to use it and become familiar with its capabilities and idiosyncrasies. It is therefore difficult to change the expression of the idea since this alters the external benefits to users. It also means the infringer cannot access the user base that determines firm economics, so potential imitators cannot compete practically and legally. These characteristics imply that a Canadian firm that develops a new biotechnology or software product can protect its intellectual property in Japan or other triad markets. Equally important, however, is the ability to sustain that technical advantage. This requires both a sophisticated market entry strategy and continual innovation according to the Vernon-Krugman model, since Japanese competition in new products and services is very intense, especially when a foreign firm initiates the process. In the case of autos, food and raw materials development, Canadian business has been an extension of the product strategy of Japanese firms. But when Canadian firms are the innovators, a Japanese strategic alliance becomes an extension of the Canadian development. This means Canadians must understand and manage the strategic process.

The pattern of competition in Japan It is well established that most large, successful Japanese firms have developed by importing products and technology from abroad, by producing for the local market, by improving on the product and the process for manufacturing it on an innovative and proprietary basis, and then by exporting. This competitive development has been supported by rapid rates of investment and aggressive pricing to build volume and global market share. These firms lack the ability, however, to establish product differentiation in a market served by similar producers using similar technologies. As a result, price pressures are severe. This pattern has been repeated in a series of more technically sophisticated and higher value-added industries (Abegglen and Rapp, 1970 and 1972; Abegglen and Stalk, 1985; Baba, 1989; Rapp, 1992; 60

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Rapp, 1993). The leading firms emerging from this intense " weeding out" process are the ones that are best at continually reducing costs. A careful analysis of firm behaviour indicates, however, that competitive pricing is not used uniformly across all products and market segments. Dumping investigations into products like televisions, automobiles, steel, semiconductors and textiles indicate that the domestic Japanese market has been used to subsidize export sales in other markets (Rapp, 1986). In addition, excessive protection in one part of a product-process chain may subsidize a whole series of related products, services, and technologies, including their export to thirdcountry markets. This can be seen in the support that ammonia-based chemicals receives from ammonia-based fertilizers, and the caustic soda cartel's subsidization of the chlorine-based chemical chain, including PVC (Rapp, 1986). Similarly, Ostrom (1993) found Japan's paper products market to be so segmented that each submarket is dominated by one or two producers. He notes, for example, that while Tomoegawa is one-tenth the size of the largest paper producer, Oji, it has a 55 percent share of the insulating paper market. Since market share and profitability are generally correlated, one would expect Tomoegawa to receive much of its profits from this market. At the same time, Japanese manufacturing firms usually offer a full range of products to their customers. When a competitor brings a new product to market, it is quickly copied. Sony's "Walkman" was soon followed by models from Sharp, Matsushita, Toshiba, Hitachi, and Sanyo. Similarly, Honda's entry into luxury cars was copied by Toyota and Nissan and then Mitsubishi and Mazda. Firms seem able to control costs in their expanded product lines because most major auto and electrical manufacturers are assemblers, and less integrated than their Western counterparts. Many use the same major subcontractors, so it is at the subcontractor level that market concentration tends to occur. Toyota has larger volume and lower costs than Mazda, and more power vis a vis major auto parts producers. But by buying from the same major subcontractors, Mazda can take advantage of Toyota's scale and efficiency. Toyota in turn benefits from the added volume of production by its subcontractors (Smitka, 1990, 1991; Fruin, 1992). Nevertheless, from a Canadian or US management viewpoint, the fact that Japanese firms are willing to incur any additional Capturing japan's attention

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cost in such a competitive and price sensitive environment appears contradictory. The answer to this apparent contradiction lies in the "competitive compulsion" or intense "follow the leader" behaviour that has been well described by Ohmae (1991) and Yoshino (1968). Rapp (1993) also notes that reluctance to risk another Japanese competitor gaining an advantage or, just as important, gaining access to a major customer abroad, which subsequently could be developed into a domestic or global relationship, is another strong factor determining Japanese FDI. With this background, it is now possible to state the competitive paradigm. Japanese firms often offer products or services to protect and maintain existing client relationships and market share. This is more important to them than making a profit. Firms consciously use existing business to cross-subsidize such activity. In other words, profits from core activities—oligopolistic or regulated markets where a firm has pricing power or low costs due to organizational and proprietary process advantages—are used to subsidize new or peripheral activities, frequently priced at or below cost. In peripheral products, competition is particularly severe for all except for the most efficient producers. Since all feel obliged to offer these products, they become relatively undifferentiated products sold almost solely on the basis of price (Rapp, 1994). The competitive pattern is, therefore, one in which firms generate profits from a small number of businesses, but break even or lose money on many ancillary products and services that encircle the customer. For example, banks receive higher returns from group companies than non-group members (Caves and Uekusa, 1976). The firm's overall return on equity may be no different from Western counterparts trying to equalize returns across a portfolio of businesses, but competitive behaviour and resource allocation differ. Resources tend to be allocated disproportionately to core businesses where the firm is quite competitive. The firm also focuses its process and organizational innovation on these businesses. Peripheral businesses, in contrast, are run as "service" or loss leaders. Market share in core businesses is substantial; it is minimal in peripheral activities. Peripherals may even 62

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be sourced from low-cost neutral suppliers. Customers and market share will be defended fiercely because of the company's total commitment to its core businesses combined with its drive for firm survival. Using these tactics means a firm can keep pressure on the cash flow of its competitors and easily exit a peripheral business. While most Japanese firms seem to exhibit this behaviour, it may chiefly be a function of their evolution rather than any special cultural attitude or particular Japanese way of doing business. While more research may be needed to answer this question fully, the foreign competitor needs to deal with the environment that exists. This argues for well-articulated investment and entry strategies to define an advantage based on technology, market position, and cost.

Foreign firms and the paradigm Foreign firms (gaisha) are by definition outside Japan's business system and do not usually represent a threat to which Japanese firms feel they must respond aggressively. At the same time, foreign firms that are able to establish and sustain a competitive position can be very profitable because the market returns on Japanese companies are based on their overall competitive environment. Foreign firms, in contrast to Japanese companies, are usually expected to offer only their specialty products, not a full range of services. This situation allows the gaisha to keep most of their core profits without having to give much back in "service" and peripherals. Foreign firms entering and trying to compete in an established or high-growth Japanese market without a proprietary product, technology, or service will find it difficult because Japanese competitors will sell peripheral products and services at or below cost. A Canadian competitor seeking to create a sustainable advantage in the Japanese market must not only establish a market for its product or service, it must also continue to define and influence the competitive evolution of the product to prevent imitation and the inevitable price-based competitive compulsion. This goal is achieved, along the lines of the Vernon-Krugman model, by the continuous introduction of innovations from outside Japan, provided these innovations remain an important element of the competitive environment. This strategy is necessary once market growth slows and greater price pressures Capturing Japan's attention

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develop, particularly if Japanese competitors are then able to develop innovative process technology advantages. Coca Cola, McDonalds, Kentucky Fried Chicken, Motorola, IBM and Marlboro have all been successful using this strategy. Foreign firms tend to lose their initial advantage in cases where emulation, substitution or process innovation by Japanese firms is relatively easy, and where outside innovations can be imitated or are competitively less important. They become much less profitable, and many are forced to exit the Japanese market and perhaps even the world market at considerable expense, since they are unable to compete with large Japanese companies prepared to give the product or service away. De facto standardization makes this result even more likely because the Japanese are excellent at imitation, volume production, and constant improvement (Imai, 1986). The net result is that a foreign firm is usually either quite profitable or loses money. This scenario has been repeated again and again for many firms and product areas. In photocopiers, for example, prices dropped and market share shifted very rapidly as several Japanese firms entered and tried to capture the growth or establish a position once the product had been standardized. And since the Japanese will always compete on price, it is important for the foreign firm to keep its costs under control, even if it can sustain its advantage in other ways. Otherwise, once the initial advantage disappears, market positions will stabilize but without foreign competitors. One way to achieve this result is by developing a close working relationship with a large Japanese company, where the Japanese partner provides service and market access while the Canadian company focuses on sustaining innovation and pursuing global market share. This is where Canada's superior access to the US market could prove to be an advantage. Software and biotechnology are two sectors where this advantage could be used, because of their economic sensitivity to the size of the user base. In these industries, simultaneously exploiting the world's two largest markets can be a source of powerful competitive advantage. Since Japan is the world's second largest market for both software and biotechnology (National Research Council, 1992), Canadian companies with world-class technology must develop this market to remain globally competitive in these industries. If they leave the 64

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Japanese market to other competitors, user base economics means they will fall behind globally, and eventually in Canada and the US as well. Major US and Japanese companies in these industries understand this well, which explains Merck's acquisition of Banyu and Microsoft's major localization program in Japan (Rapp 1995). For historical reasons, Japanese firms in these sectors are relatively weak and do not have the global or domestic user bases to overcome the first mover advantages and lower average costs of foreign firms. Yen re-evaluation and government policies have also worked against these firms (Baba et aL, 1993; Rapp, 1995), providing a clear opportunity for Canadian firms with leading edge technology. In biotechnology, an aging population has put fiscal pressure on the government's health program, which has led to budget restrictions. These restrictions have limited payment for new drugs and fiscal resources available to Japanese pharmaceutical firms for product development. Also, Japanese firms have little experience with the complex drug approval processes in foreign countries. In software, previous government policies have led to a fragmented industry (Anchordoguy, 1988 and 1989). Japanese firms are paid to localize and adapt foreign-packaged software rather than to develop it themselves (Cottrell, 1993; Coultas, 1994; Rapp, 1995). Major Japanese computer manufacturers have offices in the US specifically designed to find and adapt innovative software to their systems and customers (American Electronics Association, 1992). This offers Canadian firms a unique opportunity (Delaney, 1994) to gain capital and access to the Japanese market. They can then expand their global user base and improve their economics and competitive position in all markets. While this development will probably happen naturally for Canadian producers which are already large in these sectors, the situation for small and medium-size players is much less clear. These firms are usually entrepreneurial and rarely have the time or resources to ferret out opportunities in distant, unfamiliar Japan. This information barrier suggests a possible role for Canadian governments or for partnerships between government and industry associations. But despite the potentially positive spin-offs, current budget philosophy and actual fiscal pressures are likely to reduce such subsidies or special support for business. Japan is also out of favour Capturing Japan's attention

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compared to China and Southeast Asia. These seem like more dynamic markets, even though a large part of that dynamism is due to the flow of resources from Japanese companies, reflecting the trade and FDI strategies explained earlier in this paper. It is important to understand that while the Japanese economy is depressed as a result of the bursting of the asset "bubble" of the late 1980s, the actual result of that collapse was a massive transfer of financial assets from Japanese financial institutions to Japanese MNCs (Zielinski and Holloway, 1991), substantially increasing their power and global independence (Rapp 1993 and 1994). The current weakness of the Japanese government, because of scandals and other factors, has given the MNCs greater strategic flexibility. Canadians should therefore consider the Japanese nation and its companies as separate independent players. Canada's economic interests are linked to the companies—not to the nation—and it is the strategic attention of the companies that Canadian business and policy makers must capture. Canadians might emulate the tactics of some American states who see the Ambassador to Toyota as more important than the Ambassador to Japan. The initiative must come from the Canadian side. MNC players assigned to Canada are either too junior (but on their way up), or are older executives in the resource sections of the trading companies and banks reporting to more senior executives in New York or Tokyo. The former are in training to learn about living and working overseas and to develop their English skills. The latter are often assigned to Canada to preserve and manage the status quo which is dominated by Canada's past raw material and energy supply relationship with Japan. Their success is all too apparent in the statistics. The decision-makers in the newer industries are elsewhere and must be sought by Canadians interested in developing these opportunities. Except for the well-known global players like Delrina and Corel, Canada does not figure prominently in the competitive strategies of large Japanese firms in these industries.

Summary and conclusions In the industries of the future, the Canadian-Japanese economic relationship is working against the tide of history and an established infrastructure. The relationship until now has been influenced 66

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primarily by the evolution of Japanese competitive conditions, Canadian resources and their historical interaction. Initially, Japan's search for food, energy and raw materials created a natural interest. The Canadian reaction was favourable but cautious; a "Yes, but ..." response due to its administrative heritage of having to guard its independence from the incursions of its economically and politically powerful neighbour. Then, as the Japanese economy shifted gears from a high-growth, raw material and energy-using economy, to one emphasizing higher value-added, Japan's patterns of trade and FDI shifted. But the Canada-Japan relationship continued down its established path, closely linked to those firms that were still processing raw materials and energy. Those firms still needed their raw materials even if they were no longer at the leading edge of Japan's economic growth. The problem for Canada is that these firms unintentionally define the relationship. No longer in high-growth industries, they are sensitive to price, employment and security of supply and are reluctant to shift value-added abroad. Difficulties have existed on the Canadian side as well in very large and visible projects like the Northeast BC Coal project, where lack of cost control dramatically escalated the price of coal to major Japanese steel mills; the Come by Chance oil refinery, where the project's failure to meet its obligations at the time of the first oil crisis bankrupted Ataka, one of Japan's major trading companies; and the Mitsubishi rapeseed crushing facility, where government regulations and intransigence meant that it remained more economical to export seed than to crush it in Canada. These examples, and others involving the Dome/Beaufort oil project in the Canadian Arctic, the C. Itoh sawmill in B.C., and the Mitsubishi pulp mill, have all become negative touchstones in the minds of Japanese executives— touchstones that limit any future investment interest they may have in Canadian natural resources, before they even consider the relative economic decline in those Japanese industries. Despite these clear negatives from a Japanese business perspective, many Canadians seemed genuinely surprised when Mitsubishi invested in a copper smelter in Texas (Canada Japan Trade Council, 1990), even though Texans aggressively pursued the investment and the US President came from Texas. Canada must, however, increasingly compete for direct investment against such political obstacles as the Capturing Japan's attention

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overwhelming importance of the bilateral US-Japanese relationship, lower US taxes, greater political flexibility, and other incentives. To attract frontier or technology-intensive business, Canadians must gain a better understanding of the global strategies of Japanese firms in these industries, and position themselves to take advantage of their strengths and weaknesses. From this perspective, potential strategic interfaces between Canada and Japan include joint ventures abroad in raw material or energy development, such as Inco's project in Indonesia or the Quebec/Ontario Hydro Ventures in China, where Canadians can substitute for Americans or Europeans. These situations provide only a limited number of Canadian jobs, however. Technology-intensive industries such as software and biotechnology, where Canada is a world leader, offer better future growth opportunities because Canadians and Japanese can help each other compete more effectively. But to achieve this kind of cooperation, Canadian firms need to inventory and actively solicit such alliances. Given the user base economics of these industries, the competitive survival of these firms may depend on their access to Japan's market, even though they must continually innovate to maintain their advantage. The greatest area of potential gain is for small and mediumsize firms with such technologies, but budget restraints and the high cost of doing business in Japan may limit this access to large firms. In addition, Canada's continued dependence on raw materials, energy and food sales to Japan is bound to change the terms of trade adversely and be reflected in a constantly stronger yen, as correctly predicted by the Krugman model. A raw material-based export sector is not workable in the long term against a value-added economy like Japan's, which is based on constant process innovation. This is especially true when Japanese firms are not increasing their raw material processing in Canada. Nor can Canada force the issue. If Canada wishes to move away from its current dependence on raw materials, it will need a more proactive strategy with the Japanese. It needs to create more cases that emulate the Delrina-Fujitsu joint venture to develop facsimile scanning software or the Corel project in multimedia. Aggressive proactive strategies represent a role change for Canada. Yet, if capturing the attention of Japanese companies is a goal, it is also the critical choice. 68

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References Abegglen, James C and William V. Rapp. 1970. "Japanese Managerial Behavior and Excessive Competition." The Developing Economies. 8:4. 427-444. and William V. Rapp. 1972. "The Competitive Impact of Japanese Growth." in Jerome Cohen, ed., Pacific Partnership: United States-Japan Trade. Lexington: DC Heath. and George Stalk, Jr. 1985. Kaisha: The Japanese Corporation. New York: Basic Books. Akamatsu, K. 1962. "An Historical Pattern of Economic Growth in Developing Countries." The Developing Economies. 1:4-25. American Electronics Association. 1992. Soft Landing in Japan. American Electronics Association. Anchordoguy, Marie. 1988. "Mastering the Market: Japanese Government Targeting of the Computer Industry." International Organization. 42:3. 509-543 1989- Computers Inc. Cambridge: Harvard University Press. Asia-Pacific Partnership Committee. 1993. "Canada's Action Plan for Japan." Asia-Pacific Partnership Committee. Baba, Yasunori. 1989. "The Dynamics of Continuous Innovation in Scale Intensive Industries." Strategic Management Journal. 10:89-100. , Yasunori, Shinji Takai, and Yuji Mizuta. 1993. "The Evolution of Software Industry in Japan: a Comprehensive Analysis." Berkeley: International Computer Software Project. Canada-Japan Trade Council. 1990. Canada and Japan in the Nineties. Ottawa: Canada-Japan Trade Council. . 1994. "Statistical Supplement." Canada-Japan Trade Council Newsletter. Ottawa: Canada-Japan Trade Council. Caves, Richard E. and Masu Uekusa. 1976. "Industrial Organization." Asia's New Giant. Washington, DC: Brookings Institution. Cottrell, Thomas. 1993. "Standards and the Arrested Development of Japan's PC Software Industry." Berkeley: International Computer Software Project.

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Coultas, Katherine. 1994. Shifting Paradigms The Development of a Software Industry in Japan. Unpublished Master's thesis. Saitama: Saitama University. Craig, Tim. Forthcoming. "Location Decisions and Implementation Issues in Production and Non-Production FDI: The Case of Matsushita Industrial Company Limited." Best Paper Proceedings. Mississippi State: Academy of Management, Mississippi State University. Delaney, James E. 1994. "Software Wars: Why the Japanese Aren't Winning." Japan Digest, 12:15. Donnelly, Michael W. and John Kirton. 1988. The Potential for Partnership: Canadian-Japanese Investment and Technology Relations. University of Toronto—York University Joint Centre for Asia Pacific Studies Policies Studies Number 3. Downsview: University of Toronto—York University Joint Centre for Asia Pacific Studies. Florida, Richard and Kenney. 1991. "Transplanted Organizations: The Transfer of Japanese Industrial Organizations to the U.S." American Sociological Re-view. 56:381-398. Fruin, Mark. 1992. Japanese Enterprise System. New York: Oxford University Press. Hampson, H. Anthony. 1988. Nikka Kankei Japanese-Canadian Relations, The Opportunities Ahead. Toronto: C. D. Howe Institute. Hay, Keith A. J. 1972. Canadian Agriculture and Japan. Ottawa: Canada-Japan Trade Council. Imai, Masaaki. 1986. Kaizen: The Key to Japanese Competitiveness Success. New York: Random House Business Division. Japan Economic Institute. 1991. "Industrial Policies in Search of a Model: Comparing the Experiences of Japan and the United States." JEI Report 29A, Washington, DC: Japan Economic Institute. . 1994. "Statistical Profile: Japan's Economy in 1993 and International Transactions of Japan and the United States in 1993." JEI Report. Washington, DC: Japan Economic Institute.

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Komiya, Ryutaro. 1987. "Japan's Foreign Direct Investment: Facts and Theoretical Considerations." New Forms of Internationalization in Business. and Ryuhei Wakasugi. 1991. "Japan's Foreign Direct Investment." The Annals of the American Academy of Political and Social Science. Japan's External Economic Relations: Japanese Perspectives. Solomon B Levine and Koji Taira, special editors. 48-61. Krugman, Paul. 1979. "A Model of Innovation, Technology Transfer and the World Distribution of Income." Journal of Political Economy. 253-266. McMillan, Charles J. 1989- Investing in Tomorrow: Japan's Science and Technology Organization and Strategies. Ottawa: Canada-Japan Trade Council. National Research Council. 1992. U.S.-Japan Technology Linkages in Biotechnology. Washington DC: National Academy Press. Nelson, Richard and Sidney Winter. 1982. An Evolutionary Theory of Economic Change. Cambridge: Harvard University Press. Ohmae, Kenichi. 1991- "The Fallacy of Doing More Better." Across the Board, March: 40-43. New York: Conference Board. Okumura, Hirohiko. 1989. "Japanese Direct Investment in the U.S.: Current Situation and Medium-term Outlook." Memorandum for United States-Japan Consultative Group on International Monetary Affairs. November. Tokyo: mimeo. Ostrom, Douglas. 1993. "Japan's Paper Industry: Writing a New Chapter," JEI Report. Washington, DC: Japan Economic Institute. Ozawa, Terutomo. 1979- Multinationalism, Japanese Style. Princeton: Princeton University Press. Porter, Michael E. 1990. The Competitive Advantage of Nations. New York: The Free Press. . 1992. "Capital Disadvantage: America's Failing Capital Investment System." Harvard Business Review. 8: 65-82. Rapp, William V. 1967. "A Theory of Changing Trade Patterns Under Economic Growth: Tested for Japan." Yale Economic Essays.

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1975. "Japan's Industrial Policy." in Isaiah Frank, ed., The Japanese Economy in International Perspective. Baltimore: John Hopkins University Press. 1986. "Japan's Invisible Barriers to Trade." in Thomas A. Pugel, ed., Fragile Interdependence. New York: DC Heath. 1992. "Japanese Multinationals: An Evolutionary Theory and Some Global Implications for the 1990s." Center on Japanese Economy and Business Working Paper Series 61. New York: Columbia University Graduate School of Business. 1993. "Japanese Foreign Direct Investment in the Product Cycle." Proceedings of Association of Japanese Business Studies. 1994. "Foreign Direct Investment in Japan's Securities Industry in the 1980s." Paper presented at the Columbia-Osaka University conference. June 1994. Victoria: mimeo. 1995. "The Strategic Evolution of the Japanese Software Industry." Paper presented at the Japan Economic Seminar at Columbia. February. Rugman, Alan M. 1990 .Japanese Direct Investment in Canada. Ottawa: The Canada-Japan Trade Council. Schumpeter, Joseph A. 1947. Capitalism, Socialism, and Democracy. New York: Harper Collins. Smith, Murray G. 1991. Global Rivalry and Intellectual Property. Ottawa: Institute for Research on Public Policy. Smitka, Michael J. 1990. "Business-Business Relations: Auto Parts Sourcing in Japan." Japan's Economic Challenge. Washington DC: Joint Economic Committee, Congress of the United States. 1991- Competitive Ties: Subcontracting in the Japanese Automobile Industry. New York: Columbia University Press. Statistics Canada. 1988. Science and Technology Indicators 1988. Ottawa: Statistics Canada. 1993-1994. Canadian International Merchandise Trade. Ottawa: Statistics Canada. Vernon, Raymond. 1966. "International Investment and International Trade in the Product Cycle." Quarterly journal of Economics.

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and Louis T. Wells. Jr. 1991. The Economic Environment of International Business. New York: Prentice Hall. Wright, Richard W 1994. "Japan's Financial Downturn: Implications for Canada." The Canada-Japan Trade Council Newsletter. March-April. Ottawa: Canada-Japan Trade Council. Yoshino, Michael Y. 1968. Japan's Managerial System: Tradition and Innovation. Cambridge: MIT Press. Zielinski, Robert and Nigel Holloway. 1991- Unequal Equities. New York: Kodansha International.

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The China market: Dancing with a giant Victor C. Falkenheim

Introduction As Deng Xiaoping's seventeen year old "second revolution" has proceeded, China, a growing economic giant, has begun to affect the shape of the world economic map. While Canadian policy has anticipated this development, the response of Canadian business has been mixed. In this paper, we assess the prospects for expanded trade and investment ties between Canada and China, first by examining Canada's current standing in the China market, and then by identifying the obstacles to expanded business links and some strategies for overcoming them. In the next section, we provide an historical overview of bilateral commercial relations and an assessment of our current position. In the third section we examine several dimensions of China's trade and the investment policies and institutions that affect Canada's place in the market. In the fourth section, we look at key features of China's changing business systems with a view to assessing strategic market opportunities. In the final section, we assess Canada's readiness to develop the China market, focusing on the adequacy of our bilateral trading framework. Between 1978 and 1993, China's output quadrupled. The real economic growth rate averaged 9 percent annually during the period, accelerating in the early 1990s to 12 and 13 percent, outpacing even its East Asian neighbours at peak periods in their own dynamic development. In 1993, the International Monetary Fund (IMF) published estimates of the relative size of the world's economies in 1990, based 75

on purchasing power parity measures.1 The IMF placed the Chinese economy third in size behind the United States and Japan, with over 6 percent of world output (Lardy, 1994). By these measures and based on current growth trends, China is projected to displace the United States as the world's largest economy by 2020. China's emergence as a trading nation has been equally dramatic. Ranked as the world's 32nd largest exporter in 1978, it had become the world's 10th largest by 1993. At the outset of the Deng years, China's exports accounted for less than 1 percent of the world total. By 1993, its share of global exports had jumped to 2.5 percent, accounting for approximately 20 percent of its GDP. In 1980, primary products accounted for half of its exports; by 1993, manufactured goods accounted for 81.2 percent of the total. Import growth was equally striking. The volume of imports rose from US$20 billion2 in 1980 to US$104 billion in 1993. By 1993, manufactured goods accounted for over 86 percent of imports (MOFTEC, 1994).3 As economic growth and reform accelerated in the early 1990s, and as China took the first steps towards currency convertibility, foreign businesses and governments responded with massive investment commitments. Attracted by China's growth potential, its growing domestic consumer market and its abundant labour, pledges from foreign investors in 1992 equalled the accumulated total of the preceding thirteen years. In 1993, China ranked second in the world as a destination for foreign investment, attracting an estimated US$26 billion in realized foreign direct investment (FDI). China's accumulated stock in 1992 put it in 15th place in the world as a destination for FDI (UNCTAD, 1994:68-9). 1

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International Monetary Fund. May 1993. World Economic Outlook contained such estimates based on purchasing power parity-based weights that value the goods and services a country's own currency can buy, compared with the purchasing power of other countries' currencies.

2

Unless otherwise specified, all dollar amounts are Canadian dollars.

3

MOFTEC refers to the Chinese Ministry of Foreign Trade and Economic Cooperation. It has also been known as the Ministry of Foreign Economic Relations and Trade (MOFERT). For ease of understanding, in this paper, it will be referred to only as MOFTEC.

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China has long been a priority market for Canadian trade officials. Designated as a "Major Market" for trade promotion purposes in the mid-1980s, China trade has been supported by a significant commitment of bilateral aid and concessional and conventional credit. In 1987, a multi-departmental review produced a "Canadian Strategy for China." Its purpose was to pool Canadian energies and resources in a sectorally targeted program aimed at positioning Canada competitively in the increasingly difficult China market (Frolic, 1991). While the anticipated breakthrough was delayed by China's economic retrenchment in 1988 and the ensuing Tiananmen tragedy, Prime Minister Chretien's highly publicized Team Canada visit in November, 1994 marked the resumption of this strategy. Mission members in the accompanying 300-person joint government-business delegation signed contracts and letters of intent with a total value of $8.5 billion. The visit also marked the culmination of the process of postTiananmen political reconciliation, giving a much-needed boost to the longstanding diplomatic and trading ties between the two countries. Expressing the optimism of the moment, the Prime Minister called for joint efforts to quadruple two-way trade to a total of $20 billion by the year 2000.

Canada's position in the China market This profile of Canada's business position in China focuses on Canada's success in gaining access to the China market. The primary emphasis is on the People's Republic of China (PRC). The "Greater China" markets of Hong Kong and Taiwan are discussed principally in terms of their potential role as a springboard into the China market. This is not to lessen their direct commercial importance to Canada. Together, Taiwan and Hong Kong had the same volume of Canadian exports in 1993 as did the PRC. Taiwan alone has outpaced the PRC as a market for non-cereal Canadian exports for the past five years. However, the business systems and practices of Hong Kong and Taiwan are far more transparent and familiar to the Canadian private sector. The major challenges and opportunities for Canada in the next decade are to be found in the PRC.

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How are we doing? Despite the success of the 1994 Team Canada mission, views on the state of current Sino-Canadian bilateral trade and economic relations are mixed. While naysayers point to the recent erosion of our market position in China, others point to recent trends that suggest a more optimistic perspective. On the positive side, Canada-China bilateral trade, measured in absolute terms, has grown sharply from $161 million in 1970, the year that diplomatic relations were established. By 1979, the first year of China's "Open Door" trade policy, two-way trade totalled $770 million. By 1994, trade volume had reached $5.9 billion, an average annual rate of increase of over 13 percent from 1979- In addition, the trade balance consistently favoured Canada, which accumulated a total surplus of approximately $9 billion over the period from 1979 through 1988 (Ma, 1994). These numbers, however, conceal significant sluggishness on the export side. In the early 1980s, Canada's exports to China just kept pace with China's overall import growth. In 1979, Canadian exports to China totalled $600 million, doubling to approximately $1.3 billion in the mid-1980s, a period in which Chinese imports from the rest of the world also doubled. By the late 1980s, exports had increased by 38 percent, a rate of expansion again roughly equal to the growth in overall volume of Chinese imports. Beginning with China's retrenchment in 1988, however, export growth flattened out to an annual average of approximately $1.8 billion over the next six years, while Chinese total worldwide imports jumped by 47 percent. The major erosion in Canada's market position occurred during this period, particularly in the early 1990s, when Canada fell from its usual 7th or 8th place as a source of Chinese imports, to 14th place, displaced by Italy, Singapore, Australia, France, the United Kingdom and Indonesia. Canada's share of China's import market has correspondingly declined annually from 3.4 percent in 1988 to 1.3 percent in 1993 (IMF, 1994). Some modest recovery took place in 1994, with Canada's share of China's imports rising to approximately 1.8 percent, moving Canada upwards in the import partner ranking to 12th place. Historically, Canadian exports to China have been dominated by a single product, wheat, which averaged a 47.3 percent share of total 78

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exports between 1983-1993- While clearly a critically important component of our export trade, fluctuations in Chinese wheat demand has resulted in volatile export patterns. Spikes in 1988, 1991 and 1992 reflect China's rising grain import requirements, while sharp dips in 1984, 1989 and 1993 reflect China's domestic economic retrenchment programs as well as depressed grain sales. A better measure of competitive success is Canadian non-cereal exports, which show less volatility but only modest expansion. Excluding cereals, exports hovered uncertainly around the $700 million mark for the years 1983-1987, rising to a six-year average of $888.3 million for the period 1988-1993, an unremarkable increase of 26.2 percent (Statistics Canada). If we compare the beginning and endpoints of these two periods, 1983 and 1993, with 1993 being a banner year for non-cereal exports, the rise is a modest 62 percent over a decade, which is hardly cause for celebration. In contrast, imports from China have shown a steady increase from the mid-1980s onwards, rising steeply in the early 1990s. China recorded its first small merchandise trade surplus in 1989 and, since 1991, has widened the gap in its favour. This indifferent trade picture is relieved somewhat by two recent positive developments. The first is a sharp increase in the level of Canadian direct investment in China since 1991, a subject which is discussed in the next section. The second is a shift in the commodity composition of Canadian exports. The trend since the mid-1980s has been to increasing levels of manufactured exports. From a base of only $13 million in 1983, sales of technology-intensive industrial products rose sharply in the mid-1980s, powered by major sales of boilers for thermal plants, mining trucks, drilling equipment, telephone switching equipment, aircraft, and satellite earth stations. Sales spiked in 1985 and 1986, then dipped sharply in 1987 before resuming steady growth in 1988 (Cheh, 1988). In 1993, electrical machinery and equipment was the second largest export category after cereals. Aircraft, boilers and machinery, and electrical machinery and equipment accounted for 22.3 percent of exports to China in 1993, then increased their share to 31.6 percent in 1994. Total exports in 1994 increased by 39 percent, while electrical machinery and equipment exports alone jumped 48 percent. When the contracts and projects The China market: Dancing with a giant

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initialled in Beijing and Shanghai by Team Canada come on stream and are reflected in 1995 and 1996 manufactured goods export and investment totals, the recent upward movement in manufactured exports should be reinforced. Table 1: Canada's main exports to China, 1988-1994 (HS Chapter) Product

1988

(10) Cereals

1,679

1989

397

1990

1991

834

922

1992

1,275

($ millions) 1993

1994

447

609

(26) Ores

28.6

31.7

9.6

4.9

4.1

4.8

0.0

(29) Organic chemicals

18.4

16.3

15.4

29.8

26.7

23.9

50.6

(31) Fertilizers

160.6

126.7

152.9

182.4

82.4

84.3

214.5

(39) Plastics

232.8

68.2

42.9

101.4

84.2

39.3

31.1

42.6

12.3

1.4

2.5

9.8

43.7

19.3

165.5

105.5

133.4

180.5

152.2

116.5

207.9

63.7

28.9

19.2

18.4

10.1

28.4

26.1

(55) Manmade staple fibres 13.8

13.3

24.0

33.1

40.9

67.2

35.5

1.8

18.4

10.3

60.3

0.6

12.6

5.5

(84) Nuclear reactors/ boilers machinery

58.7

80.1

114.6

142.2

134.8

160.9

(85) Electrical machinery/ equipment

14.9

35.2

95.2

104.5

140.3

305.1

452.6

(88) Aircraft equipment

16.2

32.9

11.1

1.6

(44) Wood (47) Pulp/cellulose (48) Paper

(73) Articles of iron/steel

Total exports

2,600

1,120

150.8

1,651

1,844

31.1

2,144

0.3 1,525

56.9

2,119

Cereal exports/ Total exports (%)

64.6

35.4

50.5

50.0

59.0

29.3

28.8

Non-cereal exports/ Total exports (%)

35.4

64.6

49.5

50.0

41.0

70.7

71.2

3.5

13.2

15.6

11.9

14.6

22.3

31.6

Manufactured exports/ (HS 84+S5+88)/ Total exports (%) Note: HS: Harmonized system Source: Statistics Canada

80

Victor C. Falkenheim

Summary

Regardless of whether a renewed expansion in Canada's exports to China is in the offing, it is important to see current developments in a longer-term historical perspective. The fact is that China's share of Canada's total exports has held steady for two decades at a relatively modest 1 percent. This performance is not surprising, given the overriding focus of Canadian business on North American markets and the growing intensity of Canada-US trade ties. Nor is it surprising, given China's preference for diversification of import sources, that Canada's strong initial market position in China, based on early diplomatic recognition and the importance of wheat sales, would be eroded by gains by later market entrants. The growing strength of China's regional trade links with Taiwan and other Asian economies is a major factor. An analysis of changing trade intensities in Sino-Canadian bilateral relations shows a sharp decline in the trade intensity index between 1975 and 1985. In 1975, China's imports from Canada proportionally exceeded her total world imports by 50 percent. By 1985, Chinese purchases from Canada amounted to only half the level of Chinese imports from the rest of the world. The recent erosion of its market position in China has caused wideranging public concern in Canada. The domestic causes of this perceived deteriorating competitive position are thought to include the inadequacy of concessional financing facilities, the lack of sufficient bank trade financing, the lack of adequate private sector aggressiveness in the more difficult Asia Pacific markets, the dominance of capitalpoor small and medium-sized enterprises (SMEs) in key export sectors, the lack of an adequate SME support program, and more generally, a lack of price-competitive products. Externally, the marketing and production strengths of competing American and Japanese companies, and the geographic proximity and cultural advantages of other competitors such as Korea, Taiwan and Hong Kong, are seen as leaving Canada well back in the starting gate. Canadian companies are generally not well known in China and few have the resources to establish a foothold in the market. The recent success of Canadian manufacturers in building market share in the machinery and equipment sectors suggests, however, that these concerns may be overstated. The China market: Dancing with a giant

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While there is no a priori basis for establishing what Canada's appropriate share of the China market ought to be, there are certainly sectors in which Canada's global revealed comparative advantage is not reflected in commensurate success in the China market. On the manufacturing side, auto parts and specialized machine tools are good examples. Taiwan's exports of machine tools to China account for 27 percent of Chinese imports. The Canadian market share is .01 percent (MOFTEC, 1994:730-1). On the service sector side, banking and insurance represent other potential areas of strength that could be exploited. Competitive success, however, requires an understanding of China's rapidly evolving business environment and policy priorities.

China's changing trade and investment regime If Canadian-Japanese trade and investment relations are driven by the global and domestic competitive strategies of Japan's multinational firms (see Rapp in this volume), Canada-China economic relations are shaped by the changing policies of several levels of Chinese government. The decisions and priorities of China's central government ministries and planning agencies condition China's links to the outside world. Yet the roles of provincial and municipal governments in trade and investment are growing. China's burgeoning regional trade links to its immediate neighbours are another major determining factor. This section focuses on four specific aspects of central government policy that have an impact on Canada's trade position in China: sectoral policy and priorities, the nature of China's import regime and the structure of protection, China's technology transfer regime, and the investment/trade nexus. In the next section, which deals with the business environment, we will focus on the local dimension of trade and investment. To understand the importance of central policy priorities, it is useful to review certain fundamental features of China's economy and external trade policy. The overriding goal of China's Deng-era leadership has been to develop the competitive strength of its economy. Behind this objective lies a complex set of political, demographic, and strategic imperatives. But the priority is clear: build independent national economic strength as fast as possible. In pursuit of that goal, the Chinese, since 1978, have replaced the Stalinist system of planned 82

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development with a more market-based version of the East Asian growth model. They have harnessed their labour force to an export oriented growth strategy, while focusing on the technological upgrading of domestic industry through selective imports and targeted foreign investment strategies. Among the advanced developing countries, Korean-style development comes closest to current Chinese strategies. Although China has made widely-acknowledged strides since 1978, both in domestic market reform and in liberalizing its trade and exchange system, it is important to recognize the dominance of the state sector and the pervasiveness of state intervention in the economy (Lardy, 1992). The developmental priorities of the Chinese state strongly condition the volume and composition of Chinese imports and the nature of inwards FDI, despite 15 years of trade liberalization. China remains a highly-protected economy in which trade policy is essentially mercantilist and policies on foreign investment retain elements of an inwardly-oriented industrialization strategy. Priority has been given to exports, which have outpaced imports in most years, while foreign investment policies have favoured exportoriented ventures capable of balancing their foreign exchange transactions. Access to the domestic market is limited except for ventures that meet certain technological criteria or qualify for import substitution purposes. Many sectors are virtually closed to foreign participation although some limited liberalization is taking place in the financial services and retail sectors. China's FDI strategy, which epitomizes this approach, generally requires foreign investors to supply machinery, equipment, and often raw materials, which are then processed with low-cost labour, yielding end products targeted to foreign markets. First implemented in China's southern Special Economic Zones (SEZs) in the early 1980s, this strategy was formalized and extended in 1988 with the slogan "place both ends to the outside" (Hang tou zai wai). This epigram captures the dual role of the outside world—supplying production inputs and international markets for Chinese processed goods. This approach differs from the policies of most industrializing countries where import-substituting manufacturing FDI is emphasized. The end result is to reduce import competition in the domestic market, maximize foreign exchange availability for priority sectors, and rationally exploit China's comparative advantage The China market: Dancing with a giant

83

in low-wage labour. It also helps overcome China's weaknesses in design, distribution and marketing (Kueh, 1992). Sectoral priorities China's sectoral policies since the mid-1980s have opened up significant potential opportunities for Canadians to move beyond exports based on resources and commodities. At the outset of the reform era, China sought to readjust its industrial structure by shifting resources from heavy industry to light industry. It initially encouraged the development of existing consumer products industries such as textiles, sewing machines, bicycles, and watches. The priority shifted in the mid-1980s to the production of consumer durables, colour TVs, refrigerators, and washing machines. As economic growth picked up, the capacity of the domestic economy to supply critical raw materials and components fell behind, necessitating imports and major investments in transportation and energy infrastructure. In 1989, China's State Council formulated industrial policy guidelines that assigned priority to the development of basic industries over the ensuing decade. Priority was given to agriculture, energy, transport, telecommunications and raw materials, with particular attention to be paid to strengthening the electro-mechanical industry to promote localization of parts and component production (Hong Kong Trade Development Council, 1992). In 1994, laying out the foundations for the 9th Five Year Plan (1996-2000), the State Council set forth its industrial development outline for the remainder of the decade. It included a detailed sectoral policy for the automobile industry and draft policy outlines governing transportation, telecommunications, construction, electronics, machinery and petrochemicals (Stevenson-Yang, 1994). This basic mix of policies and priorities created a growing market for commodity suppliers of wheat, steel, fertilizer, timber and plastic resins, all chronically in short supply in China. World prices had a greater impact on company profitability than China market conditions, but China's volume purchases tended to support prices. China also became an important—though highly competitive—market for high priority capital goods including petroleum, railroads, telecommunications, power plants, mining equipment and instrumentation. The telecommunications sector illustrates how industrial policy 84

Victor C. Falkenheim

shapes market opportunities for suppliers. The strategic framework for development of the information sector was set at a cabinet level council, the Group for the Revitalization of the Electronics Industry. During its three-year tenure, 1985-1988, it set development priorities for five industry subsectors: computers, telecommunications, software, integrated circuits and sensors. Although since disbanded, its recommendations have continued to shape the strategic orientation of industry development. Among its key recommendations were a set of specific priority technologies for development and a recommendation for building ties to a limited number of foreign electronics suppliers. The overall industrial policy for the information sector calls for the commercialization of basic domestic research, together with limited strategic alliances with foreign companies. These alliances are designed to build domestic R&D capability in partnership with a limited number of foreign companies, each of which has a competitive stake in supporting China's own information industry agenda (Zita, 1991). Alcatel is the dominant supplier in the digital switching market in China, with 49 percent of the market in 1994. Northern Telecom (9.5 percent), Ericcson (12 percent), Fujitsu (8.5 percent) and Siemens (10 percent) all have roughly equal shares in the remaining half of the market (Economist Intelligence Unit, 1994). Import controls

To implement its priorities, China has replaced its pre-1979 system of import planning with a complex system of import controls (World Bank, 1994). These controls significantly limit imports in key sectors of Canadian strength. In 1992, an estimated 51.4 percent of total imports were subject to some kind of administrative regulation. The specific implementing mechanisms differ. For a limited range of products, the import plan remains a key instrument of import management. In 1992, it covered 11 broad product groups and accounted for 18.5 percent of imports by value. This includes key commodities in Canada-China trade such as grain, fertilizers, iron ore and wood pulp. Planned imports are managed differently, by a process of canalization in which import authorizations are assigned to a restricted set of designated state trading corporations. This by no means puts Canadian suppliers that are able to compete on price and quality at a The China market: Dancing with a giant

85

disadvantage. Canada's share of China's worldwide pulp imports was 42.3 percent in 1992 and 49.8 percent in 1993 (MOFTEC, 1994:17). In addition, MOFTEC administers an import license system which designates two categories of products. Category I products require licensing approval by MOFTEC's central office in Beijing. A somewhat more loosely administered set of Category II products is licensed by local trade authorities. Both require a certified foreign exchange allocation, a valid import contract and written approval from the ministry responsible for the sector. Direct import controls are also used to protect key sectors. In 1992, these controls affected a range of goods in the machinery and electronics sector, and required prospective importers to obtain import authorization from the State Council Machinery and Electronics Import Control Office. The Office maintained a list of domestic suppliers of equivalent products. When a domestically supplied substitute was available, approval was difficult to obtain (HKTDC, 1992). Tariffs became increasingly important in the 1980s as the scope of the trade plan shrank. Rates rose by the mid-1980s to an average unweighted rate of approximately 40 percent as estimated by the United Nations Conference on Trade and Development (UNCTAD). By 1992, the World Bank estimated the average unweighted tariff rate to be 43 percent. Since then, the average rates have fallen somewhat as China seeks to qualify for WTO accession and is under pressure from its trading partners. China is particularly under pressure from the US, which has obtained a number of market access concessions that reduce the number of products subject to both tariff and non-tariff barriers (Massey, 1992). The structure of protection has a direct bearing on Canadian market access to China. Tariffs are low in food grains (3 percent for wheat) and raw materials, but these products are subject to mandatory import planning and import authority is canalized. The Chinese trading companies buy on price, and, in those commodities where Canada is price competitive, Canada has a solid market share. Raw materials can be subdivided into two categories. The first category includes products that are subject to plan priorities where the domestic price is to be kept low. These include metallic ores and wood pulp which are subject to rates under 15 percent. The second group includes lower 86

Victor C. Falkenheim

priority raw materials that are subject to rates of 15-30 percent. These include items that are not subject to import planning, such as edible oils, and items that are subject, such as rubber. Relatively low tariffs apply to iron, steel and chemical fertilizers, all of which have been subject to mandatory planning in the past (World Bank, 1994:51-52). Tariffs on manufactures provide higher rates of protection for finished goods than for upstream inputs. Rates on chemicals, wood manufactures and some machinery approach 20 percent, while intermediate and capital goods are subject to rates between 20 and 40 percent. Many of these are products in which Canada has developed niche specializations and are sectors in which gains should be possible as tariffs come down in the next decade. Tariff and non-tariff barriers of this kind penalize all exporters equally and give an advantage to domestic producers, if the barriers are uniformly administered. The problem for Canadian exporters is that the barriers are applied selectively. Concessional imports, which are either duty exempt or reduced, represent a rising proportion of total imports. They currently account for approximately half of total imports. These exemptions or reductions apply primarily to processing, assembly and joint venture projects—not areas where Canada has established much of a presence to date. Canadian business is further disadvantaged in accessing the large "gray market" where legal, as well as quasi-legal, manipulation can reduce barriers to imports. In recent years, a gray market that is beyond the bounds of China's licensing and quota systems has emerged in many products. This development particularly affects sectors that are tightly controlled. In some products, low-end computers for example, the size of this market dwarfs its officially controlled counterpart. North American companies tend to lack the connections and experience to access the gray market (Laroque, 1994). General import liberalization and greater transparency will level the playing field somewhat in the future. Under a market access agreement reached with the United States in October 1992, China pledged to remove most of its import licensing and quota controls by 1998. In an initial step, import licenses and quotas applying to 283 commodities were removed effective January 1994. In addition, new regulations for the administration of import controls on machinery and electronic The China market: Dancing with a giant

87

equipment were implemented. These effectively narrow the scope of controls and simplify the import process. In a number of cases, restrictive controls were replaced by more flexible "open quotas." Procurement policy was amended for over 170 products to provide for international competitive tenders. Tariffs on a number of products have been lowered. While implementation has been delayed by ongoing US-China trade frictions centring on intellectual property rights (IPR) issues, the February 1995 Sino-American accord on IPR enforcement means that implementation of the 1992 agreement will resume shortly. Additional liberalization is also likely to result from ongoing negotiations for accession to the WTO. China has offered to impose a tariff ceiling on non-agricultural products to a maximum of 40 percent (IMF, 1994). Technology transfer regime As Table 2 illustrates, Canada ranked among the top 13 suppliers of technology to China in 1993, accounting for just over 3 percent of the total value of China's contracted imported technology (MOFTEC, 1994:52). The petrochemical industry accounted for 42 percent of the US$6 billion in technology import contracts. Machinery and electronic equipment and telecommunications together accounted for approximately 15 percent of the total. China's industrial upgrading needs are staggering. Between 1981 and 1989, government expenditures on industrial technical transformation was close to US$100 billion, with over US$27 billion in foreign exchange allocated to approximately 17,000 projects (Simon, 1991). In 1992, the value of contracted technology imports was US$6.6 billion and in 1993 it was US$6.1 billion, a level of expenditure that is expected to be at least maintained over the next five years. Import controls have been instituted to protect domestic producers, and industrial ministries even sit on the licensing committees that govern their sectors. At the same time, imports are also encouraged for the longer range purpose of technological upgrading to improve the sector's competitiveness. The rising share of industrial manufactures in China's exports, and particularly in the growing export value of electro-mechanical products, is directly traceable to the technological upgrading of the sector through imports. 88

Victor C. Falkenbeim

Table 2: Technology imports, 1993 Country

Number of contracts

Share of total contracts (%)

Total value of contracts (US$ millions)

Share of total value (%)

101

20.49

1,746

28.59

53

10.75

922

15.09

Japan Italy

83

16.84

748

12.24

104

21.10

507

8.30

Spain

6

1.22

442

7.23

Russia

14

2.84

383

6.27

8

1.62

304

4.98

Canada

14

2.84

188

3.08

France

17

3.45

175

2.86

Finland

7

1.42

152

2.49

Germany

USA

ROK

13

2.64

128

2.09

Austria

9

1.83

120

1.96

Britain

10

2.03

116

1.90

Others

54

10.95

179

Z93

493

100

6,110

100

Switzerland

Total Source: MOFTEC, 1994

Technology and equipment imports are subject to particularly stringent controls. They are first subject to planning controls. Projects of over US$5 million need approval from the State Planning Commission and those under that ceiling need approval from local planning authorities. Foreign exchange allocations are also required subject to the foreign exchange utilization plans. Implementation is based generally on a licensing system that is administered by MOFTEC. This control system applies to almost all industrial enterprises in China, including over 400,000 large, medium and small state-owned enterprises, and local township and village enterprises. Foreign-invested enterprises, including joint ventures and whollyowned ventures, are exempt from foreign exchange and import The China market: Dancing with a giant

89

planning requirements. Import licenses are required, however, when the machinery provided by the foreign party is on the import restriction list. Technology import priorities have increasingly shifted from hardware to software over the past decade, but hardware imports, particularly production lines and whole plant imports, still predominate. The Chinese acknowledge licensing as the preferred form of acquiring technology, but financial and foreign exchange limitations have led them to emphasize foreign investment as the principal mechanism for technology transfer. This policy tends to put smaller high-tech Canadian companies at a disadvantage if they are not prepared to take the risks that an investment project would entail. Larger companies have preferred to establish wholly-foreign-owned ventures (WFOs), that involve a simpler approval process, management control and better protection of intellectual property. Initially, the Chinese government discouraged WFOs in favour of equity joint ventures, but increasingly has welcomed WFOs since they have tended to involve larger investment commitments and more advanced technology. Trade-investment linkages A close correlation frequently exists between a country's investment position in an offshore market and its share of that country's imports. As the pattern of trade between Japan, the NICs and Southeast Asia suggests, exports tend to follow investment, often in the form of intrafirm trade. It is possible in many markets to sell directly, either in the form of a representative office, distribution joint venture, or manufacturing joint venture, without establishing a formal business presence. In markets like China's, however, where government policy encourages direct investment and import barriers are high, investment may be the only effective market entry strategy. The relationship between investment share and market share is far from direct. Canada succeeded in maintaining its market share in China despite a limited FDI commitment. Between 1979-1991, the total value of contracted Canadian investment was a negligible US$320 million, of which only US$65 million was actually utilized, yet trade levels continued to increase (Ma, 1994:34-35). Similarly, Japan was highly successful in selling directly into the Chinese 90

Victor C. Falkenheim

market well before its own investment commitments were made. But it seems likely that the level of investment will increasingly have a bearing on export levels in the upcoming years, given the importance of foreign-invested enterprises (FIEs) as a channel for imports. Fortunately, Canadian business investment in China has sharply accelerated in the past two years. The value of both contracted and landed investment in 1992 exceeded the total of the preceding ten years and doubled in 1993. By the end of 1993, China reported a total of 1,540 Canadian investment projects in China (MOFTEC, 1994:49). While the growth has been rapid, Canadian investments account for only 0.9 percent of the total number of such projects, with a contracted investment value of US$1.81 billion accounting for 0.8 percent of total committed investment. Table 3 compares Canada's investment position to other major trade partners of China. The annual investment totals are reported in Table 4. Table 3: Accumulated investment in China by source 1979-1993 Source

Hong Kong & Macao

Number of Share of projects total projects in PRC in PRC (%)

114,147

Total value of contracted projects (US$ millions)

Share of total value (%)

Average value per project (US$ thousands)

150,929

68.0

1,320

65.5

US

12,011

6.9

14,426

6.5

1,200

Taiwan

20,982

12.0

18,432

8.3

870

Japan

7,180

4.1

8,895

4.0

1,230

569

0.3

1,457

0.7

2,560

3,122

1.7

4,843

2.2

1,550

616

0.4

3,025

1.4

4,190

Thailand

1,399

0.8

2,095

0.9

1,490

Australia

1,309

0.8

1,247

0.6

950

Canada

1,540

0.9

1,814

0.8

1,170

Germany Singapore Britain

Source: MOFTEC, 1994:49

The China market: Dancing with a giant

91

The implications of this still modest investment profile for Canada's trade with China are not reassuring for several reasons. First, foreign-invested enterprises (FIEs) appear to be playing an increasingly prominent role both in exporting and importing, and now account for 25 percent of exports by value and 38 percent of all imports. Based on a further breakdown of customs data for the first half of 1993, over 14 percent of imports were accounted for simply by initial investments in joint ventures. An additional 2.4 percent of imports were inputs for joint ventures producing for the domestic market. A full 36 percent of imports were for processing and assembly for export. In short, 53 percent of China's imports during this period are accounted for by joint ventures or FIEs, producing both on the domestic and international markets. "Normal imports" constituted only 37.4 percent of total imports. Clearly, FIEs have become a significant conduit for exports to China, and the Canadian share in this conduit is not well developed (von Kirchbach and Aguado, 1994). Table 4: Canadian investment in China Year

Contracted Investment (US$ millions)

Actual Investment (US$ millions)

1983

64.93

3.71

1984

7.00

0.00

1985

8.73

9.40

1986

88.06

0.00

1987

25.54

10.22

1988

39.53

6.02

1989

42.32

16.95

1990

14.95

8.04

1991

30.87

10.76

1992

315.54

58.24

1993

1,175.88

123.34

Total

1,814.00

261.00

Source: Ma, 1994

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Victor C. Falkenheim

Some of these factors may change as China's FDI regime liberalizes. While China will certainly continue to press for developing country status within the WTO and the right to protect infant industries, its likely terms of accession will involve a phased transition to WTO rules, as has been Mexico's experience. And with accession will come an obligation to dismantle trade-related investment measures (TRIMs). Among the list of prohibited measures specified in the annex to the 9-point TRIM agreement are local content requirements that force firms to use local inputs and foreign exchange balancing requirements (Daniels et al., 1995). Domestic factors will also erode China's ability to impose restrictions on inwards FDI. Increasingly, local governments have the authority to set the terms of local investment, although they are still subject to national policy and legislation. More potently, foreign investors are pushing for access to the domestic market as the price of significant technology transfer or funding. The availability of alternative low-cost labour venues means that China's real comparative advantage lies in the size of the domestic market. Chinese officials increasingly recognize that sustained and close links to suppliers of technology and managerial expertise require opening the domestic market to foreign commercial presence (Fischer, 1991:785).

China's business environment and business systems The business environment in China has steadily improved in the past decade as laws, regulatory structures, and experience in international trade and investment have made the system more open and predictable. Equally, foreign businesses have gained experience in developing markets and business links with China. But with growing knowledge has come increased awareness of the complexity of China's business systems and the diversity of bureaucratic and commercial players with a stake in trade and investment projects. The label "China Inc.," if it ever accurately captured Chinese reality, no longer applies. Rivalries and turf battles between competing ministries and attached corporations and agencies are but one dimension of this complexity. Tugs of war between central and local authorities over investment policy or development policy plague regionally-based joint ventures. Inter-regional and inter-provincial rivalries abound, fragmenting the The China market: Dancing with a giant

93

market to the point that the Chinese press itself complains of a new "economic warlordism." Fragmentation is a critical feature of the Chinese system, which results in protracted efforts to reconcile competing interests and build consensus. The following discussion seeks to map out some of the key players whose intersecting interests define Chinese business networks.

Trading companies Before 1979, China's large import-export corporations monopolized external trade. One of the first trade reforms undertaken after 1979 was the decentralization of authority to engage in foreign trade transactions. By the mid-1980s, MOFTEC's predecessor had authorized over 800 separate trading corporations, many specializing in specific product lines. By the end of the decade, this number had leapt to over 5,000. Among the new companies were provincial foreign trade corporations (FTCs), many of them the former local branches of the national FTCs. The People's Liberation Army established its own trading companies, both to promote overseas arms sales and to market products from its own durable goods factories. Many production ministries set up their own foreign trade corporations, bypassing the former national FTCs under MOFTEC. Finally some of the larger companies were authorized to export and import directly. By 1993, approximately 5,000 domestic enterprises and almost 9,000 FTCs were engaged in trade, along with over 80,000 FIEs (IMF, 1994:13). While the national FTCs still controlled over half China's import trade in the mid-1980s, the situation had changed markedly by the early 1990s. Chinese customs data for 1993 identify over 30,000 exporting entities and 49,000 importers who were engaged in trade transactions. In terms of trade turnover and share of trade, the degree of concentration had become quite limited. China's largest importer accounted for less than 4 percent of imports and its top 10 importers for only 16.6 percent of imports. But imports were geographically concentrated, with Guangdong-based importers accounting for almost 40 percent of the total. Beijing importers accounted for 22 percent and Shanghai for 6.4 percent. An interesting feature of China's import trade is the continued dominance of Chinese trading companies and 94

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state-owned enterprises (SOEs), which together accounted for 60 percent of all imports (von Kirchbach and Aguado, 1994:12). Industrial ministries

China's industrial ministries are critical players in a system where vertical authority remains important. An analogy that captures the cooperative and competitive interests of China's ministries suggests that ministries be seen as separate lines of business in a state-run conglomerate headquartered in Beijing. Ministries, with attached producing enterprises numbering in the thousands, and their own trading companies, are complex business systems in their own right, and vigorously pursue their separate agendas. In some instances, ministries have been "corporatized," a reorganization that establishes an umbrella conglomerate to manage the diverse operational activities of the former ministry. The former Ministry of Petroleum Industry (MPI), now part of the Ministry of Energy Resources (MOER), is a good illustration of the degree of organizational complexity. MPI has a headquarters organization with staff bureaus for finance, planning, capital construction, science and technology, educations, personnel etc. It also has operating bureaus for transportation, marketing drilling, engineering equipment manufacturing, oilfield development and geological exploration. Below them are a wide range of enterprises and companies. Directly under MPI are the major oil fields, which have bureau level status and report to the Vice-Minister directly. Three companies under the ministry, the China National Oil and Gas Exploration and Development Company, the China National Oil Development Corporation and the China Offshore Oil Company are all authorized to deal with foreign companies. To rationalize oil production operations and reduce the amount of bureaucratic red tape, in 1988 MOPI was dissolved and replaced by an umbrella conglomerate, the China National Petroleum Corporation (CNPC). CNPC accounts for approximately 97 percent of China's crude oil output and controls all onshore fields and shallow water offshore fields (Lieberthal et al., 1988: 85-6; Tansay, 1994:8-16). Working with a single ministry is difficult enough. For foreign investors, the unhappy fact is that few transactions can be confined to The China market: Dancing with a giant

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a single ministry or its corporations. For example, the MPI depends on the Ministry of Machine Building for equipment. However, it often finds itself in the middle of battles between oil fields eager to import foreign equipment and the domestic equipment producers backed by their ministry which, working with MOFTEC, tries to limit imports. Many natural resource projects also typically run afoul of the rivalry between the Ministry of Geology, which is responsible for seismic surveys and gathering geological data, and the production ministries, which have their own exploration divisions. All hoard data and compete for a share of foreign contracts. These problems affect virtually all mining ministries, including coal, non-ferrous metals and others. A number of leading Canadian companies have found their projects snarled in China's own inter-ministry turf wars. Similar problems exist in telecommunications, where R&D and telecommunications manufacturing is split in complex ways between two rival ministries, the Ministry of Posts and Telecommunications and the ministry responsible for Machine Building and Electronics Industry. Direct sales of technology or equipment to enterprises under either national ministries or provincial bureaus of ministries usually involve the participation of ministry research and design institutes. These have the technical personnel and the mandate to assess the product according to ministry or industry guidelines. Effective marketing strategies in industrial markets should focus on ministry institutes. Enterprises or end users have played an increasingly important role in procurement decisions since the mid-1980s. A dual strategy focusing on the end user and the design institute is now the recommended approach (Grow, 1987).

Provincial and local governments China's provinces and cities, beneficiaries of a significant decentralization of planning and fiscal authority since 1980, are a critically important level of decision-making. Large municipalities and provinces can exercise independent project approval powers for various pre-authorized project investment ceilings, ranging as high as US$30 million for manufacturing projects, and even higher for real estate and commercial development projects. For certain infrastructure projects, local governments are often the critical players. For example, in 96

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telecommunications, provincial Post and Telecommunications authorities are the primary customers for foreign suppliers to intra-provincial network projects. They also provide over 60 percent of total project financing on average. Northern Telecom has very effectively pursued a dual strategy, building its ties at the national level with an umbrella agreement with the State Planning Commission in Beijing, while actively pursuing individual projects and markets at the provincial level. With the recent central government green light given to buildoperate-transfer (BOT) style infrastructure projects, provincial and municipal governments will become even more important targets for firms interested in large-scale construction and engineering projects. Since the mid-1980s, inter-provincial competition has been on the rise, with provinces actively promoting their own investment zones through local tax and other subsidies, and resorting to a variety of protectionist measures to shield local manufacturers and retailers from competition. The national government has taken strong measures to limit these rivalries, but with only partial success. A recent McKinsey study of the second-stage expansion strategies of established multinational corporations in the China market reveals that they have responded to the localized and fragmented character of the market by creating separate ventures in each target jurisdiction (Shaw and Meier, 1994:15). The absence of a genuinely unified national market constrains both foreign and domestic producers. And the still fluid system of shared central-local powers makes it important for foreign investors to be alert to changes in central government policy that may contradict undertakings given by local partners.

Canada and the China challenge The complex and difficult China market presents four specific challenges to Canadian business. Intense international competition for market share The rivals of Canadian multinationals in globalizing industries see a significant presence in the China market as a key factor in long-term competitive success. Backed by government trade promotion programs, soft loans and strong diplomatic support, the world's major multinationals are positioning themselves for a share of China's huge The China market: Dancing with a giant

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infrastructure market. Pre-conditions for success at this level of competition are size, financial, technical and marketing strength, and solid government support. Company imperatives and the Chinese ability to manipulate these rivalries to their advantage make this challenge a potent one. Moreover, the price of entry is high. A recent McKinsey study put the average cost of first phase market exploration for surveyed MNCs at $10 million, with second phase expansion costs rising on average to over $50 million (Shaw and Meier, 1994:11). The competitive environment is no less severe for smaller companies in lower value-added processing industries for whom China serves as an export platform. Most successful companies tend to come from the region—particularly from Hong Kong and Taiwan—and build on geographic proximity and linguistic, cultural affinities. As participants in informal family-based business networks, they face lower barriers to entry than their counterparts based in North America or Europe. The growth of regional economic integration in the Greater China region, as well as the broader intensification of trade ties with its immediate neighbours, inevitably has a trade-diverting effect. Four of the top five leading exporters to China are its neighbours: Japan, Taiwan, Hong Kong and South Korea. They are also the leading investor nations. The United States is the sole exception. The term "Greater China" describes the increasingly inter-meshed economies of Taiwan, Hong Kong and the southeast coast of PRC. These are de facto economic zones, with the Hong Kong dollar circulating in Guangdong and the New Taiwan dollar in Fujian province. The volume of Taiwan-PRC trade has jumped from US$1.5 billion in 1987 to US$14.3 billion in 1993. Over 5,000 Taiwanese enterprises have set up manufacturing facilities in the PRC. Similarly, more than half of the labour force in Hong Kong companies work in mainland subsidiaries. Hong Kong is China's leading export destination, and its fourth largest source of imports. Seventy percent of PRC's investment comes from Hong Kong and 10 percent from Taiwan (Ash et al., 1993:711-46). Other transnational economic zones are emerging elsewhere on China's periphery. Korean trade and investments are concentrated in Shandong across the Yellow Sea. Yunnan and Guizhou provinces in the 98

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southwest are expanding ties with Burma, Thailand and Vietnam. In northeast China, ties are expanding with the Russian Far East, Japan and Mongolia, much of it involving barter trade. While these regional networks are market-driven, their economic strength serves as a barrier to entry for many Canadian firms. Conversely, since they are open networks, they are permeable and lend themselves to incorporation of other business interests. Canadian companies with business ties to Hong Kong and Taiwan may be well-positioned to piggyback on their partners' operations and interests in China. The highly protected nature of the China market Barriers to entry include import restrictions and tariffs, as well as an increasingly prominent range of NTBs in the area of standards and certification requirements. In addition, policy shifts that limit entry in particular sectors or arbitrarily set profit limits are discouraging foreign investors. As an example, the recently announced sectoral policy for the automotive industry significantly raises the price of entry for new auto joint ventures. They now face daunting localization targets, with a start up requirement of 40-50 percent of local content, rising to 80-90 percent within a few years. Knockdown operations are prohibited and a 50 percent minimum Chinese ownership position is required along with guaranteed R&D commitments (Stevenson-Yang, 1994:4). Similarly, after encouraging foreign participation in power development in 1992 and 1993, the government set rates of return on power projects and limits on foreign ownership and control. The effect has been to stop a number of large projects already in the negotiating phase. The complexity of China's business systems Inter-ministerial and inter-regional competition aside, fuzzy, overlapping lines of authority and inadequately regulated markets make personal connections crucially important. With an economic structure still in fluid transition from plan to market, understanding the formal and informal relationships and rules that govern business transactions is a major challenge.

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Competition from domestic companies or established joint ventures As the Chinese economy modernizes with the assistance of foreign technology, much of the competition is coming from domestic companies or established joint ventures. In the light of these four challenges, the prerequisites for success in the market are readily identifiable. Reliable market information, business connections and knowhow are critical, but they are not cheaply acquired. They necessitate a strong presence on the ground and extensive experience. Partnering with the appropriate Chinese business entity is one solution, but finding the right partner is not easy. Many foreign investors in China find that their goals and those of their partners frequently diverge. Chinese partners are often most eager to gain technology and foreign exchange and financing, but are less committed to gaining and protecting market share. Learning how to manage these risks requires direct experience in the market. Only larger companies, willing to make a major long term commitment to the market, are likely to succeed. Companies must also be able to compete on price, technical specifications and on a range of other requirements, including training and after-sales service. These requirements tend to give the advantage to firms with a strong existing market presence and track record.

Canadian readiness In many respects, Canada is not well-positioned to meet these challenges. Canada's global high technology companies are few in number, and the country's limited competitive success is due to their efforts. Companies such as Northern Telecom, Babcock and Wilcox, Spar and CAE have been in the market for decades. Their experiences attest to the need for a major commitment of resources. Philips Cable, a successful exporter with major sales to China, began with a $4 million contract for covered power cable in 1984, and reached over $29 million in sales in 1993. It now, however, faces cost and quality challenges from domestic suppliers of its principal export, metallic telephone cables, and expects future expansion to lie outside the telecommunications sector (Canada China Business Forum (CCBF), 1995:44). Companies with established manufacturing facilities, such as Babcock 100

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and Wilcox (B&W), are better positioned to compete because of labour costs, transportation savings and the ability to localize production of key parts. B&W's recent successful bid on the US$155 million Yangzhou power plant, which beat out Combustion Engineering and Mitsubishi, was largely the result of ten years of manufacturing experience in the market (CCBF:23). Waiting in the wings are Canadian chartered banks which, having patiently prepared the ground for many years, are waiting for further financial liberalization to capitalize on their investments. With the 1992 liberalization of the retail market in China, companies such as The Bay have moved into China, although China's policies towards foreign participation in the service sector is far from clear. Smaller Canadian companies face a wide range of challenges. One is simply cost factors. Canadian trade officials estimate the average minimum commitment from start to contract signing to be one person-year of executive time and $50,000 in out-of-pocket expenses. An additional problem for smaller companies is the lack of recognition and exposure in the China market. This situation can only be remedied by aggressive marketing, another quality in short supply. A study of the market for environmental products and services, commissioned by the Department of Foreign Affairs and International Trade Canada and based on interviews with Chinese procurement officials, identified the following shortcomings in Canada's marketing efforts, and weaknesses of Canadian firms (EAITC, 1993:138): • absence of adequate research on the Chinese market; • insufficient budgets for business development activities; • lack of sufficient contacts with Chinese technical personnel, despite the importance of such personnel in the decisionmaking process; • insufficient participation in exhibitions and seminars and the consequent failure to become better known to potential buyers; • absence of adequate after-sales networks, coupled with insufficient training at the time of sales; • unwillingness to modify equipment to meet customers' requirements;

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• • • •

marketing techniques which have not been adapted to the Chinese environment; inflexible trade practices, including high costs and unwillingness to negotiate; inadequate number of investment ventures; and lack of patience.

Canadian trade officials generally acknowledged that these problems are widespread. They now discourage market exploration by companies that do not have a realistic long term game plan. On the other hand, many smaller Canadian companies have succeeded in China on the basis of niche specializations which make their products or technology attractive, even at a price premium. In some cases, the Chinese have taken the initiative in seeking out established technology. In others, proactive trade representatives with sector expertise have identified market opportunities for Canadian suppliers. In most cases, the active support of government trade offices, either as a source of market information or in facilitating market exploration activities, has been critical. One of the major strengths of the Canadian trade effort in China has been government support programs. At the federal level, the Export Development Corporation (EDC) provides short and mediumterm insurance, guarantees, foreign investment insurance and longterm financing. This financing support has been critical to the success of Canadian ventures in the past decade (L'Abbe, 1995). Between 1979 and 1994, the EDC supported approximately $2.5 billion in capital equipment and services in China. The EDC has established lines of credit with state banks in China, including a US$300 million facility with the Bank of China, a US$25 million credit line with the Bank of Communication and a US$200 million facility with the People's Construction Bank of China. The EDC has financed over 180 transactions under these lines and, during 1993 and 1994, financed nearly $850 million in Canadian exports. In 1993, 30 percent of capital goods exports were supported by EDC credits. In July, 1994, a new $100 million concessional facility was established for transactions that meet the Canadian government's allocative criteria. These criteria include nomination of the transaction as a national priority by the Chinese government. 102

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Funding from the Industrial Cooperation Program of CIDA (CIDA-INC) has been key to the success of many of the smaller service sector firms, particularly in the environmental and urban infrastructure market in China. While CIDA funding for bilateral programs has averaged between $30-40 million over the past decade, CIDA-INC has spent approximately $5 million annually to support feasibility studies and market exploration trips. Over the first decade of the program, CIDA-INC spent $42 million to support a wide range of private sector initiatives (Beggs, 1991:27-9)- At the provincial level, funding from organizations such as the Ontario International Corporation which facilitated bidding on ADB and World Bank projects, has been critical to the success of a number of smaller firms in the transportation and infrastructure sectors. In conclusion, as the gigantic Chinese economy is further liberalized in the years ahead, the competitive pressures and challenges for Canadian firms will intensify rather than abate. Canada's trade and investment ties are growing again, but a major strategic effort is needed to establish a presence that reflects Canada's overall revealed comparative advantage. The rising proportion of high tech manufactured exports, the massive increase in investment and the growing experience and knowledge of the China market on the part of Canada's private sector all bode well for the future. The 750,000 member community of Chinese-Canadians, many with family business connections to Hong Kong, Taiwan and the PRC, is a major untapped Canadian resource with great potential to enhance Canada's presence in the China market. This community has become increasingly active, both directly and indirectly, in facilitating projects in China. While the evidence is impressionistic, it is believed that over two thirds of Canada's 1,500-odd investment projects in China involve Chinese-Canadian initiatives. But since most Canadians are relative latecomers, their strategy should be to focus their efforts. Public sector support of those efforts will also be necessary to overcome barriers posed by distance and unfamiliarity. In meeting these challenges, the consortium approach has much to recommend it. With Canadian banks, consulting companies, law firms and trading companies entering the market, a critical mass of expertise to support business development efforts by Canadian The China market: Dancing with a giant

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small and medium sized enterprises is beginning to develop. Increasingly, even Canada's largest firms are forming consortia in environmental services, energy development, and transportation to meet the technical and financial requirements of China's infrastructure market. These are positive developments which should help sustain the momentum of the past two years.

References Ash, Robert F. and Y.Y. Kueh. 1993. "Economic Integration Within Greater China: Trade and Investment Flow between China, Hong Kong and Taiwan." The China Quarterly. 136:711-746. Beggs, John A. 1991. "CIDA-INC: China Programs." Canada China Trade Council Newsletter. November-December. Toronto: Canada Japan Trade Council. Cheh, John. 1988. "Canada's China Trade." The China Business Review. January-February: 10-13. Daniels, Michael, Richard King and Peter Bernstein. 1995. "TRIMming Protectionism." The China Business Review. March-April. Economist Intelligence Unit. 1994. "Telecoms." Business China. May. External Affairs and International Trade Canada. 1993. China's Market for Pollution Control Technology, Engineering Consulting Services and Related Equipment and Instruments. Ottawa: External Affairs and International Trade Canada. Fischer, William A. 1991. "China's Potential for Export-led Growth." China's Economic Dilemmas in the 1990s. Washington DC: Joint Economic Committee, Congress of the United States. Frolic, B. Michael. 1991. "Canada and the People's Republic of China: Twenty Years of a Bilateral Relationship, 1970-90." In Frank Langdon, ed. Canada and Asia. Vancouver: Institute for International Studies. Grow, Roy F. 1987. "How Factories Choose Technology." The China Business Review. May-June.

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Hong Kong Trade Development Council. 1992. China's Machinery Market. Hong Kong: Hong Kong Trade Development Council. 14-15. International Monetary Fund. 1994. Direction of Trade Statistics Yearbook. Washington DC: International Monetary Fund. International Monetary Fund. 1994. Economic Reform in China: A New Phase. Washington DC: International Monetary Fund. Kueh, Y.Y. 1992. "Foreign Investment and Economic Change in China." The China Quarterly. 131:638-39. L'Abbe, Paul. 1995. "Financing Opportunities and Challenges in the Emerging China Market." Presentation to The China Conferences: Building Team Canada. Toronto. Lardy, Nicholas. 1992. Foreign Trade and Economic Reform in China, 1978-90. Cambridge: Cambridge University Press. . 1994. China in the World Economy. Washington DC: Institute for International Economics. Laroque, Alain. 1994. "Piercing Import Barriers." The China Business Review. May-June:41-43. Lieberthal, Kenneth and Michel Oksenberg. 1988. Policy-Making in China: Leaders, Structures and Processes. Princeton: Princeton University Press. Ma, S.Y. 1994. "Canada-China Business Relations 1979-93: Fifteen Years of Growth." Canada-China Business Forum. NovemberDecember : 31 - 3 2. Massey, Joseph. 1992. "301: The Successful Revolution." The China Business Review. November-December. Ministry of Foreign Trade and Economic Cooperation. 1994. Almanac of China's Foreign Economic Relations and Trade. Beijing: Ministry of Foreign Trade and Economic Cooperation. 498-503. Shaw, Stephen M. and Johannes Meier. 1994. "Second Generation MNCs in China." The China Business Review. SeptemberOctober. Simon, Dennis Fred. 1991- "China's Acquisition and the Assimilation of Foreign Technology: Beijing's Search for Excellence." China's Economic Dilemmas in the 1990s. Washington DC: Joint Economic Committee, Congress of the United States. The China market: Dancing with a giant

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Stevenson-Yang, Anne. 1994. "China's Latest Industrial Blueprint." The China Business Review. September-October. Tansay, Robert. 1994. "Black Gold Rush." The China Business Review, United Nations Conference on Trade and Development. 1994. World Investment Report. New York and Geneva: United Nations, von Kirchbach, Friedrich and Johanna Aguado. 1994. "China's Foreign Trade Expansion: Towards a Portrait of the Actors." Paper presented at the Conference on the Asia-Pacific and Management in Europe. Fontainebleau: Euro-Asian Centre, INSEAD. World Bank. 1994. China: Foreign Trade. Washington DC: The World Bank. Zita, Ken. 1991. "China's Telecommunications and American Strategic Interests." China's Economic Dilemmas in the 1990s. Washington DC: Joint Economic Committee, Congress of the United States.

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Southeast Asian perceptions of Canadian business Lorna L. Wright

Introduction The economic dynamism of the members of ASEAN, the Association of Southeast Asian Nations1, reaches back thirty years. Most of these economies are still developing in an established pattern: from subsistence agriculture to export-oriented natural resource extraction and labour-intensive manufacturing for export, and then more recently to higher value-added manufacturing and services. A regional division of labour has developed in Southeast Asia, based on different national comparative advantages and on Singapore's special role as a provider of sophisticated infrastructure services in communications, transportation and commercial services (Low, 1995). Rapid growth and diversification have also led to an extensive and pragmatic restructuring of economic activity among these economies, as firms have moved labour-intensive manufacturing offshore to lowercost economies (as, for example, from Singapore to Indonesia). This process has been facilitated by large infusions, relative to the sizes of the host economies, of foreign aid and direct investment from the United States, Japan and, more recently, direct investment from Korea, Taiwan and Hong Kong. While the local governments have been reluctant to liberalize trade with each other, continuing economic diversification in the sub-region and the emergence of market-based 1

ASEAN membership includes Brunei, Indonesia, Malaysia, Philippines, Singapore and Thailand.

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economies in Vietnam and Myanmar are encouraging regional cooperation. Sub-regional "growth triangles," for example, are a new development that draw upon complementary resource endowments from neighbouring economies. Canadians have been present in the sub-region for nearly forty years, but in a haphazard fashion. Official bilateral ties with individual economies eventually evolved into links with ASEAN. These ties, led and financed by the public sector, reflected development-oriented thinking on both sides, and the Canadian government's desire to facilitate private sector activity. But Canada's relations in both the public and private sectors have not kept up with the rapid evolution of economic developments in the area. Today, local governments think, and increasingly act, regionally, as their private sectors have done for years. The challenge for Canadian governments and businesses is to catch up with these new local realities. In this paper we examine Canada's business presence in three of the ASEAN economies—Indonesia, Malaysia and Thailand—and draw lessons for the future from the experiences of the past, paying special attention to Asian perceptions of the strengths and weaknesses of the Canadian business presence. The first section summarizes Canada's long but relatively weak record. Among the major factors that account for this performance is lack of knowledge about the region. In the second section, we therefore focus in more detail on the business environment and the business systems that characterize the three countries. In the third section, we offer empirical evidence of Asian perceptions of Canadian business in the region, and then in the fourth section provide three case studies of successful ventures. In the final section, we offer recommendations that address some of the barriers to future success.

The Canadian presence in Southeast Asia Canada first developed official ties with Malaysia in the late 1950s because both shared Commonwealth membership. Initially the relationship was primarily one of aid rather than trade. This relationship waned in the early 1970s, when Indonesia became Canada's preferred partner, because of its size and strategic position (Stubbs, 1991; Hainsworth, 1986). Few major Canadian private sector interests were 108

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involved in the aid link, so the decline in the bilateral relationship with Malaysia passed almost unnoticed in Canada. The focus on Indonesia eventually evolved into an interest in the ASEAN regional grouping which included both Indonesia and Malaysia. Canada began to develop a set of bilateral relations with each of the five original ASEAN members, and to provide assistance for a number of regional projects. In 1981, an ASEAN-Canada Economic Cooperation Agreement was signed, followed by the creation in 1990 of the Canada-ASEAN Centre in Singapore. Its mandate was to increase economic and cultural links between Canada and the region. Economic interaction with Southeast Asia has been led by the public sector. By some calculations, Canada spent 160 public sector dollars for every private sector dollar spent from 1985 to 1989 (Fenwick and Supapol, 1993). Many of these public resources have been trade- and investment-related, in order to facilitate private sector activities in the region (CIDA, 1993). For example, Enterprise Thailand Canada was established in 1990 and Enterprise Malaysia Canada in 1991- Support was also made available to Canadian companies entering these markets through the CIDA Industrial Cooperation Program (CIDA-INC). By 1992, the stock of Canadian direct investment in the sub-region was around $3 billion, with most of the investment in Singapore and Indonesia (Statistics Canada, 1993). While Canadian exports to the region have increased in value, Canada's share of the market has declined in recent years. As Figure 2 in the paper by Head and Ries illustrates, in 1993 Canada imported more than it exported to each of the economies in the sub-region, with the exception of Indonesia. Export Development Corporation data show that although Asian import demand increased 14 percent in 1993, Canadian exports declined by 10 percent, the latest in a fiveyear decline. With respect to the bilateral relationships, Indonesia and Thailand feature in the top 25 markets for Canadian goods—yet they, plus Singapore, China, Taiwan and Hong Kong, still make up just 2.7 percent of Canada's total trade (Asia Pacific Foundation, 1994:81). What reasons do Canadians give for their weak presence in these dynamic economies? Canadian experts on international business in

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the ASEAN countries participated in a modified Delphi exercise sponsored by the Centre for Canada Asia Business Relations at Queen's University in 1994. They identified ten factors as obstacles to greater Canadian presence, which are ranked below (Wright, 1994): 1. lack of knowledge/awareness of the region, 2. cultural differences, 3. insufficient depth of management in Canadian firms, 4. fear, 5. lack of inspiration, 6. lack of capital, 7. insufficient information on the capability of ASEAN firms, 8. assumption or suspicion of corruption in foreign countries, 9. limited Canadian capacity to compete, 10. lack of legal protection. These views reflect two major concerns. First, Canadians lack knowledge of the region; second, they lack the skills and resources necessary to conduct business internationally. In the next two sections, we focus on important characteristics of the region that the business community should be aware of, and then examine Asian perceptions of Canadian skills and resources.

Business environment and business systems Business environment Indonesia, Malaysia and Thailand share impressive records of exportled growth, even though their levels of economic development, political systems, culture and ethnic composition are quite diverse. Growth is a major economic objective—both Indonesia and Malaysia have specified goals of becoming developed countries by 2020. A key factor in the economic dynamism of all three countries is the government's record of maintaining a stable economic environment for the private sector with low inflation, fiscal balance, and relatively stable real interest and exchange rates. Each country has encouraged foreign direct investment (FDI) as a way to acquire technology. Investment regulations have been liberalized—a variety of trade-related and fiscal incentives have been adopted to attract investment. Indonesia, for 110

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example, issued a series of deregulation packages beginning in 1986 that have greatly increased the ease of doing business there. All three countries have moved to provide "one-stop shopping" for foreign investors—Indonesia with its Investment Coordination Board (BKPM); Malaysia with its Malaysian Industrial Development Authority (MIDA); and Thailand with its Board of Investment (BOI). All three countries have had superior export performance, beginning with natural resource exports and then diversifying into manufacturing. Malaysia has been export-oriented since it gained its independence in 1957. Thailand began to move ahead in the mid-1960s, while Indonesia, with a vast domestic market to service, began its export push only recently. Each country has gone through different phases in its trade regime, as shown in Table 1, but the Table 1: Stages in the trade regimes of Indonesia, Malaysia and Thailand Indonesia

Malaysia

Thailand

Nationalism and guided development

Market-led development 1950-70

Natural resourcebased exports 1950-70

Import substitution and export promotion 1971-85

Import substitution 1971-80

1948-66

Outward oriented new-order government 1967-73 Oil and commodity boom

1974-81

Adjustment to external shocks

Reform and export incentives 1980-present

1982-85

Deregulation and outward orientation 1986-present

Export-oriented adjustment and liberalization 1986-90

Source: World Bank. The East Asian Miracle. 1993:124

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direction for all three countries has been towards greater liberalization for investment and an emphasis on trade as the engine of growth. Thinking regionally A significant dimension of economic development policy in Southeast Asia is that governments are thinking more and more regionally when defining their development goals and instruments. Sub-regional "growth triangles"—economic developments involving at least three countries—are a recent example of this approach. In a growth triangle, governments facilitate the cross-border flow of investment, goods and services by providing incentives or removing barriers to trade. This exploits the economic diversity of the participants and encourages cooperative economic development. In Indonesia and Thailand, participation in growth triangles is also a way of redirecting economic activity away from the congested and relatively wealthy urban hubs such as Jakarta and Bangkok. The first growth triangle to be established was the SIJORI triangle, set up in 1990. It includes Singapore, Johore state in Malaysia and the Riau Islands (most prominently Batam) in Indonesia. Participation in SIJORI has given Singapore access to the land, labour and resources it lacks, while allowing Malaysia and Indonesia to benefit from Singapore's greater financial, managerial and telecommunications capabilities. Indonesia in particular has seen spectacular growth: one industrial estate on Batam island has been estimated to have generated US$80 million in exchange revenue and created 20,000 new jobs ("Growth Triangle Cooperatives Make Progress," 1994). The Northern Growth Triangle (IMTGT) is a newer initiative involving Penang and the northwestern states of Malaysia, Phuket and the southern states in Thailand, as well as Medan and northern Sumatra in Indonesia. IMTGT was implemented with fewer initial advantages than SIJORI since the participating areas have greater similarity in their factor supplies and stages of development. Significant payoffs are possible, however, in the form of a reduction in regional disparities and fewer political tensions. Another growth area being discussed includes such outlying areas as Mindanao province in the Philippines, Labuan, Sarawak and Sabah in Malaysia, the provinces of East and West Kalimantan, North, 112

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South, Southeast and Central Sulawesi in Indonesia and Brunei. A growth "quadrangle" that would include northern Thailand, southwest China, Myanmar, and Laos is also being considered. Trade policy

Trade is another policy area of significant regional importance. The ASEAN Free Trade Area (AFTA) was launched on January 1, 1993, to liberalize tariffs and promote intra-regional trade within the group over a fifteen year period. Details of how the tariffs were to be reduced, however, were vague, and the process was multi-tiered. A renewed, more streamlined effort was begun in January 1994. Business/government relationships

Since economic development requires input from both government and the private sector, the relationship between the two sectors in each country is of key importance. Indonesia can be characterized as having a triangular relationship between the President, the military and the Chinese business community. Thailand has a parallel relationship between government and business with an informal relationship to the King (Schlossstein, 1991)- Malaysia's experience has been different. Before 1970, the private sector functioned freely, but racial tensions that led to riots in 1969 forced the government to intervene. In 1970, the government introduced the New Economic Policy (NEP), requiring all enterprises to move towards 30 percent Malay participation. This heightened tensions between ethnic Malays, who control the government, and the predominately Chinese private sector. In 1991, the New Development Policy (NDP) eliminated the quota requirement and tensions have eased somewhat since then. In both Malaysia and Thailand, formal consultative links exist between the government and business organizations, but the effectiveness of these links is questionable. Malaysia deliberately set out to emulate Japan when it introduced formal public-private cooperation in 1983. Indonesia has no formal mechanism linking business and the government. However many senior government officials are linked informally with major enterprises, which has led to a high degree of informal cooperation (World Bank, 1993). One formal, but not particularly strong, link is through KADIN, the Indonesian Chamber of Southeast Asian perceptions of Canadian business

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Commerce, set up under President Suharto's New Order (Ordre Baru) government in 1968. KADIN is the leading business association and the "officially designated conduit for intermediation between the state and the business community" (Maclntyre, 1991:42). Development policy

Public policy has also made a major impact on the development of the private sector through official efforts to direct credit towards agriculture and small- to medium-sized enterprises (SMEs). The agricultural policies have generally been more successful than the promotion of SMEs, since a strong SME sector needs some external assistance. Indonesia has not had much success with its support programs because of weak institutional capabilities, although the private banking system appears to have been helpful in developing some SMEs. Both Malaysia and Thailand have active support programs, but their effectiveness has not yet been measured (World Bank, 1993). The dominant form of business in these countries is the conglomerate, discussed in the next section. Its prevalence is due partly to history and partly to a shortage of managerial and business talent, but mostly because conglomerates are congruent with dominant cultural values. Each country has a development plan that sets out the government's objectives and priority sectors. Indonesia introduced its first 5-year development plan (Repelita) in 1969, but it was only in Repelita IV (1984-1989) that the private sector was expected to play a more important role in the development process. The authors of that plan anticipated that about 46 percent of the investment funds required to meet the plan's targets would have to come from the private sector. Indonesia is now at the beginning of Repelita VI (19941999). Its objective is to generate sufficient growth to provide adequate employment opportunities for the expanding work force. The government will focus its development expenditure on infrastructure and regional and human resource development, while leaving the production sectors in the hands of private entrepreneurs. In the plan, the manufacturing sector is targeted to expand by 9.4 percent, with the non-oil/gas segment targeted for an even higher growth rate of 10.3 percent (Country Profile, 1995). Repelita VI is the first phase of the 2 5-year Second Long-Term 114

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Development Period, which is intended to transform Indonesia into a modern industrial economy by 2020. It represents a transition from a resource-dependent, highly government-controlled economy to a modern industrial one led by the private sector (Country Profile, 1994). In contrast to Indonesia, there has been a strong private sector role in the development process in Thailand since the 1960s. Since Thailand's fifth development plan (1982-1986), the government's major emphasis has been on reducing rural poverty and maintaining a balance between development and conservation, by increasing exports (especially of manufactured goods), and conserving energy. The sixth plan (1987-1991) stressed a more central role for the private sector in the development process (Country Profile, 1994) to help address increasing concerns about the widening development gap between Bangkok and the country's peripheral regions, the increasingly evident infrastructure bottlenecks and the skill deficiencies in human resources. Like its neighbours, Malaysia utilizes five-year plans to promote the goals outlined in the NEP and now in the NDP. Manufacturing is the designated engine of growth; the objective is to redistribute wealth between Malays and ethnic Chinese and to become a developed nation by 2020. The Sixth Malaysia Plan (6MP) (1991-1995) aims to diversify the industrial base, increase factor efficiency, enhance human resources, promote technological upgrading and reduce structural imbalances in the country (Country Profile, 1994). Human resource development

To ensure adequate investment in human resources, governments have placed an emphasis on primary and secondary education. The results so far have been mixed. Thailand is the weakest in this area, and a serious lack of educated workers has begun to threaten its growth. In the early 1990s, secondary school enrollment in Thailand was only 33 percent; Malaysia was already at 34 percent back in 1970 and Indonesia's current enrollment is 45 percent (EIU, 1994). Most Thai students take social science/humanities courses at university; there is a 1 percent ratio of scientists and technicians per thousand people compared to Indonesia's ratio of 10 percent (EIU, 1994). With a shortfall of an estimated 5,000 engineers a year, Thailand's private Southeast Asian perceptions of Canadian business

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sector is increasingly encouraged to take on more responsibility for education. In summary, the business environment for the private sector in Southeast Asia is a positive one. Governments pursue developmental objectives but they have also ensured a stable macroeconomic environment and, more recently, outward-oriented trade and investment policies under which the private sector has flourished. Business Systems Business systems in Southeast Asia can only be understood through the history, ownership patterns, and values of each country. History Thailand is the only country of the three that was not colonized. While this means an absence of colonial scars on the national psyche (Aikman, 1986), it also implies that the Thai system is not very transparent to foreigners and western languages are not widely used. Malaysia, in contrast, was a British colony for over 150 years, and the influence of the British on its administration, legal, and education systems is still evident. Malaysia is a multiracial society, with three important groups—the Malays, Chinese, and Indians. (The British brought in Chinese to work in the tin mines, since the Malays were traditionally rubber tappers and farmers). Indonesia was a Dutch colony for approximately 300 years. The Dutch had no interest in training the local people for anything but labour, and so brought in Chinese to serve as merchants and entrepreneurs, and to act as a buffer between them and the local population (Suryadinata, 1988; Constandse, 1982). The Dutch were aided by the fact that in Java the indigenous elite, the priyayi class, had no interest in commerce, viewing it as crass or kasar, and not a fit occupation for gentlemen. (Indigenous peoples from the islands of Sumatra and Sulawesi, in contrast, had a much more entrepreneurial focus.) Once Malaysia and Indonesia gained independence, they took steps to eliminate any further Chinese migration. Thailand, on the other hand, continued to encourage immigration. The Thai indigenous population, like the Malaysians and Indonesians, did not view business as an appropriate activity for the elite. However, whereas 116

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Malaysia and Indonesia had a small indigenous trading class that the Chinese edged out, Thailand did not, and the Chinese were welcomed to fill that role (Mackie, 1988). As a consequence, the Chinese are more thoroughly integrated in Thailand than in any other Southeast Asian country. Absence of overt tension is also attributed to the tolerance of Buddhism and its proximity to Chinese beliefs and values, causing fewer barriers than Islam in Malaysia and Indonesia. Because Thailand was never colonized, the Chinese community was closer to the Thai elite and inter-marriage was frequent. In Malaysia and Indonesia, the ruling class with which the Chinese aligned themselves was the colonial power. With independence they found themselves estranged from the local elites (Mackie, 1988). Structure

Two distinct features of business systems in these countries are the dominance of conglomerates (historically Chinese-led), and their informal links with powerful groups in the government or the military. In Thailand, economic power is not very concentrated for several reasons. First, the government restricted Chinese activity during a nationalistic period in the late 1940s and 1950s. Second, capital has not accumulated in large amounts. It has tended instead to flow out of the country in the form of remittances to families in China, and to other countries because of uncertainty about Thailand's fate during the Vietnam war (Yoshihara, 1988). Most of the Thai private sector groups originated in one of three ways: commercial bankers who established their businesses in the early 1950s and developed them into conglomerates in the 1970s; industrial groups based on import-substituting industries in collaboration with foreign capital after the 1960s; and the agribusiness group which emerged in the late 1970s and rapidly expanded by integrating agricultural exports with industrial activity. The largest of the three groups today is the financial conglomerate based on the commercial bank (Suehiro, 1992). In Thailand, it is common for two or more families to share ownership of a group, for example the Bangkok Metropolitan Bank and the Bangkok Bank (Phipatseritham and Yoshihara, 1983). Southeast Asian perceptions of Canadian business

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Approximately 30 to 40 of these groups dominate Thailand's private sector (Rahman and Balcome, 1987). The economy is not primarily controlled by them, however, since foreign multinationals account for 39 of the top 100 groups and for 49 percent of total combined sales (Suehiro, 1992). In Malaysia, the Chinese groups came primarily from trading roots (Jesudason, 1989). Since the Malays held political power, but the economic reins were in the hands of the Chinese, a primary concern of the Malaysian government was to bring more economic power into Malay hands. The objective of the NEP was to have Malays own 30 percent of the economic assets by the end of the program in 1990 and to reduce Malay poverty. Businesses were required to have a plan to hire personnel based on ethnic percentages. They fell short of their goal by 10 percent, but considerable progress was made in reducing Malay poverty. The program is also thought to have contributed, particularly among small businesses, to a pattern known as ali-baba in which Chinese business people (baba), partnered with Malays (ali), to procure licenses or obtain government assistance. Indonesia has emphasized the promotion of more locally owned, or pribumi businesses, but it has never had as formal or as radical a program as Malaysia's NEP. The Chinese started out in small trading and moved into big conglomerates. One family tended to control each group. When President Suharto took power and introduced the new order, Indonesian business groups began to change. Many of the Chinese who were successful under President Sukarno at the time of independence did not prosper after 1966 (Suryadinata, 1988; Sato, 1989). New business groups, associated with the military, began to appear (e.g., Liem Sieo Lieong). These Chinese, called cukong (literal meaning is "master"), provide the skills to run the business, and sometimes the capital, while the pribumi elite provide protection and various facilities (Suryadinata, 1992; 1988; Mackie, 1988). Sato (1989) calculates that around 129 business groups consisting of at least five companies had been formed between the end of the 1960s and 1985. Of the 47 largest groups, 39 are led by Chinese. The uneasy relationship between the pribumi/bumiputera and the ethnic Chinese in Indonesia and Malaysia has led to violence on occasion. One might therefore ask if the pre-eminent position of the 118

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Chinese in economic activity will last. Several factors point to its continued viability. For example, in Indonesia, the cukong system serves a useful function for both pribumi and Chinese elites, so it will likely remain as long as there is no drastic change in the socio-political climate (Suryadinata, 1988). More Chinese conglomerates in Indonesia and Malaysia are making efforts to employ more nonChinese staff, which helps ease tensions. Furthermore, the Chinese conglomerates have integrated themselves into an international network, with international capital (Robison, 1986; Yoshihara, 1988), which decreases the ability of national governments to control them. It is estimated, for example, that Southeast Asian investment in China is about US$8 billion (Hicks and Mackie, 1994), but much more may be channeled through subsidiaries and intermediaries in Hong Kong and Taiwan. Will the traditional family-run Chinese conglomerate survive? Conventional Western wisdom maintains that multinationals are too large and complex to be family-run (e.g., Redding, 1980), and that, as local stock markets mature, more companies will turn to public ownership. Limlingan (1986), however, has reported on several Southeast Asian Chinese multinationals that are still family run, proving that it can be done. He states that survival is possible partly because of a strong belief that entrepreneurship and professionalism are complementary rather than contradictory. Professional managers may be hired to run the organization, but decision-making will still be the family's responsibility. Although the Chinese have been the driving force in these economies, royalty is another important player. In Malaysia, there are nine kingdoms, and members of at least two of the royal houses are now prominent in business (Clad, 1989). Antah Holdings, run by the sons of the current King of Malaysia, is one of the rapidly rising stars of bumiputera business. In Thailand, although the King himself stays above business, the Crown Property Bureau is a partner in several business ventures. In Indonesia, conglomerates controlled by members of the President's family are an increasingly important force. State enterprises have been major players in all three countries. In Indonesian, the prominence of state enterprises is due to the nationalization of Dutch assets after independence. Nationalization Southeast Asian perceptions of Canadian business

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focused on plantations, the mining, banking, sea and air transportation sectors and the production plants of some key capital goods. By the end of the 1980's there were 213 state-owned corporations. Sato (1989) calculates, however, that private companies accounted for 80 percent of the total companies, and private capital for 47 percent of the total capital by the late 1980s. State owned companies accounted for only 3 percent of the total companies and 34 percent of total capital. In Thailand, the state was forced to become an active investor when it wanted to counter Chinese economic dominance, and Thai entrepreneurship was slow in developing (Phipatseritham and Yoshihara, 1983). There are only about 60 public enterprises, far fewer than in Indonesia, but their economic impact is important. Most generated a profit. With the introduction of the Sixth National Development Plan (1987-91), however, the government committed to privatization. So far, a number of public enterprises have been privatized or have ceased to operate (Dhiratayakinant, 1990). In Malaysia, state enterprises flourished with the NEP. In 1957, there were only ten public enterprises. By the mid 1980s, there were over 800, and the government's attention turned to privatization (Jomo, 1990). It sought greater cooperation between private and public sectors, and Prime Minister Mahathir's "Vision 2020" speech pledged to rely on the private sector as the primary engine of growth (Mahbob, 1992).Since 1983, parts or all of 120 businesses have been sold, making Malaysia a trail-blazer in privatization (Jayasankaran, 1995). While the business systems in the three countries differ in their historical development, certain common trends in structure are apparent. First, all three are moving away from single-line businesses into multi-industry conglomerates (Sieh, 1992; "Asia's Leading Companies," 1995). The more established groups seem to be managing their diversity, but some of the newer conglomerates appear to be seriously lacking in focus, which hampers their ability to raise capital (Hamlin, 1993). Second, there is a growing tendency, particularly in Malaysia, to move from the old way of individual tycoons to professional management teams. Furthermore, as the stock markets mature, companies are moving away from generating funds internally to borrowing externally (Sieh, 1992). Third, since markets in Thailand 120

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and Malaysia are small in size, rapid growth prospects lie in investing across borders, both within the region and overseas. P.T. Astra and Salim Group in Indonesia, Charoen Pokphand (CP) Group in Thailand, and Hong Leong Group in Malaysia are good examples of this new behaviour. Finally, all three countries are seeking strategic alliances with foreign investors, particularly with the Japanese, to create ties with networks of sub-contractors in the region's manufacturing industries ("Asia's Leading Companies," 1995). Values

Since Indonesia is a secular state, the government has adopted a state philosophy, known as Pancasila, which is distinctly Indonesian, to reconcile the considerable religious diversity in the country. Pancasila encompasses five basic principles (Mubyarto, 1985): 1. the profession of religious beliefs, 2. compassion and respect for human dignity, 3. national unity, 4. representative government, 5. social justice for all citizens. The importance of Pancasila is exemplified by the fact that government officials have cited as one of their goals when negotiating engineering projects, that projects adhere to its principles (Wright, 1991)- Thailand does not have a formal national philosophy, but believes devoutly in the trio of national principles: monarchy, nation, religion (Clad, 1989). Beyond government philosophy and state values, Hofstede (1982) propounded a useful cultural framework for comparing work values across cultural groups. He developed four cultural dimensions: power distance (the extent to which people expect and accept that power in institutions and organizations is distributed unequally), uncertainty avoidance (the extent to which a society feels threatened by uncertain and ambiguous situations and tries to avoid them), individualismcollectivism (the extent to which a society is a loosely-knit social framework in which people take care of their families only, or a tight social network in which people distinguish between in-groups and out-groups), and masculinity-femininity (the extent to which Southeast Asian perceptions of Canadian business

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dominant values in society are stereotypically "masculine"— i.e. assertiveness, acquisition of material goods, etc., or "feminine"— i.e. concern for quality of life, cooperation, etc.). All three countries differ from Canada on these dimensions, and although they differ from each other as well, generally they tend toward the same end of the continuum. Within Malaysia, the three main cultural groups differ somewhat on the dimensions, but they fall, with one exception, on the same ends of the continuums. Chinese, Malays and Indians fall at the large end of the power distance continuum and at the collective end of the collective-individualism dimension, with the Malays being the most collective and having the highest power distance. Canada, in contrast, has small power distance, and is much more individualistic. All three Malaysian ethnic groups show weak uncertainty avoidance, with the Malays at the most extreme end. Canadians are closer to the mid-point on this dimension. However, on the masculinefeminine dimension, Canada is closer to the Chinese and Indian groups on the masculine side, while the Malays are much further toward the feminine end (Yeates, et al., 1993). What this means for management in Malaysia is that motivations will differ, with Chinese and Indians being driven more by material rewards, and Malays by relationships and quality of life. Uncertainty avoidance affects planning, budgeting and control systems. Since there is no great difference between the groups on this dimension, it should not be difficult to reach consensus on these points. The large power distance means that participative management is not likely to work well, and that the preferred organizational structure will be a pyramid (as opposed to a flatter organization). Status differentials will be important. This may be difficult for Canadians to deal with, since they are brought up in a very different system, based on different values. Falling at the collective end of the scale means that Malaysians will value group based decision-making, reward systems and organizational climate more than Canadians, which again may cause misunderstandings if not appreciated (Yeates et al., 1993; Abdullah, 1992). Thailand falls toward the same end of Hofstede's continuums as Malaysia does, with the exception of uncertainty avoidance, where Thailand appears at the high end. Although manifesting a high power 122

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Table 2: A comparison of work values across cultural groups Country

Power Distance

Uncertainty Avoidance

Collective/ Individual

Masculine/ Feminine

Canada

Small

Mid

Individual

Masculine

Thailand

Large, but smaller than Indonesia

Strong

Collective

Feminine

Indonesia

Large

Weak

Collective

Feminine

Malaysia • Malay • Chinese • Indian

Large Large Large

Weak Weak Weak

Collective Collective Collective

Feminine Masculine Masculine

Source: Hofstede (1983), Yeates etal. (1993)

distance, it is lower than either Malaysia or Indonesia. Thailand is similar to the Malay group (in contrast to the Chinese and Indian) in being stronger on the feminine side. Thais tend to be open to compromise and flexible—characteristics that kept Thailand free of colonial domination. Respect, gratitude, harmony and love of fun (sanuk), are also important values (Intravisit, 1990). Intravisit also maintains that even with the rapid development of modern-day Thailand, the influence of the Western cultures and the change in generations, these values will remain. (Of all three countries considered here, the greatest generational differences are found in Thailand. For Canadians doing business, these need to be taken into consideration, along with differences found dealing with Sino-Thai firms, Thai family firms and Thai government officials (Svita, 1986).) In Hofstede's dimensions (Hofstede, 1983), Indonesia is high on power distance, low on uncertainty avoidance, collective and slightly feminine. This implies that: Southeast Asian perceptions of Canadian business

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1. Personnel selection should take ethnic and family factors into account, 2. Payment by results is rarely possible, 3. Direct appraisal of performance is delicate, 4. Dismissal of employees is culturally undesirable, 5. Direct confrontation should be avoided, 6. Go-betweens have an important role, 7. Models of participative management are out of place, 8. Status differences are desirable, 9. Formal politeness and restraint of emotions are imperative, 10. Punctuality and technical precision demand a lengthy learning process, 11. Sympathy for the weak should not a priori be expected. Interviews with Canadian and American business people have reinforced these implications (e.g., Mann, 1987, 1990; Wright, 1991; Draine and Hall, 1986), as does Soemardjan's (1975) description of the cultural background of the Indonesian businessman. The ideal Indonesian organizing principle for management is "return on favours," in contrast to Western "return on investment" (Vroom, 1981). Soemardjan (1975) also comments that "administration manifests itself in the confidence people are able to invest in the personality of those in power," rather than in formal programs or policies. Thailand's noted "patron-client" relationship in business is another manifestation of the same principle.

Southeast Asian perceptions of Canadian business Given these fundamental differences between Canadian and Southeast Asian business systems, how do Southeast Asians view Canadians who seek to do business in their countries? A large amount of anecdotal evidence has been accumulated over the years. Based on a selection of this evidence and on the Delphi session with experts held at Queen's University, one could hypothesize that Asian perceptions of Canadian businesses in the region are mixed. In particular, that: 1. Canadian companies are not interested in Southeast Asia, 2. Canadian companies are not well-prepared,

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3. Canadian companies do not understand the culture of the countries, 4. Canadian technology is respected, 5. Canadians are friendly, 6. Canadians are preferred to Americans in business dealing, 7. Canadians are not risk-takers. To test these perceptions, surveys were designed to study how Thais, Malaysians, Indonesians and Canadian companies perceived Canadians doing business in Southeast Asia. Sixty Thai business people were randomly selected from the Thai Canadian Chamber of Commerce Directory. Another forty were drawn from the lists of Enterprise Malaysia Canada and the Malaysia Canada Business Council in Kuala Lumpur. The names of thirty Indonesian business people were obtained from a list compiled by the Canadian Investment Advisor to the Investment Coordinating Board in Jakarta. (This was every name on the list.) The number of recipients was limited because they were required to have had some direct experience with Canadian business people. Since the main focus was on Asian perceptions of Canadians, only thirty surveys were sent to Canadian companies to act as a control group. There were twenty responses from Thai and Indonesian companies (22 percent response rate). Of the Asians responding, over half (56 percent) were the president of their company. Half the companies were medium-sized (51-500 employees), and a third were small (under 50 employees). One third (31 percent) were in the consulting business, and the remainder divided roughly evenly between high tech, manufacturing, financial services, tourism, trade, and resources. All had conducted business with Canadians—almost two-thirds (62 percent) had done so for over five years. Agent/licensee was the primary relationship (44 percent). Almost two-thirds of the participants (64 percent) indicated that they felt Canadians were less successful at conducting business in the region than other foreign business people were. Twenty-one percent felt Canadians were equally as successful.

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Factors in success The first set of questions asked participants to list the factors required for Canadian businesses to be successful in Southeast Asia, and then list possible barriers to success. The list of barriers was much longer than the list of success factors (20 compared to 12), and responses on success factors may have been normative (what should be, rather than what is). Understanding the culture was a key factor for success. But not understanding the culture did not appear in the barriers. Other success factors were commitment, access to Canadian government support, non-colonial attitude, friendliness, and being technically advanced. "Acceptable, but not excellent, technology" was mentioned by one person, which may have meant "appropriate technology." Harriers Barriers mentioned by at least three people included little intention of investing overseas, poor knowledge of the market, distance from the market, and a bad attitude. Too conservative, uncompetitive prices, lack of commitment, and short term expectations were all listed by at least two people. Perceptions The second set of questions asked respondents about their perceptions of Canadians, and asked them to list the word or phrase they felt best captured Canadian business culture. The most common perception of Canadians was that they were friendly (nine citations), followed by conservative (four). Of the twenty-nine different phrases used to describe Canadians, almost one-third (eleven phrases) could be considered positive (e.g., friendly, calm, flexible, polite, well received, easy to work with, patient). Almost half (fourteen phrases) could be considered negative (e.g., unfriendly, arrogant, inflexible, lack negotiating skills, naive, not serious enough), and four could be considered neutral (high expectations, not too aggressive, no Team Canada approach, conservative). Of the neutral phrases, the first two tend toward the positive, and the second two toward the negative. Of the twelve different phrases used to sum up Canadian business culture, only two were definitely positive (friendly and efficient, international standard with a human touch). Three more were neutral (OK, 126

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similar, less aggressive than American style). The remainder had strong negative connotations (time consumers, no interest, not so good, still amateur, inflexible). Only half the respondents indicated what they found most difficult about doing business with Canadians: 1. convincing Canadians of the necessity of long-term relationships in strong as well as weak markets, 2. lack of business focus, 3- inflexible, 4. products don't suit the market, 5. instability of Canadian business organizations (i.e. personnel changes), 6. lack of responses, 7. trust, 8. decision-making procedures are ineffective and long, 9. involvement of lawyers in the process of deal-making, 10. too conservative; do not want to take chances. More of the respondents were willing to give advice to both Canadian companies and Thai companies doing business with Canadians. Advice offered to Canadians included: learn the culture, choose the right partner, be flexible, have a longer term commitment, and do your homework. Advice offered to Asians included: understand that Canadians approach projects differently (time and conservatism), and be straightforward and sincere. Two other pieces of advice appear to refer to the frequently-mentioned conservative nature of Canadian business people: "Go ahead and do it if they are nice people, but you will need a lot of effort to convince them of anything," and "Be prepared to negotiate. Beware when dealing with people with less entrepreneurial perceptions." The results of this survey are bolstered by documented opinions of Asians and Canadians. Government officials in four countries— Thailand, Malaysia, Indonesia, and Canada—have commented on the Canadian private sector's lack of aggressive pursuit of business opportunities in the region (e.g., Milner, 1989; Malaysia Special Report, 1993; APFC, 1994; van Nostitz, 1995; Bell, 1995). This lack of aggressiveness when entering Asian markets is a common complaint, Southeast Asian perceptions of Canadian business

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not to be confused with assertiveness and persistence as desirable individual traits. Other frequently cited characteristics include a lack of knowledge of ASEAN countries and a failure to follow through (e.g., Malaysia Special Report, 1993; van Nostitz, 1988; van Beek, 1990). Thai-Canadian Business (TCB) (Nov-Dec. 1989-Jan-Feb. 1995) and Thai Business Review (TBR) (Oct 1993-Nov 1994) were also used as sources of data for the study. Content analysis supported the study's findings that Asians perceive Canadians as friendly, well-received, technically advanced and not too aggressive. Further content analysis revealed that Canadians are also perceived to be slow in reacting, impatient, not market-oriented, lacking in market knowledge, lacking in price-competitiveness, and having little interest in investing overseas. A specific comment was that Canadians expect a contract to be signed quickly, whereas the Thai partner prefers to take the time necessary to feel comfortable with the person before committing to business (TCB, July-Aug 1992:18). Sean Brady, a Canadian consultant and former government official, has a different perception—that the younger generation of Thais is more intent on proceeding to a deal (Ward, 1990). This may be indicative of the generational differences mentioned earlier. Key success factors were mentioned primarily in the context of required qualities, rather than necessarily in the context of what Canadian companies already possess. The one factor mentioned more than once was commitment. Perseverance, patience, mutual trust and respect, adaptability and commitment were mentioned by both Thais and Canadians. Many of the factors mentioned in an earlier study (Rahman and Balcome, 1987) also appear in this study, eight years later. Canadians are still perceived to be unfamiliar with the Thai market and uninterested. There were two factors in the earlier study that did not appear in this study, however. Eight years ago, Canadian companies were perceived to be subsidiaries of US companies and too reliant on the Canadian government. Today Canadian government support is considered a success factor. Published sources like Thai-Canadian Business and Thai Business Review were not available for Indonesia or Malaysia. In the course of a study on Canadian-Indonesian project negotiations (Wright, 1991), 128

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however, 30 Indonesians and 32 Canadians were interviewed to determine, among other things, how the Indonesians viewed Canadians doing business in Indonesia. Many of the Indonesians interviewed did not distinguish between Canadians and Americans, assuming such differences to be minimal. In general, Indonesian perceptions of Westerners were negative. They were viewed as inflexible, short-term oriented, concerned with business rather than relationships, prone to expressing all their feelings, always demanding, and with little understanding of new conditions. They felt that Westerners tried to influence by teaching, thus putting Indonesians in an inferior position. There was also a hint that Westerners should have more of a sense of obligation to help poorer countries and not be such tough negotiators. Those with specific experience with Canadians (twelve of the thirty), felt Canadians tended to see the project rather than the people, and that in negotiating they were often divided rather than working as a team. They felt Indonesians were more prepared to accommodate than Canadians, and that Indonesians placed more emphasis on verbal commitments while the Canadians relied on written. Other comments were that Canadians were honest, kind, willing to learn, did not understand general business practices in Indonesia, were not looking for a market in Indonesia, and were not usually successful there. When comparing Canadians to other nationalities, they found Canadians to be gentler than Americans, more flexible than Germans, and to have different principles from the Japanese. The general view of Canadians, however, was that they were rigid and inflexible. This was also borne out by interviews conducted with Indonesian negotiators at the end of an observed negotiation (part of the same study). The general view by the Indonesian team was that the Canadian negotiator had been extremely inflexible, even though the researcher had found him very flexible. The researcher and the Indonesians were basing their views of flexibility on different precepts (Wright, 1991). O'Grady's research (1991) on Canadian retail companies entering the US market came up with similar findings. Inflexibility was one of the key reasons for failure. Canadian executives scored lower than their American counterparts on the Jackson Personality Inventory on achievement, risk-taking and tolerance. On her self-developed scale, Southeast Asian perceptions of Canadian business

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Canadians scored much higher on cautiousness than did Americans. The following factors in this survey have also been found in others (Rahman and Balcome, 1987; TCB content analysis; Wright, 1991): Key Success Factors: Barriers:

Perceptions:

Commitment (TCB) Technologically advanced (TCB; R&B) Little intention of investing overseas (TCB; R&B; Wright) Poor market knowledge (TCB; R&B) Friendly (TCB) Not flexible (Wright) Honest (Wright) Naive (R&B) Not market-oriented (TCB) Lack of cultural understanding (Wright) Not aggressive enough (R&B) Not successful (Wright) Short-term orientation (R&B)

Canadian companies in Southeast Asia: Three case studies Before we discuss the implications of the above list for Canadian business, it is useful to review some actual examples of Canadian companies doing business in Southeast Asia. One frequently-mentioned Canadian success story in the region is Bata Shoe. Bata, however, invested in Indonesia and Thailand in the 1930s, while it was it still a Czech company and Indonesia was still a colony of the Netherlands. The situation is so different now that it is hard to draw parallels that will be useful for companies today. Another famous example is Inco in Indonesia, with its operations in Sulawesi, one of the eastern islands. Again, it is questionable whether there are useful parallels for Canadian companies today. With a recorded investment of US$1.4 billion ("Indonesia Focus," 1993), it was a massive venture on a scale very few Canadian companies are capable of. It was negotiated in the early 1970s under different regulations than prevail now, and began operations in 1978. Inco has had a troubled history, plagued by accidents and low nickel prices, but the 130

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company has persevered, and recently unveiled a plan for a US$500 million expansion (McBeth, 1994). It is also important to note that there has been Japanese involvement throughout most of the life of the investment and it is now a joint venture. Canadian resource-related companies (oil, oil service, mining) and service sector companies (engineering, consulting, and insurance) have been more successful in Southeast Asia than manufacturing companies (Hainsworth, 1986; Wright, 1991). The following are case studies of three service sector companies that have been successful in Southeast Asia. Two are engineering consulting firms in Indonesia; the third is an environmental services firm in Malaysia. Lavalin International and N. D. Lea International Inc. in Indonesia2 Lavalin International and N.D. Lea, have spent more than ten years in Indonesia. Both had broad experience in the Southeast Asian region, and both approached the market in a similar fashion, investing in building contacts and long term relationships. They differed in size and areas of specialization: Lavalin was much larger and more diversified; Lea was medium-sized, specializing in highway design and construction. Because these companies experienced both successes and failures, four specific projects are compared. A project in management assistance (Lea) and one in design work (Lavalin) were successful. The two negotiations that failed were in supervision work, where competition is fierce because of high profit margins. Both of the successful projects had multiple goals. Lavalin's goals were all connected with the financial aspects of the negotiation, while Lea's goals included technical and relational ones as well. The differences in the goals may be because Lea viewed its project as crucial to its future success in Indonesia, while for Lavalin, this was just another project in one of its areas of expertise. The unsuccessful projects had 2

All the information here is based on Wright (1991).

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only one goal each, which may have limited the possibilities of trade-offs or creative bargaining, which can be a contributing factor to failure. In the successful projects, the Canadian firm was in a joint venture with another foreign firm (Japanese), had had a prior relationship with the local partner, made initial contact through either the local partner or other personal connections, did a great deal of preparation, and maintained close contact. In both the failures, the Canadian firm did not team up with another foreign firm, had no prior relationship with the local partner, made initial contact through other work they had carried out or through written notification, did less preparation, and did not maintain contact. In three of the four cases, the Canadian negotiator had a good knowledge of the culture, spoke the language, and had favourable perceptions of the Indonesians. In the most spectacular failure, where negotiations ended with bad feelings on both sides, the Canadian chief negotiator had a poor knowledge of the culture, negative perceptions of the Indonesians, did not speak the language, and had a determination to be tough. His personality may have contributed to the failure; very aggressive, abrasive personalities may not function well in feminine, collective cultures like Indonesia's. Knowledge of culture and favourable perceptions of the other side appear to be a necessary, but not sufficient, condition for success. They are usually, however, coupled with good relations, and it may be this added element that makes for success. Everyone on the Canadian side said a good relationship with the client was the main reason for the success of a particular negotiation. (The Indonesians agreed in one case, and could not remember in the other.) However, in itself, this will not guarantee a successful negotiation. One needs the relationship plus professional competence, as indicated in a second reason given—a good proposal. As one person said, "A good relationship can make the difference between being ranked second or first, but it won't pull you up from fourth position." The reasons given for failure were more varied. They included external factors: local politics, allegations that the second ranked company paid a bribe and had many contacts, the chief Indonesian negotiator not wanting to give the company the project, government 132

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regulations, and bad timing. They also included internal factors: intracompany friction, quality of personnel chosen, unethical behaviour of the chief, the tactics of the Canadian chief negotiator, and clash of personalities. (The Indonesians, both government and local partner, attributed one of the failures entirely to the personality and approach of the chief Canadian negotiator.) Since contracts are a major signal of success to most Canadian business people, it is interesting to note that in one successful case project implementation pre-dated the signed contract, and signing the contract did not end the negotiation process in either of the successful projects—there were further bargaining sessions to negotiate changes in the contract throughout the projects. Gartner Lee in Malaysia3 Gartner Lee specializes in environmental consulting. It is a small firm that began international work recently in order to expand its growth opportunities beyond the domestic market. A number of years ago, the company began to hire staff who could help them internationally, including a Malaysian and an Indonesian. Gartner Lee made a strategic decision to stay away as much as possible from international financing institutions, believing that route to be extremely competitive and a slower way to secure contracts. They searched for a region with growth opportunities where language would not be a barrier. Singapore was too expensive; not enough was known about Thailand; and Indonesia was perceived to have cultural differences that they were not comfortable with, such as informal negotiation practices, and an emphasis on knowing the right people and having the right contacts rather than on merit or efficiency. Malaysia met most of their decision criteria, and since they could only afford to set up one office, it could be used as a beachhead to access other countries as well. The first project in Malaysia was with a consulting firm in 1993. The project took one year to negotiate, with the actual work lasting only five months. They did not make money, but viewed it as an important step towards establishing themselves in the market, and felt 3

All the information here is from a forthcoming case study, Wright (1995).

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that the project had created a link to the Ministry of the Environment. At the end of the contract they had a clearer view of what they needed in a joint venture partner. They wanted a partner with both political and private connections, that they could work with on a sustained basis, so that the partner could generate work for them. Since their present partner was a consultant who was more interested in working on a project by project basis, they parted amicably. The Canadian High Commission was very helpful in the partner search—setting up meetings, advising on potential partners and inviting them to receptions so they could meet people. They used the services of Enterprise Malaysia Canada (EMC) to facilitate the joint venture arrangements. Their help on the financial side, assistance with negotiations and provision of "savvy" were felt to be extremely beneficial. They are now very comfortable with their new partners—a division of HICOM. (HICOM is the corporation set up by the government to spearhead Malaysia's industrial drive. Its most well-known project was the development of the national car—the Proton. It is now one of the country's biggest industrial and investment organizations.) Unlike the other case studies in this section, which are already finished and can be assessed, Gartner Lee is just at the beginning of its project. It appears to be off to a good start. The key factors in this company's success are: • a commitment to the region and their strategic plan, • the trade mission that provided the opportunity to meet their eventual partner, • having a Malaysian on staff to introduce them to the country and brief them on the culture, • having already worked in Malaysia, • hiring a consultant in Canada in the early stages to open management's eyes to international opportunities, particularly in Asia, • networking, • having a joint venture with another Canadian company (Keir Consultants Inc.), • demonstrating through their relationships with EMC and the Canadian High Commission that they were well connected, and not a fly-by-night organization. 134

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Gartner Lee has made a commitment to travel to the region three times a year for a minimum of three weeks each to help with marketing. The agreement with HICOM is for the entire ASEAN region, not just Malaysia, and it could extend beyond this, if opportunities arise. The three successes have several important similarities. They all involved a joint venture with another foreign firm. Knowledge of the culture was felt to be important, and relationships were cultivated. All three had prior experience in the country in which they were seeking projects. A difference was that the first two were funded by an international financing institution, while the third relied on Canadian government support.

Implications for Canadian business The survey evidence shows that Canadian firms are, on average, some distance from business success in Southeast Asia. The case studies, however, document some notable exceptions. Lessons can be learned from the practices of successful companies, as well as from the advice and perceptions of survey respondents: build on positive perceptions, counteract negative perceptions, and understand the local business environment—particularly government-business relations and unfamiliar business systems.

Opportunities There are tremendous sectoral opportunities in Southeast Asia where Canadian firms can build on their technical strengths. Host governments are preoccupied with responding to demands arising from rapid economic growth and development. Large investments in infrastructure are planned, that will involve local partners and government clients. Canadian firms are already involved in these projects, providing consulting engineering services at the feasibility and design stages. Since most are not yet involved in supervising these projects, there is room for growth. Telecommunications will be another significant growth area as deregulation occurs. Many local conglomerates are expanding into this sector, even if their core business is in another area entirely (for example, the C.P. Group in Thailand started out in agribusiness but is expanding into telecommunications). Since they bring the financial Southeast Asian perceptions of Canadian business

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resources but are learning the business, partnership opportunities exist for Canadian firms with expertise. A third sector that is often overlooked is in educational services. Most Southeast Asian governments rank development of human resources high on their list of priorities. Deregulation in Thailand and Malaysia means new opportunities. Malaysia is also one of the first three countries where Canada, with the Asia Pacific Foundation as executing agency, has opened a Canadian Education Centre (CEC). The Team Canada concept mentioned in the survey results will be of great benefit here, and was one of the reasons behind setting up the CECs. Private sector links with the academic sector should also be explored. Many projects in infrastructure and telecommunications require technology transfer and training. Since these are educational services, partnerships between companies and universities or community colleges could be mutually advantageous when bidding on contracts. Since professors are part of the civil service in most of Southeast Asia, and there is constant movement between government departments and universities, there is more respect for universities than perhaps there is in the Canadian business community. Mining, and oil extraction and services are other areas of traditional Canadian industrial strength. In the present climate, opportunities may not be so much in the exploration and extraction, both of which require a great deal of capital, but in the provision of oil and mining related services, which are in great demand. Environmental services, another Canadian strength, is a high growth area, as Southeast Asian governments recognize the need for environmental protection as well as economic growth. Finally, auto parts—a sector that may not be at the forefront of most Canadian thinking about Southeast Asia—should not be overlooked. Canadians have the expertise, and the auto industry in Southeast Asia is growing rapidly. While most assemblers and many auto parts firms are Japanese-owned, the North American Big Three are beginning to make a production presence. Tying into the North American facilities as they come on line is the most obvious option, but a second option is to tie into the Japanese network using supplier arrangements that have been created in Canada. Thailand is now the largest producer of auto parts in the region. The Malaysian 136

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government formed a joint venture with Mitsubishi to build the Proton, which is now being exported. In Indonesia, Astra has a major joint venture with Toyota, and a vast domestic market. Implications for Canadian Companies 1. Joint ventures with other firms Many infrastructure projects, such as the rapid transit systems in Bangkok and Kuala Lumpur and the power plants in Indonesia, may be too large and complex for a single Canadian firm to handle. Options should be considered for partnerships with other firms. For example, ventures with other Canadian companies fits the Team Canada concept and provides risk sharing. Another option is to locate a foreign partner, from Japan or Korea, for example, where firms tend to have more regional experience, better networks and a better understanding of local cultures. Partnering with a firm from another country also may help win a bid, because the client can then please two countries with one project. Southeast Asian governments are increasingly accustomed to official intervention by governments on behalf of their firms, particularly in large projects funded by multilateral institutions. 2. Knowledge of the local culture Choosing to partner with an experienced firm as an entry strategy into a new market is a way of gaining the knowledge needed to be successful there. However, in order to ensure that knowledge is actually transferred, explicit systems need to be put in place to ensure that people are learning. This can be done, for example, by pairing two people, one from each company, in a mentoring role or buddy system, and asking for reports, pre-negotiation briefings and post-meeting debriefings on what happened and why. (Did that "yes" really mean agreement, or was it merely politeness?) The same holds true for learning from your local partner. Once that knowledge is institutionalized in your company, you are in a much stronger position to bid on future projects. Another way of shortening the learning curve is to hire a national from the target market. Canadian business has not taken advantage of the number of recent Asian immigrants (APFC, 1994). Although

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many are from Hong Kong, substantial numbers are from Malaysia and Singapore (fewer from Thailand and Indonesia). Hiring a Thai or Indonesian who is studying in Canada or the US to help with a particular project in their area of expertise is also a way to add knowledge to the company. Travelling to the region, after having done some preparation, is a sine qua non. Preparation for such travel should include briefings on cultural values, etiquette, negotiating style, business systems and ways of doing business. It is also helpful to debrief afterwards, so that the knowledge gained is shared with the entire group. It is also important to remember that knowledge gained in one country may not necessarily apply to another country. Cultural familiarity and preparation are critical to success. 3. Personal relationships It is becoming increasingly important, given the mobility of employees, to ensure that the company knows what each of its employees knows. As international competition increases, this is a relatively inexpensive way to give a company an edge. It is equally important, however, to make use of this knowledge. For example, by now, most Canadian business people with any interest in Asia know that personal relationships are important, but many still skimp on the time that is necessary to develop such relationships. The importance of developing personal relationships cannot be overstated. As mentioned previously, the organizing principle for many Southeast Asian companies is not the Western standard of return on investment, but rather return on favour. This necessitates personto-person knowledge and contact. It also means that loyalty accrues to the person and not necessarily to the organization itself. Canadian companies should be sending the same people to the region on a continuing basis, and allowing these people to introduce new personnel. As Gartner Lee's experience shows, relationships developed in Southeast Asia can be used to enter other countries, such as China or India. Southeast Asian conglomerates understand the cultures better than Canadian companies, are entrepreneurial and have extensive networks. Canadians companies will gain knowledge about product 138

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development, processes for overcoming obstacles and adapting to local conditions that will strengthen their competitiveness both back in Canada and internationally. Canadian companies should consider forming partnerships in more than one country in the region. With the growth triangles, AFTA and the importance placed on ASEAN by the governments, a regional strategy may be a more effective way of utilizing scarce resources to deal with the rapid growth and intense competition in ASEAN. All of this clearly shows, however, that the single most important decision in a business venture may be the choice of a business partner. It is wise to choose a local partner with care. It is important to remember that harmony is a strong value in each of these cultures. A spirit of partnership is much preferred to an attitude of "giver of expertise." The size of the partner is important. Large conglomerates may not be interested in small Canadian partners, and small firms run the risk of being swallowed. However, small local firms tend to be weaker than conglomerates, both financially and managerially, and will require assistance with financial and other business practices, as well as technology. The business philosophy of a potential partner is also important. A group with strong trading roots may have a short-term, high turnover outlook that may not suit a Canadian business. Attitudes towards quality, service and ethics should be investigated. Since many of these markets are relatively young, there is no concept of an "educated consumer". Some companies have not made quality and service a top priority, and may not understand why it is necessary. 4. Connections

Developing and maintaining business connections is particularly important in Southeast Asia (as indeed throughout the region). Networks can be built and maintained through meetings, playing golf, remembering birthdays, sending information on university entrance for colleagues with teenage children, etc. It is also important to write or fax from Canada even if there is nothing concrete to report, to ensure the lines of communication remain open in spite of the distance. Canadian firms are perceived to be uninterested in the market, so they must work hard to overcome these negative perceptions. They Southeast Asian perceptions of Canadian business

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also need to make their physical presence felt, either by setting up an office or making regular trips. The effort and expense of setting up an office is a concrete way of demonstrating long-term commitment, a factor shown by the survey to be critical to success in the region. 3. Prior experience Prior experience was a common factor in the three successful projects reviewed earlier. Companies with no experience in the Southeast Asian market, and that don't have an experienced firm to partner with, may want to consider doing a project on a break-even basis, as Gartner Lee did. 6. Multiple goals Inflexibility was one of the barriers to success identified in the survey. It was also perceived to be a major characteristic of Canadian businesses. The successful projects in Indonesia all had several goals, which made the companies flexible enough to make tradeoffs during bargaining. Implications for the Canadian government The availability of support by the Canadian government was identified by the survey as a critical success factor. The Canadian government has three implied functions: information dissemination, acting as a catalyst, and providing direct support. 1. Information dissemination Working through industry associations such as the Canadian Manufacturers' Association, and through the various bilateral business councils (each of the three countries now has one), the government should ensure that information about business opportunities is disseminated as widely as possible. These groups can also act as sources of information about culture and ways of doing business, directing members to private consultants or universities for more information when necessary. 2. Catalyst The Canadian government can act as a catalyst in developing a Team Canada approach. This approach would allow companies to get the maximum value from limited resources, and give the countries in 140

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Southeast Asia the feeling that there is substance and focus, which form a solid base for long-term commitment. Companies that are seen to have the support of their government are well received in Southeast Asia. 3- Support Since small- and medium-sized enterprises are considered to be a significant source of growth in the Canadian economy attention needs to be paid to making them "export ready" (e.g., revamping the FITT program). Programs such as CIDA-INC, Enterprise Malaysia Canada, Enterprise Thailand Canada are valuable sources of financial support and advice and provide the contacts necessary for entry into the local business community, particularly for smaller companies. However, it is important that these programs, and others such as the Program for Export Market Development (PEMD), be used to prepare and encourage firms, but not to make them entirely dependent on them for success.

Conclusion The Canadian presence in Southeast Asia has not kept pace with the dynamic economic opportunities in the region, as the survey of several key countries in this paper shows. Local governments and firms think increasingly in regional terms in order to move beyond relatively small local markets and exploit the rich diversity of crossborder opportunities, within the region and beyond. This means the local environment is generally a welcoming one for foreign firms. Yet the Canadian presence in Southeast Asian markets has not reflected this fact. Our investigations highlight weaknesses in two areas that are keys to success: Canadians have not been interested in the market and have not made the effort to understand the cultures. Neither obstacle is difficult to overcome if the interest exists. Canadian companies need to move from a production outlook to a marketing outlook. Development of such an outlook requires an understanding of the characteristics of the markets—local cultures, local business environment and business systems, and local and foreign competitors. The Japanese are known in the region for the efforts they make in this direction, and they have the results to show for it. Canadians need to make similar efforts if they are to be successful. Southeast Asian perceptions of Canadian business

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Government has a role in helping firms overcome the inhibitors of a Canadian presence in Southeast Asia: fear, lack of capital, and lack of legal protection. Fear can be reduced by providing information. Capital constraints can be eased by programs such as PEMD, and through services offered by the Export Development Corporation. Inter-governmental negotiations can help solve the problem of the lack of legal protection. Progress in this area is steadily being made. Perhaps the least-tangible obstacle is distance. Many Canadians still seem to think of Southeast Asia as distant—over the horizon, yet US and European competitors contend with this obstacle successfully. Government and business need to understand that the barriers to success identified in this study are mostly under our own control, and are things that we can do something about through training and information-gathering. We have identified strengths on which Canadian firms can build. Many of the sectors that are priorities for the Southeast Asian governments are also sectors of Canadian expertise (e.g., infrastructure, telecommunications, education). Thus, we must develop successful entry strategies, a topic explored by Head and Ries earlier in this volume, and capitalize on the fact that Canadian technology is good and perceived to be good—it just needs to be successfully marketed. But as this study has emphasized, entry strategies are only part of the challenge. Investments in good relationships, reflecting sensitivity to the values of Southeast Asia's more collective cultures, are just as important.

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References Abdullah, Asma. 1992. "The Influence of Ethnic Values on Managerial Practices in Malaysia." Malaysian Management Review. 27: 3-18. Aikman, David. 1986. Pacific Rim: Area of Change, Area of Opportunity. Boston: Little, Brown and Company. Asia Pacific Foundation of Canada. 1994. Canada's Hidden Advantage: Asian Canadians. Vancouver: Asia Pacific Foundation of Canada. "Asia's Leading Companies." 1995. Far Eastern Economic Review. January 5: 38-72. Bell, John. 1995. "Canadian Opportunities in Malaysia." Speech given at Asia Pacific Foundation Breakfast. Toronto, January 18. Chow, Wyng. 1994. "Indonesia Ready, Willing." Vancouver Sun. April 13. CIDA Programs in Asia. 1993. Ottawa: Asia Branch, Canadian International Development Agency. Clad, James. 1989- Behind the Myth: Business, Money and Power in Southeast Asia. London: Grafton Books. Constandse, William. 1982. Inside Indonesia: A Practical Guide for Businessmen. Tucson: Utama Publications. Country Profile: Indonesia 1994/95. 1995. London: The Economist Intelligence Unit. Country Profile: Malaysia, Brunei 1993/94. 1994. London: The Economist Intelligence Unit. Country Profile: Thailand, Myanmar 1993/94. 1994. London: The Economist Intelligence Unit. Dhiratayakinant, Kraiyudht. 1990. "Public Enterprises." In Peter G. Warr, ed. The Thai Economy in Transition. London: Cambridge University Press. Draine, Cathie and Barbara Hall. 1986. Culture Shock! Indonesia. Singapore: Times Books International. Economist Intelligence Unit. 1994. "Education in Thailand: Private Partial Solutions." Business Asia. September 26: 5-6.

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EDC Today Supplement. Summer 1994. Ottawa: Export Development Corporation. Fenwick, Ian and Bhanich Supapol. 1993. "Canadian Direct Investment in the Southeast Asian Pacific Rim, with Particular Reference to Thailand." Kingston: John Deutsch Institute, Queen's University. "Growth Triangle Cooperatives Make Progress." 1994. Indonesia Development News Quarterly. Winter: 13. Hainsworth, Geoffrey B. 1986. Innocents Abroad or Partners in Development? An Evaluation of Canada-Indonesia Aid, Trade, and Investment Relations. Singapore: Institute of Southeast Asian Studies. Hamlin, Kevin. 1993. "Asia's Rising Stars." Asia Inc. July: 36-40. Heng Pek Koon. 1992. "The Chinese Business Elite of Malaysia." In Ruth McVey, ed. Southeast Asian Capitalists. Ithaca, N.Y.: Cornell Southeast Asia Program. Hicks, George and J.A.C. Mackie. 1994. "A Question of Identity." Far Eastern Economic Review. July 14: 46-51. Higgins, John, David Balcome and Michael Grant. 1988. Canadian Investment in the Association ofSouth-East Asian Nations. Ottawa: The Conference Board of Canada. Hofstede, Geert. 1982. Culture's Consequences: International Differences in Work-Related Values. Beverly Hills: Sage Publications. . 1983. Cultural Pitfalls for Dutch Expatriates in Indonesia. 2nd ed. Jakarta: Deventer. Indonesia Backgrounder. October 1994. Vancouver: Asia Pacific Foundation of Canada. "Indonesia Focus." 1993. The Financial Post. August 17. Intravisit, Apichart. 1990. "Thai Values in the Workplace." Friends of Thailand News. 2:6. 3. Jayasankaran, S. 1995. "Privatization Pioneer." Far Eastern Economic Review. January 19: 42-44. Jesudason, James V. 1989. Ethnicity and the Economy: The State, Chinese Business, and Multinationals in Malaysia. Singapore: Oxford University Press.

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Jomo, K.S. 1990. Growth and Structural Change in the Malaysian Economy. London: The MacMillan Press Ltd. Low, Linda. 1995. "The Evolution of Southeast Asian Business Systems." Paper presented to the Association for Asian Studies. University of Michigan: mimeo. Limlingan, Victor Simpao. 1986. The Overseas Chinese in ASEAN: Business Strategies and Management Practices. Manila: Vita Development Corporation. Maclntyre, Andrew. 1991- Business and Politics in Indonesia. North Sydney: Asian Studies Association of Australia/Allen and Unwin. Mackie, J.A.C. 1988. "Changing Economic Roles and Ethnic Identities of the Southeast Asian Chinese: A Comparison of Indonesia and Thailand." In Jennifer W. Cushman and Wang Gungwu, eds. Changing Identities of the Southeast Asian Chinese Since World War II. Hong Kong: Hong Kong University Press. . 1992. "Changing Patterns of Chinese Big Business in Southeast Asia." In Ruth McVey, ed. Southeast Asian Capitalists. Ithaca, N.Y.: Cornell Southeast Asia Program. Mahbob, Sulaiman. 1992. Issues in Recent Malaysian Economic Growth. Kuala Lumpur: Arena Ilmu Sdn. Bhd. "Malaysia Special Report." 1993- The Financial Post. August 28. Mann, Richard, ed. 1987. Canadians in Indonesia: An Investment and Trade Primer. Toronto: Gateway Books. . 1990. Business in Indonesia. Toronto: Gateway Books. McBeth, John. 1994. "Show of Mettle: Inco Indonesia Banks on Rising Nickel Prices." Far Eastern Economic Review. December 15: 53-54. McBride, Gail. 1994. "Exporting Engineering Services to Asia." CanadExport. 12:11. Milner, Brian. 1989. "Canadians Missing Thai Opportunity, Trade Official Says." Globe and Mail. October 25. Mubyarto. 1985. Pancasila Economic System. Jakarta: Gadjah Mada University Press.

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O'Grady, Shawna. 1991- Canadian Retail Companies Doing Business in the U.S. Market: A Cultural Perspective. Ph.D. Dissertation. London: The University of Western Ontario. Phipatseritham, Krirkkiat and Kunio Yoshihara. 1983. Business Groups in Thailand. Singapore: Institute of Southeast Asian Studies. Rahman, Syed and David Balcome. 1987. Canadian Business Linkages with the Developing Countries: th e Asian Experience. Vol 1. Ottawa: The Conference Board of Canada. Redding, Gordon. 1980. "Cognition as an Aspect of Culture and its Relation to Management Processes: An Exploratory View of the Chinese Case." Journal of Management Studies. 17(2): 127148. Richards, Peter. 1987. The Cultural Context of Doing Business in Thailand. Issues 2: 4. Robison, Richard. 1986. Indonesia: The Rise of Capital. North Sydney: Allen & Unwin. . 1992. "Industrialization and the Economic and Political Development of Capital: The Case of Indonesia." In Ruth McVey, ed. Southeast Asian Capitalists. Ithaca, N.Y.: Cornell Southeast Asia Program. Sato, Yuri. 1989. The Development of Business Groups in Indonesia: 19671989. Jakarta: Universitas Indonesia. Schlossstein, Steven. 1991. Asia's New Little Dragons: The Dynamic Emergence of Indonesia, Thailand and Malaysia. Chicago: Contemporary Books. Sieh, Mei Ling. 1992. "The Transformation of Malaysian Business Groups." In Ruth McVey, ed. Southeast Asian Capitalists. Ithaca, N.Y.: Cornell Southeast Asia Program. Smith, David. 1990. "MDA Lands $30M Contract." The Vancouver Sun. December 5. Soemardjan, Selo. 1975. "The Cultural Background of the Indonesian Businessman." Ekonomi dan Keuangan Indonesia. 23(2): 95-100. Statistics Canada. Canada's International Transactions in Services. Catalogue 67-203- 1990 and 1991.

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Stubbs, Richard. 1991- "Canada's Relations with Malaysia: Picking Partners in ASEAN." Pacific Affairs. 63(4). Suehiro, Akira. 1992. "Capitalist Development in Postwar Thailand: Commercial Bankers, Industrial Elite, and Agribusiness Groups." In Ruth McVey, ed. Southeast Asian Capitalists. Ithaca, N.Y.: Cornell Southeast Asia Program. Suryadinata, Leo. 1988. "Chinese Economic Elites in Indonesia: A Preliminary Study." In Jennifer W. Cushman and Wang Gungwu, eds. Changing Identities of the Southeast Asian Chinese Since World War II. Hong Kong: Hong Kong University Press. . 1992. Pribumi Indonesians, the Chinese Minority and China. Singapore: Heinemann Asia. Svita Foundation. 1986. Thais Do Business the Thai Way. Bangkok: CIDA/Thailand. Thai Business Review. All issues October 1993 to November 1994. Thai Canadian Business. All issues November-December 1989 to January-February 1995. Thailand Backgrounder. October 1994. Vancouver: Asia Pacific Foundation of Canada, van Beek, Steve. 1990. "Canada's Man in Bangkok." Canadian Magazine. October: 88-94. van Nostitz, Manfred G. 1988. "Canadian Presence in Malaysia: Evolution and Trends." In Martin Rudner, ed. Canada Malaysia: Towards the 1990's. Kingston: Ronald P. Frye & Company. . 1995. "Opportunities for Canadian Business in Thailand." Speech delivered at Queen's University. January 17. Vroom, C.W. 1981. "Indonesia and the West: An Essay on Cultural Differences in Organization and Management." Majalah Management & Usahawan Indonesia. November-December: 25-31. Ward, Doug. 1990. "Working at a Different Pace." Vancouver Sun. October 4, 1990. World Bank. 1993. The East Asian Miracle: Economic Growth and Public Policy. Oxford: Oxford University Press.

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Wright, Lorna. 1991- Cross-cultural Project Negotiations in the Consulting Engineering Industry: A Study of Canadian-Indonesian Negotiations. Unpublished PhD dissertation. London: The University of Western Ontario. . 1992. "A Comparison of Thai, Indonesian and Canadian Perceptions of Negotiating." Queen's University working paper. . 1994. "Are Canadian Companies Missing the Boat?" Approaching Asia. 1:1. 1-2. . 1995. Forthcoming. Gartner Lee. Kingston: Queen's University. Yeates, Ian, Winnie Leung, Brigitte Smoes and Lorna Wright. 1993"Managing in Malaysia: The Racial Challenge." In Lorna Wright, ed. Dealing with the Dragons Conference Proceedings. Kingston: Centre for Canada-Asia Business Relations. Queen's University. Yoshihara, Kunio. 1988. The Rise of Ersatz Capitalism in South-east Asia. Singapore: Oxford University Press.

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Where to from here? A.E. Safarian

The introduction to this volume notes that Canada's low share of trade and investment in much of Asia does not necessarily mean that Canadian business is not competitive in the region. It reflects mainly the growing share of economic activity with the United States, which has engaged both business and government policy for some time. Canada's early presence in some of the East Asian countries may also have been weakened as these countries diversified their contacts in the process of rapid growth. This is encouraging in the sense that business inefficiency is not likely to be a major barrier to entry to such markets. The issue is rather whether public policy and business strategy should focus more fully on the East Asian markets, in the ways they have focused in recent decades on the US market. These studies bring out a number of reasons to favour such an approach. First, Canadian firms that have realized economies of scale through trade and investment in North America may be in a stronger position to move into other markets. Some of the business alliances formed in this process with firms located in the United States may be helpful in penetrating East Asian markets. Second, several of the studies in this volume point to the recent success of Canadian firms in sectors where both imports and direct investment are being liberalized in many East Asian countries, such as in basic infrastructure. More generally, Canadian firms have shown at a global level that they have considerable skills in areas now much in demand in various Asian countries. These include, for example, various infrastructure services 149

and related manufactures, resource development and financial services. Third, the study by Head and Ries emphasizes that Canada's small presence in East Asia may reflect the absence of substantial profit opportunities, given such factors as strong competition and barriers to exports. They go on to note that public support can be justified where firms lack information about profitable opportunities or where they fail to take into account how their presence benefits other Canadian firms. The problem for many Canadian businesses, especially the smaller ones that lack the international contacts and specialized information or skills, is that the entry costs to the dynamic Asian markets are high and variable. They are high for many reasons, including competition from existing firms. One important reason is that Asian business systems, markets and government policies often differ from those in countries that are most familiar to Canadian businesses. They are variable because each Asian country is different in the ways mentioned above, and each has a different set of current or prospective opportunities. As Rapp explains, Japan now puts less emphasis on natural resource and energy imports, but several East Asian countries appreciate the skills of Canadian firms in natural resource development and management. The challenge for governments, businesses and researchers is to reduce the costs of entry. One important way to go about this is to help reduce some of the information gaps. Some of these gaps are addressed in the normal course of government and business research and other activities—government research identifies macroeconomic and regulatory policies in each country, for example, while business research identifies business opportunities by country, region and sector. What may add value to this standard commercial and political intelligence is a deeper understanding of the business systems in the different Asian countries. Three of the papers in this volume bring out the importance of understanding the political and private priorities and organizations within which business activity takes place. For Rapp it is the strategies of firms in the product cycle, since these are what drive trade and direct investment in a period when the influence of government has been somewhat muted in Japan. For Falkenheim it is the structure and 150

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priorities of the many Chinese ministries and state enterprises at the central, provincial and local government levels. For Wright it is the ownership patterns and value systems of the conglomerates in Indonesia, Malaysia and Thailand. These conglomerates have been dominated by Chinese family groups, but this is now modified in varying degrees by businesses associated with state enterprises, the military, royalty and foreign direct investment. We see these approaches as related. The nature of organizations and their value systems clearly affect their choice of business strategies and the ways in which they implement them. To a greater or lesser degree in each country, the priorities of the ministries and state corporations must be taken into account when deciding both business strategies and implementation methods. "Business systems" then becomes a term to describe the most typical ways in which business strategies are decided and carried out in each country, with emphasis on the formal and informal organizational relationships that are involved. More specifically, this would involve a closer look at the Japanese keiretsu, Korean chaebol, Chinese ministry and state corporation, overseas Chinese conglomerates, and perhaps some other organizational forms depending on the country. For reasons explained below, this set of studies could be combined with a study of either or both of a) the ways in which governments in Canada support Canadian trade and investment in Asia, and b) the Canadian fiscal systems more generally. A study of this kind should interest both the research and business communities, but the business community might relate to it more easily. Relationships must be mastered with partners, competitors, industry associations, financial and legal services, government and para-governmental agencies—and these relationships may differ radically from those at home. From a research standpoint the challenges are both daunting and potentially rewarding. The following series of possible questions brings out how this relates to growth, competitiveness, and firm strategies. 1. What are the characteristics of each of the key organizational forms and how do they differ from those in Canada and other North Where to from here?

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American or European contexts? After all, vertical and horizontal integration, financial-industrial ownership links, concentration of stock ownership, and non-ownership alliances of various kinds are not unknown in Canada and other "western" countries. What, if anything, is distinctive about such arrangements in East Asia, for example? One point worth following up on is the evidence in some studies that certain types of formal alliances are largely concentrated in the developed countries, especially Japan, the United States and Western Europe. This would seem to be the case for technology alliances outside of joint ventures (Freeman and Hagedoorn, 1994:775). Studies of technical collaborative agreements, however, may not reflect the often informal, though continuing, collaboration seen in various East Asian countries through supplier, subcontractor and similar arrangements, even though this less formal collaboration involves considerable learning.1 Still less do they address the family and trust relationships involved in conglomerates controlled by overseas Chinese groups, both in relations among themselves and with China or with non-Chinese groups. Even a relatively straightforward process as Rapp suggests— to inventory and actively solicit alliances with Japanese firms—could make a significant difference not only in terms of trade and investment with Japan but also in securing business ties in North America and elsewhere. 2. One way of looking at these issues is to ask what difference organizations make to economic growth and competitiveness. Saving, investment in physical and human capital, foreign trade, innovation and the borrowing of knowledge from abroad—these activities are considered critical to growth in the Asia-Pacific region (World Bank, 1993). They all take place within organizations that supply strong incentives for activities to be undertaken in certain ways. The role of organizations in economic growth has been under-researched by economists generally, although it has received more attention by some 1

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Such network relationships can extend to supply, production and distribution as well as to technology cooperation.

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other social and management sciences.2 Where economists have looked at some of the important organizations, such as the keiretsu, the results are inconclusive, with some emphasizing the competition-limiting aspects while other emphasize pro-growth aspects. 3. Considering some additional claims made regarding the Japanese keiretsu in particular can bring out what may be at issue here for both researchers and businesses. While all of the countries in the region have been moving towards more open trading and investment regimes, some have much further to go in terms of liberalizing trade or investment. There is some evidence that, for some types of trade in manufactures and services particularly, trade and investment liberalization go together. One interesting point is that Japan's inward FDI position is exceptionally low. At the end of 1992, for example, the stock of inward FDI has been estimated at US $38.7 billion for Japan. Much smaller industrial countries have much larger inward stocks— for example, Belgium has $57 billion and Italy $62 billion. Even Singapore, which has encouraged such investment, has an inward stock of $42 billion.3 There is considerable debate about just why this low propensity for inward FDI exists (see, for example, Kreinin 1988, Wakasugi 1994). Some research points to the high yen and high rental costs in the late 1980s when global FDI rose most rapidly, to buyer preferences for local products and to the strong competitive power of Japanese firms. Other research points to some residual effects of the pre-1980 restrictions on FDI. More important, there is emphasis on keiretsu structure and policies that limit the potential for acquisition of larger firms, steer procurement to related firms, and exercise other exclusionary policies. Whether these are more exclusionary than industrial structures in some other developed countries is one of the points at issue. 2

See North (1994) for a discussion of the role of institutions and organizations in growth. He defines institutions as the rules of the game, organizations and their entrepreneurs as the players. See Redding et al., (1994) for research in some other disciplines.

3

Data from UN 1994, annex, based in part on adding flows to earlier stock figures.

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Similar questions have been raised about outward FDI from Japan, namely whether exclusionary sourcing and other characteristics exist that give it a distinctive presence in East Asian FDI. The question heard most frequently is whether Japanese MNEs are using their trade and FDI strategies (abetted, perhaps by Japanese government policies supporting such FDI) to develop a yen bloc in East Asia. The concern is that such firms are creating operating networks that exclude relations with firms outside the networks, thus compounding the effects of arrangements that allegedly exclude both imports and local foreign-owned firms in Japan itself. These are points to which existing research gives inconclusive answers. For example, Lawrence (1993) suggests the evidence points on the whole to exclusionary business practices by Japan, while Saxonhouse (1993) disagrees. Some researchers suggest, in fact, that the evidence points to more regional bias in the EU or NAFTA than in East Asia. Some of Frankel's (1993) research points in this direction. Dobson (1993) suggests that some convergence is underway in the practices of affiliates in the electrical/electronics industries because of competitive pressures, host policies to localize production, and more independent sourcing policies of small and medium-sized Japanese firms. 4. There are other closely-related topics that could be studied. One is the internal adjustment processes of an internationally-driven growth mechanism, particularly the relatively quick and smooth adjustment to a sequence of major structural changes. Japan has transferred large sectors of industry abroad several times in the postwar period, most recently because of such factors as the rising yen and high labour costs, as have the newly industrialized Asian countries. They have apparently done so with less of the long-term unemployment, slowing of productivity growth, and the social disruption that have often accompanied such changes elsewhere. The more general point is that many countries are undergoing structural changes in industry as a result of greater internationalization in some sectors, and because of the effects of other factors such as technological changes. Canadian businesses are among those that have experienced such rapid structural changes in recent years. Some countries appear to be able to 154

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absorb changes like these more rapidly and less painfully, because of the nature of their labour markets, corporate and public policies and other factors. This seems to be a critical subject for studies of growth and competitiveness, both because of what is involved in terms of the ease with which more rapid growth is achieved, and because of the closely related question of the sharing of the costs and gains from growth. Before leaving the topic of business systems it is worth mentioning once again that we consider a business system to include both the strategies typically followed by businesses and associated government support systems, as well as the structure of ownership and the cultural values involved. As Rapp emphasizes, it is critical when entering Japan to take account of the nature of competition in that market— quick copying, extreme price competition, protection of the core business while allowing peripheral business to act as a loss leader. Knowledge of the equivalent characteristics in each market is equally critical to success. 5. The above studies should be analytically revealing in themselves. They should also be helpful to businesses attempting to understand what is necessary to cooperate with and compete with business in various Asian countries. Another way to approach this is to ask what Canadian governments can do to improve Canada's ability to compete in the context of Asian business systems, among others. It should be obvious that emulation of the growth characteristics of Asian business systems is not going to be possible in any direct sense, and may be undesirable in some ways. Canada has its own business system, which is a result of its own history, geography, cultural experience and social values. We can ask, nevertheless, whether the public programs that already exist can better help Canadian businesses in their efforts to enter and succeed in Asian markets. This question makes an assumption that was raised by several of the papers in this volume: that there is the political commitment to recognize the development of business ties in the Asian region as a priority of governments. If this is the case, then both framework and focus policies need to be reviewed. The framework policies that need to be considered relate to fiscal Where to from here?

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and financing issues. This poses questions like how financial resources are mobilized for investment in different parts of Asia and what the implications are for the Canadian business and financial community. What this comes down to ultimately is how far our fiscal and financial systems are oriented to growth in general, and how well they support businesses competing with firms in Asia and elsewhere in particular. The focus part of such a study would be to determine how in tune various business support programs, such as export financing and foreign aid, are with the current realities of cooperation and competition with firms in various Asian countries in particular. The studies in this volume point to both strengths and weaknesses in our present programs as they relate to Asia. One way to carry out such an evaluation would be to ask, first, what the sectors of Canada's revealed comparative advantage are, based on both global and Asian experience, and how these sectors appear to be changing over time. The studies in this volume supply some tentative answers to the question of where Canada can compete in the Asian market. We have already shown strength in resource development and management, in some infrastructure services such as transport, communications, and various utilities, as well as in related areas of manufacturing, in several sectors of financial services such as insurance, and in a variety of engineering and consulting services. Judging by our success elsewhere, we might well have potential in many other areas such as specialized machinery and software. A more thorough study would pinpoint other and more specific categories. Such a study would be followed up by a further question: how well do the support programs reflect the needs of the firms and sectors where Canada has shown actual advantage or the potential for it, and how well do the programs address the problems involved in entering and succeeding in Asian markets. One preliminary line of enquiry here is the adequacy of the efforts made so far to determine from both questionnaires and case studies the nature of the problems and needs of various types of businesses in those markets. We do not mean simply the closing of information gaps which business alone cannot handle, important as those may be. It may be just as important to identify weak links in the range of capabilities required to penetrate and succeed in Asian business systems, and to find ways to close these 156

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weak links. If, for example, as one of the studies suggests, it turns out that we are better known for production technology than for marketing or negotiation skills, ways can be developed to strengthen the weak areas. 6. Finally, most of the studies draw attention to the large number of East Asian immigrants in Canada. The Asia Pacific Foundation (1994) has pointed out that five of the top ten sources of immigrants—including most of Canada's business immigrants—have been from the Asia Pacific region over the past ten years. It also notes that the third most common mother tongue in Canada is Chinese. This potential asset to the development of business links with East Asia is underutilized, judging by the trade and investment data in this volume. One study noted that Indo-Canadians accounted for a very small proportion of recent business collaborations between India and Canada, considerably smaller than that by non-resident Indians generally (Siddharthan and Safarian 1995). However, evidence of the relationship between immigration and business ties is both sparse and somewhat mixed. Gould (1994), as cited in Head and Ries, suggests that the pattern of immigration into the United States has had a considerable influence on US bilateral trade flows. Globerman (1995) concludes that no such relationship is evident in the case of Asian immigration to Canada. A useful study might be to determine the extent and the determinants of the actual business links Canadians from some of these countries have with East Asia, whether improvement of such links is an effective economic policy from Canada's viewpoint, and how best to go about establishing them.

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References Asia Pacific Foundation. 1994. Asian Canadians: Canada's Hidden Advantage. Vancouver: APFC. Dobson, W. 1993. Japan in East Asia. Singapore: Institute of Southeast Asian Studies. Frankel, J.A. 1993. "Is Japan Creating a Yen Bloc in East Asia and the Pacific?" In Frankel and Kahler, eds. Regionalism and Rivalry. Chicago: University of Chicago Press. Freeman, C. and J. Hagedoorn. 1994. "Catching Up or Falling Behind: Patterns in International Interfirm Technology Partnering." WorldDevelopment: 22:5. 771-80. Globerman, S. 1995. "Immigration and Trade." In D.J. Devoretz ed. Diminishing Returns. Toronto: C.D. Howe Institute. Lawrence, R.Z. 1993. "Japan's Different Trade Regime: An Analysis with Particular Reference to Keiretsu." Journal of Economic Perspectives. 7:3North, D.C. 1994. "Economic Performance Through Time." American Economic Review. 84:3. Redding, S.G., A. Norman and A. Schlander. 1994. "The Nature of Individual Attachment to the Organization: A Review of East Asian Variations." In H.C. Triandis et al. eds. Handbook of Industrial and Organizational Psychology, 2nd ed. Vol.4. Palo Alto, CA: Consulting Psychologists Press. Saxonhouse, G.A. 1993. "What Does Japanese Trade Structure Tell Us About Japanese Trade Policy?" Journal of Economic Perspectives. 7:3. Siddharthan, N.S. and A.E. Safarian. 1995. "Technology Transfer Between Canada and India." Toronto: Centre for International Studies, University of Toronto: mimeo. United Nations. 1994. World Investment Report: Transnational Corporations, Employment and The Workplace. New York and Geneva: UNCTAD Division on Transnational Corporations and Investment. World Bank. 1993. The East Asian Miracle: Economic Growth and Public Policy. Oxford: Oxford University Press.

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About the authors Wendy Dobson (PhD Princeton), is Professor and Director, Centre for International Business at the University of Toronto. She has served as Associate Deputy Minister of Finance in the Canadian government and as President of the C.D. Howe Institute. Her most recent publications include Japan in East Asia (1993), and Economic Policy Coordination: Requiem or Prologue? (1991). Victor Falkenheim (PhD Columbia University), is Professor of Political Science, University of Toronto. He has served as an advisor to the Canadian International Development Agency on China's economic reforms and has travelled extensively throughout the country. Recent publications include a study of China's special economic zones for the Joint Economic Committee of the US Congress. His most recent book is Chinese Politics from Mao to Deng. 1989- New York: Paragon Books. Keith Head (PhD MIT), is Assistant Director of Policy Analysis, Faculty of Commerce and Business Administration, University of British Columbia. His research interests include foreign direct investment, international trade policy and economic geography. He has recently authored "Agglomeration Benefits and Location Choice," and "Infant Industry Protection in the Steel Industry" (both forthcoming in the Journal of International Economics.} William V. Rapp (PhD Yale), is Professor of International Business and occupies the Chair in Economic Relations with Japan at the University of Victoria. Rapp has extensive diplomatic experience in Japan and has authored many articles, including "Japanese Foreign Direct Investment in the Product Cycle," published in Proceedings of the Association of Japanese Business Studies, and Japanese Multinationals: An Evolutionary Theory and Some Potential Global Political Implications for the 1990s, January 1992.

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John C. Ries (PhD University of Michigan), is Assistant Professor, Faculty of Commerce and Business Administration, University of British Columbia. His primary research interests are international and Japanese business and economics. Fluent in Japanese, Ries has worked as a researcher at the Ministry of International Trade and Technology in Tokyo. He is the author of a number of articles on these topics in the Canadian Journal of Economics, Journal of Industrial Economics, and the Journal of International Economics, among others. A.E. Safarian (PhD Berkeley), is Professor of Business Economics at the Faculty of Management, University of Toronto and an Associate of the Canadian Institute for Advanced Research. He has served as Dean of the University's School of Graduate Studies and as President of the Canadian Economics Association. He was elected a fellow of the Royal Society of Canada in 1973. Professor Safarian was a member of the Canadian National Committee on Pacific Economic Cooperation during the 1980s. He is author of Multinational Enterprise and Public Policy (1993), Governments and Multinationals (1983), and Foreign Ownership of Canadian Industry (1966), among others. Lorna L. Wright (PhD The University of Western Ontario), is Associate Professor of International Management and Organizational Behaviour, School of Business, Queen's University. She has extensive professional experience in Thailand, Indonesia and Japan, speaks Thai, Indonesian and Japanese fluently, and teaches international business strategy, cross-cultural management and managing diversity. She is author of a number of articles in International Studies of Management and Organization. Her research interests include international negotiations, technology transfer and conditions for Canadian success abroad. Two current projects include analysis of success in Japan by Canadian companies and an examination of international business training practices in Canadian companies.

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Centre for International Business Mission Founded in 1993, the Centre's mission is to focus the University of Toronto's expertise in international economics and strategic management in ways that assist Canadian businesses to increase their international competitiveness and to develop strategies to become world leaders in their fields. Strategic Direction The Centre's research has two aims: 1. To analyse global economic trends and assist executives in understanding the risks and opportunities inherent in those trends that are beyond their control. 2. To study trends in international business and provide executives with knowledge applied to building lean, innovative and internationally competitive organizations. The research strategy is formulated in consultation with an Advisory Committee, and is carried out in collaboration with members of the global research networks of the Centre's Associates. Centre Associates Director: Wendy Dobson (international economics) Associates: Joseph D'Cruz (strategic management) Michael Donnelly (political science) John Grant (business economics) Jack Mintz (tax policy and public finance) Peter Pauly (international economics) Alan Rugman (international business) Anil Verma (organizational behaviour) Eleanor Westney (strategy and international management, Sloan School, MIT) Tom Wilson (business economics, industrial organization, fiscal and tax policy)

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Key research issues • Global research on international business, focusing on firm competitiveness, behaviour and strategies. • Global research on the economic environment for international business, including policies that affect trade and investment. • International environmental research that recognizes that, in a globally-integrated business environment, both the economic and environmental effects of environmental policies must be examined in a cross-national perspective. Programs and services International Business Perspectives Published quarterly and disseminated widely to the business and policy communities, Perspectives presents concise analyses and interpretations of current developments in the global economic environment and anticipates future trends that will have an impact on North American businesses. Particular attention is paid to anticipating developments in the G-7 economies and in East Asia. The CIB Roundtable Round tables, held monthly, provide a forum where CEOs can focus on and discuss developments in international business and in the global economic environment. In sessions led by Associates and invited speakers, the focus is on anticipating, interpreting and responding to these developments. The International Business Conference

Organized annually by the Centre and the Faculty of Management in collaboration with the Globe and Mail, the Faculty brings together senior private and public sector leaders in "sleeves-up" sessions addressed to challenges faced by Canadian businesses seeking to become world leaders in their sectors and to translate these into "take-away" benefits.

Centre for International Business Faculty of Management University of Toronto 246 Bloor Street West Toronto, Ontario, Canada M5S 1V4 Tel: 416-978-2451 Fax: 416-928-6694

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