Towards a Knowledge-based Economy: East Asia's Changing Industrial Geography 9789812305848

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Reproduced from Towards a Knowledge-based Economy: East Asia’s Changing Industrial Geography, edited by Seiichi Masuyama and Donna Vandenbrink (Singapore: Institute of Southeast Asian Studies, 2003). This version was obtained electronically direct from the publisher on condition that copyright is not infringed. No part of this publication may be reproduced without the prior permission of the Institute of Southeast Asian Studies. Individual articles are available from < http://bookshop.iseas.edu.sg >

Nomura Research Institute, Ltd. (NRI), established in 1965, is one of Japan’s largest and most comprehensive private-sector research organizations. It offers a wide range of services, including public policy research, investment and financial research, management consulting, contract research and regional planning. The company is also Japan’s leading supplier of systems consulting, integration and operating services. NRI has a staff of 3,000 and operates globally through offices in Tokyo, Yokohama, Osaka, New York, Washington, D.C., San Francisco, London, Frankfurt, Paris, Zurich, Sydney, Hong Kong, Singapore, Taipei and Seoul. NRI also manages the Nomura School of Advanced Management, one of Japan’s foremost centres for management training, and is affiliated with the Tokyo Club Foundation for Global Studies, a non-partisan foundation supported by Japanese industry to promote better understanding of world issues. The Institute of Southeast Asian Studies (ISEAS) was established as an autonomous organization in 1968. It is a regional research centre for scholars and other specialists concerned with modern Southeast Asia, particularly the multifaceted problems of stability and security, economic development, and political and social change. The Institute is governed by a twenty-two-member Board of Trustees comprising nominees from the Singapore Government, the National University of Singapore, the various Chambers of Commerce, and professional and civic organizations. A ten-man Executive Committee oversees day-to-day operations; it is chaired by the Director, the Institute’s chief academic and administrative officer. ii © 2003 Institute of Southeast Asian Studies, Singapore

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First published jointly in 2003 by Institute of Southeast Asian Studies 30 Heng Mui Keng Terrace Pasir Panjang Singapore 119614

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Nomura Research Institute New Otemachi Building 2-2-1 Otemachi Chiyoda-ku Tokyo 100-0004, Japan

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of the Institute of Southeast Asian Studies. © 2003 Tokyo Club Foundation for Global Studies ISEAS Library Cataloguing-in-Publication Data Towards a knowledge-based economy: East Asia’s changing industrial goegraphy/ edited by Seiichi Masuyama and Donna Vandenbrink. (ISEAS current economic affairs series, 0218-2114) 1. Knowledge management—Economic aspects—East Asia. 2. Knowledge management—Economic aspects—Asia, Southeastern. 3. Electronic commerce—East Asia. 4. Electronic commerce—Asia, Southeastern. 5. Information technology—Economic aspects—East Asia. 6. Information technology—Economic aspects—Asia, Southeastern. 7. Telecommunication—Economic aspects—East Asia. 8. Telecommunication—Economic aspects—Asia, Southeastern. I. Masuyama, Seiichi. II. Vandenbrink, Donna. III. Series. HC415 I55T73 2003 sls2002046707 ISBN 981-230-179-8 (soft cover) ISBN 981-230-180-1 (hard cover) ISEAS on the Internet The responsibility for facts and opinions in this publication rests exclusively with the editors and contributors and their interpretations do not necessarily reflect the views or the policy of ISEAS, NRI, the Tokyo Club Foundation, or their supporters. Typeset by Superskill Graphics Pte Ltd Printed in Singapore by Seng Lee Press Pte Ltd iv © 2003 Institute of Southeast Asian Studies, Singapore

Contents List of Tables List of Figures Acknowledgements List of Contributors Foreword Shozo Hashimoto

vii x xii xiii xiv

INTRODUCTION 1

The New Industrial Geography of East Asia under the Knowledge-based Economy Seiichi Masuyama and Donna Vandenbrink

3

PART I ICT PAVING THE WAY TO A KNOWLEDGE-BASED ECONOMY 2

3

4

ICT in Korea: Current Situation and Policy Direction Dongseok Kim

43

Taiwan’s Transition from an Industrialising Economy to a Knowledge-based Economy Shin-Horng Chen and Meng-chun Liu

83

The Internet Revolution in China: Current Situation and Future Outlook Xiaodong Li

112

PART II NURTURING NETWORK-READINESS 5

Linking Thai “Brick-and-Mortars” to the Global Network Economy Somkiat Tangkitvanich

129 v

© 2003 Institute of Southeast Asian Studies, Singapore

6

7

8

Information Technology and E-commerce in the Philippine Economy Roberto de Vera and Peter Lee U

153

Telecommunications and Information Technology Development in Indonesia Hamonangan Hutabarat

179

Inequality, the Digital Divide, and International Collaboration in East Asia Wan Latifah and Zainal Aznam Yusof

217

PART III REGIONALISATION OF THE INTERNET ECONOMY 9

The New Role of Hong Kong as a Regional Hub in an Emerging E-economy Edward K. Y. Chen and Raymond Ng

231

10 Singapore: A Regional Hub in ICT Chia Siow Yue and Jamus Jerome Lim

259

11 Impact of B2B E-commerce on Japanese Corporate Networks in East Asia Shoichiro Hara, Seiichi Masuyama, and Hideo Teramura

299

vi © 2003 Institute of Southeast Asian Studies, Singapore

List of Tables 1.1 1.2 1.3 1.4 1.5 1.6

World Telecommunications Service Sector Global Foreign Exchange Turnover and World Trade Asia’s Share of Global Electronics Production, 1985–98 Volatility of East Asian and Advanced Economies Indicators of R&D Capacity Linkages with the U.S. Innovation System

5 5 12 21 26 31

2.1 2.2

Categorisation of Korea’s ICT Industry Contribution of ICT Industry to Korea’s Economic Growth, 1995–99 ICT Industry Employment by Sector, 1997–99 ICT Industry Exports by Sector, 1996–99 Subscribers with High-Speed Internet Access by Type of Service Subscribers with High-Speed Internet Access, June 2000 – January 2001 Korea’s Technology Lag in Major Fields U.S. Patents in ICT Held by Korea, Taiwan, Japan, and United States Cost Breakdown for Constructing Korea’s Information Super Highway Comparison of Forecasts of the Size of Korea’s E-commerce Market Korean E-marketplaces Digital Divide in Korea by Personal Characteristics Informatisation in Korea, 1993–2000 Informatisation in Selected Economies, 1998 Production of ICT Equipment and Services, 1993–99 Domestic Sales of ICT Equipment and Services, 1993–99 Exports of ICT Equipment and Services, 1993–99 Imports of ICT Equipment and Services, 1993–99 Balance of Payments in ICT Equipment and Services, 1993–99

46

2.3 2.4 2.5 2.6 2.7 2.8 2.9 2.10 2.11 2.12 2.13 2.14 2.A1 2.A2 2.A3 2.A4 2.A5

3.1 3.2

Knowledge-based Industries in Taiwan Information Intensity of Selected Service Industries

49 50 51 52 53 57 57 60 63 65 67 70 71 78 79 80 81 82 88 89 vii

© 2003 Institute of Southeast Asian Studies, Singapore

3.3 3.4 3.5 3.6 3.7

3.8 3.9 3.A1 4.1 4.2 4.3 4.4 4.5 4.6 5.1 5.2 5.3

5.4 5.5 5.6 5.7 6.1 6.2

Composition and Growth of Manufacturing Sector by Technology Intensity in Selected Economies Technology Trade by Knowledge-based Manufacturing Industries, 1998 Factor Scores from Principal Component Analysis of KBE Indicators for Selected Economies IC Industry Statistics for Taiwan and the World, 1996–99 R&D Intensity and Capital Expenditure Intensity of the IC Industry in the United States, Japan, Korea, and Taiwan, 1995–99 Indicators of IT Application in Selected Economies OLS Estimates of Labour Productivity Function KBE Indicators for Principal Component Analysis Internet Bandwidth, 1998–2000 Internet Access and Users, 1996–2001 Mobile Phone Subscribers in the United States, China, and Japan Status of E-commerce in China, 2000 Value of E-commerce Transactions in the United States and China, 1998–2003 Internet User Fees in Selected Economies Cost Structures of Thai Manufacturers and Their Main Foreign Competitors, by Industry Estimates of Savings from Electronic Supply Chain Management, by Industry Financial Impact of Introducing Electronic Supply Chain Management at a Hypothetical Thai Manufacturing Firm E-Thailand Working Groups and Issues Government E-commerce Initiatives Availability of Qualified ICT Skills in East Asian Economies Demand for IT Workers in East Asian Economies Shares of Output and Employment by Sector, 1996–2000 Growth Rate by Sector, 1996–2000

viii © 2003 Institute of Southeast Asian Studies, Singapore

91 92 93 98

100 102 104 111 116 117 118 121 122 123

130 131

132 137 139 143 143

153 154

6.3 6.4 6.5 6.6 6.7 6.8 7.1 7.2 7.3 7.4 7.5 7.6 7.7 7.8 7.9 7.10 7.11 7.12 7.13 7.14 7.15 8.1 8.2 8.3 8.4 8.5 8.6

Telephone Densities in Selected Asian Economies, 1992–98 Structure of Philippine Telecommunications Industry, 1997–2000 Mobile Cellular Service Subscribers, 1992–2000 Information and Telecommunications Infrastructure of Asian Economies Key Internet Statistics for Selected Asian Economies Status of PEZA-accredited Cyberparks in 2001 Companies Affiliated with PT Telkom Details of PT Telkom’s Joint Operating Scheme Mobile Cellular Subscribers and Fixed Telephone Lines, 1990–2000 Comparison of Telecommunications Acts of 1989 and 1999 Trade in Information Technology and Telecommunications Products, 1998 and 1999 Sales of Personal Computers, 1991–2000 Internet Users and Subscribers, 1996–2000 Registered Domain Names, 1995–2000 Local Domain Names by Type Credit Card Use, 1991–2000 Fixed Phone Lines and Density in Selected Asian Economies Mobile Phone Density and Penetration in Selected Asian Economies PC Penetration in Selected Asian Economies Internet Penetration in Selected Asian Economies, 1999 and 2000 Internet Domain Servers in Selected Asian Economies Poverty in Asia Income Inequality in Selected East Asian Economies Key GNP Statistics of Selected Asian Economies Growth in the Global K-economy, 1998–2002 K-skills of Workforce in Selected Economies, 1997 IT Service Market in Southeast Asian Economies, 1998–2003

159 159 160 161 163 169 184 191 195 199 200 202 203 204 204 206 207 208 209 210 210 219 219 220 221 221 224 ix

© 2003 Institute of Southeast Asian Studies, Singapore

8.7

10.1 10.2 10.3 10.4 10.5

11.1 11.2 11.3

Four Major Areas of Commercial Transactions over the Internet ICT Diffusion in East Asia Value Added of ICT Activities by Sector in Singapore, 1990 and 1996 Electronic Products and Components Manufacturing in Singapore, 1990–2000 Singapore–East Asia Trade in Electronics, 1990–99 Trade in Machinery and Transport Equipment 1990–2000 Development Path of B2B E-commerce Use of B2B E-commerce by Japanese Firms in East Asia B2B E-commerce of Japanese Affiliates in East Asia by Type of Transaction

228 274 275 279 282 283 301 312 313

List of Figures 1.1

International Externalities of East Asian Economies

30

2.1 2.2

Rise of the Age of the Knowledge-based Economy Production of ICT Equipment and Services by Sector, 1987–99 Annual Growth Rate in Sales of ICT Services, 1991–99 Schematic View of the Five-Year Plan Information Super Highway, December 2000 Digital Divide by Age

44 50 54 58 61 68

KBE-related Indicators for Japan, Korea, United States, and Taiwan

94

2.3 2.4 2.5 2.6 3.1

5.1 5.2

Cost of 20 Hours of Dial-up Internet Access in Selected Asian Economies Monthly Charge for 64-Kbps Internet Leased Line in Selected Asian Economies

x © 2003 Institute of Southeast Asian Studies, Singapore

140 141

6.1

Exports by Philippine Electronics and Semiconductor Industries, 1992–2000 Philippine Software Exports, 1993–2000 Students Enrolled in IT and Related Programs, 1992–2000

158

7.1

Vision of Nusantara-21 Backbone Infrastructure

194

8.1

Fixed Telephone Line Penetration in Selected Economies, 1998 Personal Computer Penetration in Selected Economies, 1998 Model of Empowerment towards a Self-teaching and Self-regulating Society

6.2 6.3

8.2 8.3

10.1 10.2 10.3 10.4

155 155

222 223 227

10.8 10.9

Effect of Industry-specific Factors on Agglomeration Effect of Transport Costs on Agglomeration Effect of Transport Costs on Location Porter’s Diamond Model of Locational Competitive Advantage Government Influences in Porter’s Diamond Model Framework for Singapore’s National Information Infrastructure (NII) Public Research Institutes and Centres (RICs) Grouped by Industry Focus Framework for Electronic Commerce in Singapore Conceptual Pillars of e-ASEAN

288 291 293

11.1

Emerging Organisation of B2B Networks in East Asia

318

10.5 10.6 10.7

262 263 264 265 266 287

xi © 2003 Institute of Southeast Asian Studies, Singapore

Acknowledgements The publication of this book was made possible through the generous funding of the research project by the Tokyo Club Foundation for Global Studies. The editors express appreciation to the many people associated with Nomura Research Institute (NRI) and the Institute of Southeast Asian Studies (ISEAS) who contributed to this publication.

xii © 2003 Institute of Southeast Asian Studies, Singapore

List of Contributors Edward K.Y. Chen Shin-Horng Chen Chia Siow Yue Roberto de Vera Shoichiro Hara Hamonangan Hutabarat Dongseok Kim Xiaodong Li Jamus Jerome Lim Meng-chun Liu Seiichi Masuyama Raymond Ng Somkiat Tangkitvanich Hideo Teramura Peter Lee U Donna C. Vandenbrink Wan Latifah Zainal Aznam Yusof

Centre for Asian Pacific Studies, Lingnan University, Hong Kong Chung-Hua Institution for Economic Research, Taipei Institute of Southeast Asian Studies, Singapore University of Asia and the Pacific, Manila Nomura Research Institute, Tokyo Centre for Policy and Implementation Studies, Jakarta Korea Development Institute, Seoul Development Research Centre of the State Council, Beijing Institute of Southeast Asian Studies, Singapore Chung-Hua Institution for Economic Research, Taipei Nomura Research Institute, Tokyo Hong Kong Baptist University, Hong Kong Thailand Development Research Institute, Bangkok Nomura Research Institute, Tokyo University of Asia and the Pacific, Manila Nomura Research Institute, Tokyo MIMOS Berhad, Kuala Lumpur Institute of Strategic and International Studies (ISIS) Malaysia, Kuala Lumpur

xiii © 2003 Institute of Southeast Asian Studies, Singapore

Foreword The IT paradigm has evolved from large mainframe computers, to individualised PCs and workstations, to interconnected, networked terminals. As the technology continues to miniaturise, computing power will become ever more portable and IT will be present virtually everywhere. The evolution of the IT paradigm has shifted the basis for economic activities from material to knowledge and information inputs, and this has had profound effects on economic relationships — on relationships within firms, on relationships among firms and among sectors within national economies, and on relationships between economic activities located around the world. The network is perhaps the concept that best captures the essential character of economic relationships in the face of the IT revolution. In order to understand its impact on the integration of the East Asian economies, the Tokyo Club Foundation for Global Studies asked researchers from the leading think-tanks in ten East Asian economies (the AT10) to examine the changing importance of networking in the production and service sectors in their home economy. In early February 2001 these AT10 researchers met in Tokyo to discuss their papers. I am pleased that the Tokyo Club, in co-operation with ISEAS and NRI, can share the results of the work of the AT10 researchers.

Shozo Hashimoto President Tokyo Club Foundation for Global Studies

xiv © 2003 Institute of Southeast Asian Studies, Singapore

July 2002

THE NEW INDUSTRIAL GEOGRAPHY OF EAST ASIA UNDER THE KBE 1

INTRODUCTION

© 2003 Institute of Southeast Asian Studies, Singapore

00 SEAsians_ASEM.indd 10

9/18/14 10:52:23 AM

Reproduced from Towards a Knowledge-based Economy: East Asia’s Changing Industrial Geography, edited by Seiichi Masuyama and Donna Vandenbrink (Singapore: Institute of Southeast Asian Studies, 2003). This version was obtained electronically direct from the publisher on condition that copyright is not infringed. No part of this publication may be reproduced without the prior permission of the Institute of Southeast Asian Studies. Individual articles are available from < http://bookshop.iseas.edu.sg >

THE NEW INDUSTRIAL GEOGRAPHY OF EAST ASIA UNDER THE KBE 3

1 The New Industrial Geography of East Asia under the Knowledge-based Economy Seiichi Masuyama and Donna Vandenbrink FORMATION OF A KNOWLEDGE-BASED ECONOMY ICT Brings Growth in Productivity and a Rise in Services

Advances in information and communications technology (ICT) over the past twenty-five years have had profound economic effects. The ICT Revolution — the new digital communication technologies that expanded the capability of the computer beyond simple computation — have drastically improved the efficiency of production, distribution, and innovation processes (Brynjolfsson and Hitt 2001). By pushing up productivity growth the ICT Revolution is expected to become the longrun engine of the global economy. The ICT Revolution reaches into all aspects of the economy. The Internet reduces business-to-business (B2B) and business-to-consumer (B2C) transaction costs, improves management efficiencies through supply chain management (SCM) and other schemes, and facilitates innovation by increasing the efficiency of knowledge dissemination and international collaboration. Procurement over the Internet is said to cost only one-tenth as much as physical procurement.1 The benefits of ICT-based management and logistics systems may be even greater in developing economies, which are relatively less efficient currently. For example, the Bangkok office of the World Bank calculated that the profits of a hypothetical Thai electronics assembly firm could increase 65 percent, assuming that the introduction of SCM reduced costs by 5 percent (Chapter 5). Moreover, the ICT Revolution increases the efficiency of innovation activities such as research and development and new product development by reducing the time and cost of creating and disseminating knowledge.

© 2003 Institute of Southeast Asian Studies, Singapore

4 SEIICHI MASUYAMA & DONNA VANDENBRINK

As the ICT Revolution proceeds, demand for services increases more than demand for hardware. Processing information by ICT increases demand for “codified knowledge”, that is information in the form of data, images, and symbols. Computer software, research and development, know-how, content, and financial products are more in demand, in part because they can be processed and distributed in a codified format. Not only does their production and dissemination become dramatically more efficient with the application of ICT, but also they are the kinds of innovation activities that the knowledge-based economy requires. Demand for music and visual content is increasing with the greater diversity of delivery channels brought by the diffusion of broadband telecommunication services, and demand for financial services has increased with the fusion of ICT with financial innovations such as options and futures. The growth of services is being pushed by the separation of software from hardware, the separation of the production process from the innovation process, the increasing demand for content, and the high growth of financial services, among other things. With the progress of the ICT Revolution, it becomes possible to separate, code, process, and transport the “knowledge” that was once inextricably embedded in physical goods, and the distinction between the manufacturing and service industries, and between hardware and software, blurs. Moreover, computer simulation and ICT remove the necessity for research and product development activities to be carried out in close proximity to production activities and thus the innovation process becomes physically separated from the production process. As these functions are outsourced to different firms, the weight of service inputs in manufacturing increases. The results of innovation activities often take the form of services, such as provision of software, intellectual property, research and development (R&D), and know-how. In the United States, the weight of business services in value added by the corporate sector doubled to 5.1 percent from 1980 to 1997 (OECD 2000). These kinds of ICT-enabled transactions are not adequately reflected in conventional economic statistics, but they appear to be expanding fast. International trade in services, in particular, is growing rapidly. This is inferred from statistics on international telecommunications and foreign exchange transactions. Globally, revenues from telecommunications services more than doubled from 1991 to 2000 and international telephone traffic increased 189 percent (Table 1.1). In April 2001, average daily turnover in foreign exchange was US$1.2 trillion, about twenty times the average daily volume of international trade in goods in that year (Table 1.2). In 1999 global production of optically stored music, data, and video

© 2003 Institute of Southeast Asian Studies, Singapore

THE NEW INDUSTRIAL GEOGRAPHY OF EAST ASIA UNDER THE KBE 5

TABLE 1.1 World Telecommunications Service Sector

Telecom services revenue (US$ billions) International telephone traffic (billion minutes)

1991

2000

2001e

403 38

920 110

1,010 120

Source: International Telecommunication Union, .

TABLE 1.2 Global Foreign Exchange Turnover and World Trade (US$ billions)

Average daily turnover, April World merchandise exports World commercial service exports

1989

1995

2001

590

1,190 4,935 1,189

1,210 6,185 1,435

Note: World trade data refer to 2000, not 2001. Source: BIS Press Release, 9 October 2001, “Central bank survey of foreign exchange and derivatives market activity in April 2001”, and WTO .

information was growing at an estimated rate of 70 percent while the growth rate for production of magnetically stored information was estimated at 55 percent per year.2 The ICT Revolution Spawns the Knowledge-based Economy

The ICT Revolution is facilitating a move to knowledge-related activities as the main source of competitiveness and added value. We are witnessing the structural transformation of the economy to a knowledge-based one. A knowledge-based economy (KBE) is one in which knowledge is created, captured, delivered, and utilised efficiently by firms, organisations, individuals, and communities and where outdated knowledge is continually replaced. Hence, a KBE requires that the economic and social system facilitate ongoing industrial restructuring by providing incentives to end obsolete activities and replace them with more efficient activities (Dahlman

© 2003 Institute of Southeast Asian Studies, Singapore

6 SEIICHI MASUYAMA & DONNA VANDENBRINK

and Andersson 2000). Moreover, network externalities work in many sectors of a KBE because of the pervasive use of ICT.3 Crucial to a KBE are efficient ICT industries and ICT infrastructure, efficient — often international — production networks, powerful innovation systems, human resources to support the preceding three factors, and industrial and organisational renewal. The ICT Sector and Infrastructure are the Platform of the KBE

The platform that provides the means for creating, disseminating, and utilising knowledge for a KBE includes both the ICT sector and the ICT infrastructure. Many economies are rushing to construct a so-called national information infrastructure, to facilitate their transformation to a KBE. In the United States, which leads in this transformation, investment in ICT equipment and software increased from 29 percent of total investment in 1987 to 52 percent in 1999 (OECD 2000). The information infrastructure, or “info-structure” consists of not only telecommunications networks but also strategic information systems, supporting policy and legal systems, and human resources to develop and utilise the physical infrastructure (Dahlman and Andersson 2000). Electronic commerce is expected to constitute a growing part of the info-structure. To facilitate info-structure development, deregulatory measures that enhance market competition are preferred over public spending, at least in advanced economies. The Rise of International Production Networks

The greatest impact of the KBE may be on the formation of international production networks (Chapter 3). Before the rise of the KBE, international production networks were typically patchwork arrangements between core firms and local affiliates to give the core firm access to cheaper labour or local markets. In contrast, international production networks in a KBE are integrated, co-ordinated systems of activity nodes that take advantage of the specialised technology, skills, and know-how at each node (Borrus, Ernst, and Haggard 2000). These production networks tend to organise firms, including small and medium enterprises (SMEs), horizontally not hierarchically and to co-ordinate their activities through SCM with the use of ICT. The geographical organisation of production networks in a KBE tends to have manufacturing processes located separately from innovation centres. With the costs of transporting knowledge inputs and outputs approaching

© 2003 Institute of Southeast Asian Studies, Singapore

THE NEW INDUSTRIAL GEOGRAPHY OF EAST ASIA UNDER THE KBE 7

zero, the location of suppliers or clients need not affect the location of producers as much as in a manufacturing-based economy. At the same time, producers in some industries tend to concentrate in local networks or clusters. In the case of the KBE, the force to agglomerate arises more from the advantages of physical proximity for sharing and diffusing knowledge, than from the advantages of central location for minimising transport costs. As industrial activities become more complex and involve many firms in complementary activities, access to supporting industries becomes more important to competitiveness. A typical example of the KBE-type of production network is found in the software sector, where the innovation centre in Silicon Valley is linked with production bases in Bangalore, India, and Israel, among other places. Similar international production networks are forming in other industries, linking innovation centres in advanced countries, particularly in Silicon Valley, with local agglomerations in ICT hardware manufacturing that are taking shape in East Asia. These include the ICT cluster around Taiwan’s Hsinchu Science Park, the electronics industry cluster straddling Singapore and Malaysia, and the ICT industry cluster in the Pearl River delta of southern China. The Importance of Innovation Systems

Investment in the creation of knowledge is a primary source of economic growth in a KBE, and an economy’s ability to provide a congenial environment for innovation activities determines its international competitiveness. Moreover, a firm’s competitiveness in a KBE depends, to a large degree, on its ability to differentiate its products and services, on its rights over intellectual property, and on its development of ICT services, and the firm’s innovative capability determines its success in these factors. Finally, innovation capacity is becoming particularly important for the success of advanced economies and the firms based there, as innovation activities separate from manufacturing and as manufacturing activities transfer to developing economies that have abundant unskilled labour. Innovation results from complex interactions among those who produce, disseminate, acquire, and apply various types of knowledge. These include workers in private firms, universities, and public research institutes involved in co-operative research, human exchanges, cross-licensing, and equipment purchases (Dahlman and Andersson 2000). The likelihood of successful innovation depends on the performance of the entire complex of interactions,

© 2003 Institute of Southeast Asian Studies, Singapore

8 SEIICHI MASUYAMA & DONNA VANDENBRINK

or what is called the innovation system. Just as with manufacturing systems, some functions of innovation systems tend to concentrate in close geographic proximity. One crucial component of the innovation system for a KBE is internationally competitive universities, which create scientific knowledge. Another component is interaction between academia and industry, which facilitates the creation of knowledge as well as its dissemination. Financial systems that support innovation-oriented start-up firms, such as venture capitals and emerging company markets, facilitate the replacement of outdated knowledge with new knowledge. Advanced economies have developed markets such as NASDAQ in the United States, EASDAQ in Europe, and Neuer Markt in Germany to meet this need. Finally, stronger protection of intellectual property rights and standardisation of these protections across national borders enhances the efficiency of innovation systems. Corporations strive to obtain patents in other countries — particularly the United States — to ensure their international protection. In the era of economic globalisation, local innovation systems need external links in order to expose domestic activities to best knowledge and best practice and to benefit from the interaction. The sharing of standard language and common culture assists national economies in establishing links with innovation systems beyond their own borders. For example, the existence of an ethnic Chinese community spanning the Pacific Ocean has contributed greatly to the transfer of knowledge from the United States, particularly Silicon Valley, to Taiwan and China. In addition, sending people abroad to study in advanced economies, especially in the United States, and proficiency in English, the linguistic standard in the Internet age, facilitate the international linkage of innovation systems. Embodied Knowledge: Human Resources Are Key

Human resources, which embody knowledge, are essential to a KBE. The needs of a KBE are not the same as those of the industrial age. Industrial economies relied on workers with an accumulation of skills working in a co-operative organisation. A KBE requires both creative talents to sustain innovation systems and ICT workers to support the information and telecommunication network infrastructure. Moreover, the fast pace of innovation in a KBE means that knowledge becomes obsolete quickly and that people need to refresh their skills and keep up-to-date on the required knowledge. Thus, in order to supply a labour force that serves firms in a KBE, a society’s education model must foster individual creativity and

© 2003 Institute of Southeast Asian Studies, Singapore

THE NEW INDUSTRIAL GEOGRAPHY OF EAST ASIA UNDER THE KBE 9

openness to lifelong learning. Societies and firms need to design their education and training programs to meet the needs of the KBE. The market for knowledge talents is becoming global, even encompassing developing economies. As advanced economies try to build competitive advantage in innovation to replace the out-migration of manufacturing processes, knowledge workers are the critical resource. The economy of Silicon Valley, which is supported by engineers from all over the world, particularly ethnic Indians and Chinese, is in the forefront of this phenomenon. Firms in advanced economies are also shifting innovation activities abroad, even to developing economies to tap local talents. Motorola and Microsoft, for example, each set up R&D centres in China. In other cases, firms in advanced economies outsource knowledge-intensive activities to foreign firms that control knowledge workers. The outsourcing of software production by U.S. firms to firms in India and Israel is such an example. At the same time that the KBE needs skilled human resources to do knowledge work, it also, rather ironically, depends on goods and services that are produced by low-cost unskilled labour in developing economies. Developing economies that have abundant labour have emerged as manufacturing centres, because the production of ICT equipment includes many labour-intensive assembly operations and because capital investmentsaving and labour-intensive production methods are more flexible and cost-effective when product life cycles are extremely short and product changes are frequent. In these circumstances, with an almost unlimited supply of cheap, industrious, and fast-learning labour, China has emerged as the major centre for the manufacture of ICT equipment. The Reorganisation of Industry and Corporate Structures

The increase in knowledge inputs and the application of ICT are leading to the reorganisation of industries, firms, and economic activities. First, the reorganisation, or restructuring, of industry is being accelerated by the confluence of three trends: (1) the rapid growth of ICT equipment and service industries, which itself fosters industrial restructuring; (2) the application of ICT to logistics as seen in SCM, which encourages reorganisation of value chains within the industrial sector; and (3) the ongoing separation between innovation and manufacturing, which is prompting the reorganisation of industries internationally. The overall outcome is that developing economies with abundant low-cost labour increase their share of manufacturing industries and advanced economies

© 2003 Institute of Southeast Asian Studies, Singapore

10 SEIICHI MASUYAMA & DONNA VANDENBRINK

specialise in innovation activities and knowledge-intensive service industries. With the transition to a KBE, corporate organisations are moving away from centrally directed, vertically integrated structures towards new forms of business organisation. Horizontal organisations with distributed authority can respond more rapidly to changing conditions. In a KBE, successful enterprises may outsource most functions to relatively autonomous specialists and use ICT to co-ordinate among the network nodes, for example, to manage the flow of information and materials through the supply chain. Advances in ICT have reduced transactions costs, shrinking the economic rationale for the scope of the firm. The complementarity between this type of organisation and the spread of ICT has accelerated the physical and organisational separation of the innovation function from the manufacturing function. This separation is seen in the emergence of the so-called “fabless” manufacturers and other specialised manufacturers such as electronics manufacturing service (EMS) providers and semiconductor foundries. In the semiconductor industry, the fabless firms concentrate exclusively on chip design, maintaining no production facilities and outsourcing the manufacture of chips to foundries, which specialise in original equipment manufacturing (OEM) production. With the spread of ICT, network externalities apply to many industries. They are especially conspicuous in “module-type” industries, such as ICT equipment, where a common technical standard smoothes interchanges between firms. At the same time, because with network externalities all members of a networked organisation share in the economies of the network’s scale, the success of each individual member is less dependent on its own scale of operations. Thus, there is a greater role for SMEs in a KBE. Already this phenomenon is taking shape. For example, emerging small firms are central players in Silicon Valley, and Taiwan’s relatively small PC producers networked with small producers of parts are more competitive than, say, Japan’s large integrated corporations. Small firms are still at a competitive disadvantage, however, in industries such as automobiles, which require close collaboration involving many nonstandardised parts and components. The need for networking in the KBE stimulates corporate alliances. Cooperative alliances are more flexible and adaptable than more traditional inter-firm relationships or joint ventures. Thus, the KBE may give birth to “alliance capitalism”, an economic system characterised by co-operative arrangements that facilitate strategic sharing of knowledge between producers and innovators (Chapter 3).

© 2003 Institute of Southeast Asian Studies, Singapore

THE NEW INDUSTRIAL GEOGRAPHY OF EAST ASIA UNDER THE KBE 11

As a KBE requires such drastic changes in the organisation of industries and firms, we can say that an economy cannot fully realise the benefit of productivity growth due to ICT unless and until such reorganisations proceed. To facilitate this process and the transformation to a KBE, many economies will have to allow more liberalisation and deregulation. Moreover, a well-functioning capital market is essential to support such restructuring. Start-up businesses and SMEs, the kinds of firms that are critical to the KBE, face difficulties in obtaining bank financing because they lack the physical assets to submit as collateral for loans. Thus, capital markets, particularly equity markets are necessary to fill the financial needs of a KBE. These markets are important also because the corporate governance they impose stimulates the continual reallocation of resources to their best use. Possibilities of Leapfrogging and Knowledge Divides

In the current transition from the industrial age to the age of the KBE, there are growing divides between those countries, societies, enterprises, and peoples that have smoothly adapted to the paradigm shift and those that lag in making the adjustment. Such divides have appeared within and among advanced economies, but the ones between advanced and less developed economies are more perilous. The divides with some developing economies could widen if policy failures and/or the lack of human and financial resources continue to delay their adaptation to the new paradigm. On the other hand, the relentless restructuring of industries and organisations around the world gives developing economies that have adapted to the new economy an opportunity to catch up with, or even leapfrog, advanced economies that are behind in replacing investments in the technologies, institutions, and organisations of the old economy. The prospects for leapfrogging and for wider knowledge divides arise from the developing economies’ strengths and weaknesses in the ICT sector and infrastructure, international production networks, innovation systems, human resources, and industrial and corporate reorganisation, the essential components of a KBE. The competitiveness of innovation systems and the development of service industries seem to be crucial determinants of the relative economic performance of the advanced economies and NIEs. For NIEs to leapfrog advanced economies, their progress in these areas is essential. For less developed economies, on the other hand, adaptation to international production networks is a more important determinant of relative economic

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12 SEIICHI MASUYAMA & DONNA VANDENBRINK

performance than the competitiveness of indigenous innovation systems because these economies can utilise knowledge transferred from advanced economies. Digital divides could jeopardise their adaptation to international production networks, however. Deficiencies in ICT infrastructure and ICT human resources could hinder the development of B2B transactions, for example. IMPACT OF THE KBE ON EAST ASIAN INDUSTRY Turning into the Manufacturing Base for International Production Networks

The ICT Revolution has already greatly affected the East Asian economies, both in short-run performance and in industrial structure. So far, the impact of the Information Revolution on Asia has occurred largely through the region’s function as the world’s main manufacturer of ICT equipment (Table 1.3). Concerning short-run performance, the production and export of ICT equipment to meet strong global demand pulled the region out of the 1997 financial crisis, and then the meltdown of the ICT boom in 2001 sent these economies plunging. With the progress of the ICT Revolution, manufacturing capacity in the region shifted from Japan to the newly industrialised economics (NIEs) and then to ASEAN and, especially, China as these two areas became bases for the manufacture of ICT equipment. At the same time, Singapore and Hong Kong have emerged as regional ICT hubs. On the other hand, though, the East Asian economies have not established a strong position in the soft side of the ICT industry, that is, in software and IT-related service industries. TABLE 1.3 Asia’s Share of Global Electronics Production, 1985–98 (Percent)

Asian NIEs Japan Other Asia All Asia

1985

1990

1995

1998

4.27 18.56 2.43 25.26

8.69 26.39 4.56 39.65

12.31 25.73 8.03 46.07

10.93 18.03 9.90 38.87

Source: Poh-Kam Wong, “ICT Production and Diffusion in Asia: Digital Dividends or Digital Divide?”, Table 1. .

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The Emergence of OEM Producers in the Asian NIEs

As the innovation and manufacturing functions continue to separate, networking between innovation activities in advanced countries and manufacturing activities in East Asia is on the rise, especially in the ICT sector. By compensating for their lack of domestic innovation capability, networking with advanced economies increases the East Asian economies’ capacity for growth. In this way, the region has become the world’s centre for the manufacture of ICT equipment. Since the 1990s, as ICT became a core technology, the United States has eclipsed Japan as the source of innovation for East Asia’s manufacturing centre. In the electronics sector Japan produces only a small share of highgrowth ICT equipment, while it continues to produce a large share of lowgrowth consumer electronics goods. The prevailing system in the ICT equipment industries is one in which brand-possessing firms mainly in advanced economies carry out research and development and firms in the Asian NIEs do OEM production. This division of labour initially took shape when U.S. electronics makers switched from Japanese to Taiwanese and Korean manufacturers to supply components such as integrated circuits. With this strategic decision, the U.S. manufacturers circumvented their previous dependence for key components on the vertically integrated Japanese manufacturers, which were also their competitors in final product markets (Borrus, Ernst, and Haggard 2001). As a consequence, the influence of Japanese manufacturers in the East Asian ICT industry declined significantly, although they still supply a significant share of key components. This division of labour between brand-name firms in advanced countries and OEM producing firms in developing economies benefits the producing firms in several ways. It frees them from the need to devote resources to R&D and marketing and allows them to concentrate on producing as efficiently as possible. It also allows them to accumulate experience and knowledge that can serve as the basis for developing their own technologies or products. In this way, electronics firms in Taiwan and Singapore have begun to transform from OEM producers for global brand-holders in the United States and other advanced economies. They have used the knowledge and feedback on product development they gained through these long-term contract production relationships to take on higher functions such as original design manufacturing (ODM) and co-ordination of customers’ supply chains. Specialised contract electronic manufacturers are now

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14 SEIICHI MASUYAMA & DONNA VANDENBRINK

evolving into EMS providers of overall service packages. Through these changes, ICT firms in the Asian NIEs have become more competitive, especially in terms of price, against Japanese firms producing PCs, semiconductors, and other electronic goods and components. In particular, EMS providers already threaten Japanese firms and have prompted their reorganisation. The emergence of OEM producers in Asian economies such as Taiwan is due also to organisational innovation. The ICT industry in Taiwan consists of many SMEs, in contrast to Japan or Korea where large firms dominate the industry. Taiwan is second behind the United States in the number of ICT design firms (127), and the domestic sales ratio for information and communications (IC) production in Taiwan (54.7 percent) is greater than in North America, Japan, or Europe (Chapter 3). Moreover, many of Taiwan’s SMEs are run by independently minded Chinese who share a respect for the importance of “relationship”. These characteristics meshed with the horizontally organised local production networks required by the KBE and thus facilitated the formation of efficient industrial clusters in Taiwan’s ICT industry. In addition, the industry’s diversified network structure smoothed the linkages between Taiwanese firms and similarly organised firms in Silicon Valley (Chapter 3). The Emergence of China as a Major Production Base

China has become a major node in the production networks linking the United States and East Asia. From the middle of the 1990s ICT manufacturers based in the Asian NIEs, particularly in Taiwan, shifted their labour-intensive production processes to ASEAN and more recently to China to maintain competitiveness as wages rose at home. By 1999, Taiwanese PC firms produced 47 percent of their US$18.9 billion output overseas (Chapter 3). Export-oriented foreign investment in contract manufacturing, mainly from Taiwanese firms, attracted by southern China’s seemingly inexhaustible supply of unskilled labour, helped the Pearl River (Zhu Jiang) Delta area become a production base for ICT hardware exports. Indeed the inflow of foreign direct investments (FDI) is giving rise to a virtuous circle in which the development of FDI-financed parts and components suppliers increases the area’s ability to attract more FDI. Concentrated public investment in infrastructure by China’s central government also helped to attract foreign investment. The area now accounts for more than half of the world’s production of copiers, printers, and

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desktop PCs, and recently, it has become a major source of ICT parts as well. Along with their investments in southern China, Taiwanese firms introduced a networked structure, which encouraged the development of clusters of ICT manufacturers and parts makers. In addition to its comparative advantage in unskilled labour, the competitiveness of the Pearl River Delta is based on this agglomeration of parts manufacturers and on financial and logistics support from nearby Hong Kong (Kuroda 2001). The Chang Jiang Delta near Shanghai has developed as a centre of notebook PC and mobile phone production with the help of foreign investment oriented towards the domestic market. China’s telecommunications market is already huge, with 120.6 million mobile phone users at the end of July 2001, and its growth potential is similarly large. The Shanghai area offers a significant pool of educated workers, and the existing local industries are concentrated in knowledge- and capitalintensive sectors (Kuroda 2001). As they did in the Pearl River Delta, Taiwanese investments have been playing a crucial role in the industrial development of the Chang Jiang Delta. It is said that more than 300,000 Taiwanese now reside in the Shanghai area. Taiwanese firms, which have begun to possess their own innovation capabilities as a result of past transfers from firms in the United States and Japan, are now transferring these technologies to Chinese engineers and firms. This transfer is proceeding rapidly, helped by the common language and culture of Taiwan and Mainland China. Moreover, with the accession of Taiwan to the World Trade Organisation (WTO) at the end of 2001 it will be difficult for the Taiwanese government to restrict Taiwanese firms from trading and investing in China (Kuroda 2001). At the same time, with its accession to the WTO China expects to attract more foreign investment by Western and Japanese firms, which would further accelerate technology transfer. China is also beginning to develop its own innovation systems. A largescale competitive innovation centre seems to be emerging in Beijing. The Zhongguanchun area in Beijing already has a concentration of software and R&D firms linked with the capital’s high calibre universities and research institutions. Firms in this area could connect with the versatile industrial concentrations in southern China and near Shanghai to form innovation-oriented, domestic production networks. Moreover, China seems to have a greater abundance of the entrepreneurial spirit required in a KBE than the ASEAN economies have. Domestic firms captured 90 percent of China’s TV market, 80 percent of the PC market, and close to 10 percent

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16 SEIICHI MASUYAMA & DONNA VANDENBRINK

of the mobile phone market in 2000. Thus it seems quite possible for China to leapfrog ahead of the ASEAN economies. Although the general level of industrial development is still much lower in China than in Japan, several conditions are more favourable to future development in China than in Japan, mostly because Japan has been so slow in adapting to the KBE. First is the regional diversity and the fierce inter-regional competition in China. These can create more liberal, efficient investment conditions and greater innovative efficiency than the centralised innovation and production systems in Japan. Second are the linkages between universities and the industrial sector in China. Such linkages are well suited to innovation systems under a KBE. Chinese universities have played an active role in local industrial clusters not only in Beijing but also in other cities such as Shanghai and Tianjing, in contrast with Japanese universities, which do not compete with each other and have played a very limited role in industrial development. Third, even though state-owned enterprises are generally plagued with inefficiency and weak financial conditions, some Chinese firms have shown themselves more capable than Japanese firms at low-cost production of such goods as motorcycles and consumer electronics. On the other hand, a number of other conditions in China stand in the way of its future development, at least in the short run. The level of higher education and the number and quality of scientists and engineers in China are not sufficient to create comparative advantage in high-tech areas for the foreseeable future. Moreover, if it is to support high-tech industrial development, China needs to improve its protection of intellectual property rights and its financial system. China’s financial system, including its stock markets, are designed and operated to support the stagnant stateowned enterprises (SOE) sector, but it provides very little support to the dynamic ICT sector that is led by private firms. Moreover, the lack of an efficient nationwide transportation system may hinder the spread of production networks to inland areas. China’s accession to the WTO is expected to bring significant improvement in these conditions in due time. Moreover, even if high-tech activities remain confined to a few locations in China, the sheer size of China’s economy means that the further development of even these few concentrations will probably have significant repercussions for the rest of the world, and particularly for East Asia. The Rise of Hubs to Service the East Asia Region

Singapore and Hong Kong have developed into nodes of a regional network, providing support for production activities spread throughout the region © 2003 Institute of Southeast Asian Studies, Singapore

THE NEW INDUSTRIAL GEOGRAPHY OF EAST ASIA UNDER THE KBE 17

and links with innovation centres in advanced economies. They carry out engineering and co-ordinating functions for international production networks. They play critical roles in the Asian network based on their agglomerations of transport, logistics, and financial services. Singapore strives to be a hub for the Asia-Pacific region with a focus on Southeast Asia, while Hong Kong aspires to be the hub for activities focused on China. Both Singapore and Hong Kong seek to upgrade further by also becoming ICT hubs in synergy with their traditional hub functions of transport, logistics, and financial services. Among other things, an ICT hub needs an active electronic commerce sector, a financial sector that generates demand for ICT services, and a publishing and broadcasting sector that creates and distributes Internet content. The comparative advantage of Hong Kong and Singapore as ICT hubs comes in part from the fact that their residents can use both English and Chinese languages. Because English is increasingly becoming the communication standard for ICT-related activities, these co-ordinating hubs are usually located in English-speaking places (Chapter 5). Such synergies are promoting the proliferation of e-marketplaces in Singapore, for example. Disruption of the Flying Geese Pattern in Asia

The development pattern of East Asia has long been characterised by the orderly image of a flock of flying geese, with Japan in the lead, followed by the Asian NIEs and then the less developed economies in the region. Mature industries moved from Japan to the NIEs through investments and technology transfer, and from Japan and the NIEs to the other economies in the region, with a beneficial impact on economic growth. Overall, it is becoming apparent that in the transition to a KBE, the flying geese pattern is being disrupted and a new economic geography is emerging in East Asia. As explained before, the reconstructing of international production networks and innovation systems to suit a KBE creates opportunities for leapfrogging. In Asia, the NIEs have begun to outperform Japan in the PC industry, in parts of the semiconductor industry, and in some service industries such as finance and distribution. Also, China has been rapidly developing industrial clusters in the ICT equipment area and is now posing a serious competitive threat not only to the ASEAN economies but also to the NIEs and even to Japan. One aspect of opportunity is the new growth poles, constituting international production networks, such as the Pearl River Delta, the Chang Jiang Delta, Taiwan, Singapore, and Korea, which have popped up to meet the surge in demand for ICT hardware. But there © 2003 Institute of Southeast Asian Studies, Singapore

18 SEIICHI MASUYAMA & DONNA VANDENBRINK

is also a risk that some economies may fall further behind. The laterdeveloping countries in ASEAN including Malaysia, Thailand, the Philippines, and Indonesia seem to be finding it difficult to adapt to a KBE. EAST ASIA’S AGENDA FOR TRANSFORMING TO A KBE Agenda for the KBE

To transform and adapt to the emerging KBE, the East Asian economies must work on each of the five supporting components by: • developing the ICT sector, including ICT-related service industries and ICT infrastructure, as a platform for the KBE; • adapting to international production networks; • strengthening innovation systems; • upgrading human resources; and • restructuring industries and corporations. Furthermore, the Asian economies need to reorient themselves to make the best use of ICT because the benefits of the ICT Revolution derive more from its use than its production (OECD 2001, p. 9). Moreover, they need to increase the share of knowledge in their inputs by emphasising local innovation activities. These moves need to be supported by the ICT-related service sector. Although all East Asian economies have the same list of agenda items, different items have priority according to each economy’s stage of development. For example, later-developing economies tend to emphasise measures to help their economies adapt to and connect with international production networks: to prevent the appearance of a digital divide by improving the telecommunications infrastructure and building an ICTtrained work force and developing industrial clusters. The top priority in the NIEs, on the other hand, is generally the same as in the advanced economies: enhancing innovation activities. One unique and critical issue for the NIEs, though, is how to transform from catch-up systems that emphasise transfer of knowledge from advanced economies into systems that emphasise the indigenous creation of knowledge. If the NIEs are to take advantage of the paradigm-shifting ICT Revolution to leapfrog the advanced economies by adapting more promptly to a KBE they will need more than simply ICT strategies. They should devise a comprehensive approach that emphasises strengthening innovation systems by fostering more creative human resources.

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THE NEW INDUSTRIAL GEOGRAPHY OF EAST ASIA UNDER THE KBE 19

Another important aspect of the strategy of East Asian economies with respect to the KBE is international linkages. It is extremely important for them to expand and strengthen their linkages with the two giant economies in the Pacific, the United States and China. Linking with Japan is becoming less important for them. Developing ICT Infrastructure

The disparity among East Asian economies in ICT infrastructure is wide. The NIEs have reasonably well-developed telecommunications systems and indeed, Korea, Hong Kong, and Singapore are ahead of Japan in broadband telecommunications infrastructure, which is crucial for the development of e-commerce. According to an OECD report, Korea is the world leader in broadband Internet connections.4 In other East Asian economies, though, low penetration rates of fixed telephone lines and of mobile phones have retarded the diffusion of the Internet, and in ASEAN and China the state of the infrastructure is a serious problem. The inadequacy of basic telecommunication infrastructure in Indonesia, the Philippines, and Thailand has constrained their use of the Internet and development of Internet-related businesses (see Chapter 6, Table 6.6). Providing adequate land-based telecommunications service is particularly difficult given the geography of Indonesia and the Philippines. In both economies alternative telecommunications systems and local models of Internet access have emerged. The government of Indonesia pioneered in using satellites to provide domestic telecommunications for the archipelago. Providing access to telephone and Internet service has become a rapidly growing business for small and medium-sized Indonesian entrepreneurs and the 2,000 to 2,500 Internet kiosks in Indonesia are the most of any economy in the Asia Pacific region (Chapter 7). Filipinos have also been turning to Internet cafes and mobile telephones as a way around the deficiencies of the telecommunications infrastructure. East Asia’s divergence from the flying geese pattern is nowhere more evident than in the development of Internet infrastructure. On one hand, the NIEs are pulling ahead of the long-standing leader, Japan, and on the other hand, the gap between the leaders and the other developing economies seems to be widening. The reversal in the order of development between Japan and the NIEs and the widening gap between the NIEs and the other developing economies in the region reflect differences among the economies in the extent of deregulation in the sector. Inadequate competition due to over-regulation of telecommunications has undermined the building of an

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20 SEIICHI MASUYAMA & DONNA VANDENBRINK

infrastructure platform in some economies. In Thailand, the lack of competition among Internet connection firms has kept Internet access charges at high levels (Chapter 5). Thus, facilitating competition in the telecommunications sector is a major agenda item for East Asian economies, and the governments have been increasing their efforts in this area. It is observed that the state’s monopoly of the telecommunications sector is an obstacle to the penetration of the Internet and the emergence of Internet-based businesses and applications in Thailand (Chapter 5). The ASEAN economies acknowledged with the e-ASEAN Framework Agreement the need to adopt regulatory and legislative frameworks for e-commerce (Chapter 7). Next, it is critical to foster an environment conducive to the development of e-commerce. Adapting to International Production Networks

East Asian economies have been deepening their access to international production networks, which are an important element of a KBE. They have developed physical infrastructure such as roads, ports, and telecommunication facilities and increased the efficiency of customs procedures to improve their part in the logistics of international production networks. Latecomer economies such as Vietnam and Myanmar, however, still must undertake many improvements in this area before they are well adapted to serve and benefit from international linkages. In addition to a higher volume of international transactions in goods in services, smoother networking has also resulted in an increase in crossborder payments and settlements. The international payments infrastructure needs to be improved to cope with this new aspect of the global economy. The region would become even more attractive as an international network node if participants could be confident of smooth settlement of the financial aspect of transactions. In particular the East Asian economies have much to gain from finding ways to connect the real-time gross settlement systems of individual economies with regional networks (Chapter 9). FDI-fed agglomerations of industry, such as the ones in Singapore– Malaysia, southern China, and Thailand, have been the foremost source of the region’s high performance in international production networks so far. Fostering existing industry clusters and creating new ones is therefore an important way to strengthen East Asia’s connections to international production networks. Recognising the importance of industrial agglomeration, the Singapore government is seeking to develop a new

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THE NEW INDUSTRIAL GEOGRAPHY OF EAST ASIA UNDER THE KBE 21

cluster in the ICT equipment industry. In its Industry 21 Masterplan, the government selected the electronics industry as the key cluster to make Singapore a pre-eminent electronics hub by attracting leading global firms that hold the most advanced product design, manufacture, and application software capabilities (Chapter 10). Similarly, in order to stimulate a strategic cluster of firms specialised in Internet and multimedia applications, the Hong Kong government joined with a private firm to provide the needed infrastructure in the “Cyberport Project” (Chapter 9). Malaysia’s Multimedia Super Corridor project is intended to attract a cluster of high-tech industries. Promoting ICT-Related Service Industries

East Asia has become the world’s top supplier of ICT equipment, but the relative weakness of the region’s economies in the service side of the ICT industry prevents them from fully capturing the benefits of a KBE. Another compelling reason for these economies to develop ICT-related service sectors is to diversify their industrial structures and increase their macroeconomic stability. The comparatively heavy dependence of East Asian economies on external markets for ICT hardware has made them relatively volatile, as evidenced by their rapid recovery from the 1997 crisis followed by their sharp plunge in the wake of the global ICT bust (Table 1.4). TABLE 1.4 Volatility of East Asian and Advanced Economies Standard Deviation of Monthly Growth Rates Industrial Production G-7 economies Asian NIEs ASEAN-4 World sales of semiconductors

0.5 7.0 3.7 14.7

Notes: Standard deviation of de-meaned series 1993M2-2001M3 for industrial production and 1991M1-2001M4 for semiconductors. Source: IMF World Economic Outlook 2001, Table 1.12. .

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22 SEIICHI MASUYAMA & DONNA VANDENBRINK

The skewing of East Asia’s industrial structure towards manufacturing to the neglect of services was, to some extent, a natural consequence of the prevailing Japanese model of industrial development in the region and the flow of FDI from Japan and the NIEs. Korea and Taiwan, which followed the Japanese model closely, are comparatively weak in the service sector including ICT-related services. Only 7 percent (US$4.1 billion) of Korea’s total IT output in 1999, was software and other computer-related services, and 70 percent of that was produced by foreign firms (Chapter 2). Similarly, in 1999, the US$3.0 billion of software and other IT services produced by Taiwan was less than one-tenth of its worldwide production of hardware (US$39.9 billion). Korea and Taiwan are much weaker in the software and other ICT service industries than are advanced countries including Japan and than Singapore, which functions as an ICT hub. As the ICT Revolution generates a growing emphasis on service-type activities, the East Asian economies are being forced to readjust their underlying industrial strategy and orientation. From 1998 to 1999, software and IT service output in Taiwan grew at a rate of 35 percent per year, almost twice the 18 percent per year rate of growth of hardware output (Chapter 3). Taiwan recognises that the future growth fields include the OEM production of mobile phones, telecommunication and broadband networks, software, and optical electronics, and software and services are increasingly important inputs in these fields. The gap in ICT production between Taiwan and the leaders, the United States and Japan, is attributed to its lag in the production of software (Chapter 3). Korea also expects that the software and computer-related service sector, which has been growing at twice the rate of ICT equipment and services, will become an ever more important part of the economy, especially as new technologies emerge in several fields (Chapter 2). The Philippines has high expectations for its software industry as well as for ICT-related administrative processing activities, based on Filipinos’ fluency in English and on its long-standing commercial relationship with the United States. With wages only 15 percent of U.S. levels, the Philippines is hoping that U.S. firms will contract with local firms to outsource customer support and back office services in finance, accounting, and healthcare. Such services are suited to Filipinos’ relatively low-level ICT skills and also they have a large effect on non-ICT white-collar employment. Already, AOL operates a call centre in the Philippines and several industrial-office parks with infrastructure designed to attract such services have been constructed (Chapter 6). The Philippine Economic Zone Authority has accredited 200 hectares in nine Information Technology Parks, which provide infrastructure, support

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THE NEW INDUSTRIAL GEOGRAPHY OF EAST ASIA UNDER THE KBE 23

facilities, and amenities to attract ICT firms and promote the development and export of software products and services (Chapter 6). Two factors, in addition to the legacy of the past development model, contribute to the persisting weakness of some East Asian economies in ICT services as the ICT Revolution transforms economies. One is the happenstance of linguistic heritage. With about 80 percent of Internet transactions carried out in English, non-English speaking Asian economies are at a disadvantage in selling content and application software for the Internet market. On the other hand, India and the Philippines, which have relatively strong English language ability, have been able to enjoy global economies of scale in software and Internet-related businesses. Exports of software from the Philippines increased 41 percent per annum from 1993 to 1999 (Chapter 6). More than the limitations of language, however, the inadequacies of the region’s innovation systems have contributed to the underdevelopment of East Asia’s ICT-related services sector. Strengthening the Innovation System

East Asian economies are weak in the innovation activities that are increasingly valuable in a KBE. Such activities mostly take place in advanced countries, which account for nearly 90 percent of R&D expenditures around the world and for about the same proportion of patents granted and scientific papers produced (Dahlman and Andersson 2000). The weakness of innovation systems in East Asia is a major reason for the underdevelopment of the service sector in the region. Even the NIEs lag well behind the advanced economies in technological level. Experts judge that the ICT industry in Korea stands at 60 to 70 percent the level of its counterparts in advanced countries and two to three years behind them, except in the narrow areas of semiconductor memory, TFTLCD, and CDMA mobile phone standards where Korea has the lead (Chapter 2). Taiwan’s technology trade balance still shows a large deficit. In recognition of these problems, East Asian NIEs all take the view that their corporations need to expand innovation activities, establish their own brands, and increase the share of service business in order to increase value added. In part, the weak innovation systems reflect the predominant catch-up economy model by which East Asian economies concentrated on manufacturing products that were developed in advanced economies and relied on advanced economies for technology transfer. For example, having specialised in OEM production under contract to foreign companies, many

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24 SEIICHI MASUYAMA & DONNA VANDENBRINK

firms in the NIEs, unlike ones in Japan, lack experience in product development. They are weak in basic research skills and experience, as they have mainly concentrated on applying technologies that were developed in advanced economies. The way that research efforts are organised also contributes to the lack of innovation. For example, Korea spends about the same proportion of GDP on R&D as advanced economies do, but the efficiency of that spending is very much lower, as seen, for example, in the number of wellcited patents. This is said to be because R&D spending in Korea is concentrated in large firms and managed in a centralised and hierarchical manner (Dahlman and Andersson 2000). Advanced economies came to prefer a cluster approach to a sector approach in science, technology, and innovation policy in part after recognising that geographically concentrating technologically related sectors tends to stimulate innovation.5 East Asian economies appear to be moving in a similar policy direction for similar reasons. For East Asian economies — the NIEs in particular — strengthening weak innovation systems is a major challenge in the transition from catch-up industrial economies to KBEs. Encouraging clustering is one of many policies that government may adopt to try to raise an economy’s innovative capacity. Experience has shown that when government intervenes too much, it tends to stifle the creativity that grows out of voluntary collaboration among individuals and organisations. Thus, government support of national innovation systems should be indirect, such as by creating an overall environment that is conducive to innovation. East Asian economies that have traditionally relied on a top-down, interventionist approach to encouraging and directing innovation are being forced to shift to a more open, co-operative, bottom-up paradigm. For example, in a newly adopted policy framework the Taiwan government has been promoting co-operation among industry, public research institutes, and universities. Furthermore, in the recently published “Long-term Vision for Science and Technology Development”, the Korean government seeks to change: • from a government-led, development-oriented, and domestically networked R&D system to a private-led, dissemination-oriented, and globally networked system; • from a supply expansion policy to an efficient utilisation policy; and • from policies to cope with short-term demands to long-term policies that will lead to the creation of new markets.6

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Upgrading Human Resources

Demand for the human resources that are critical in the transformation to a KBE, workers that embody knowledge, is increasing rapidly in East Asia, as elsewhere in the world, but such workers are in relatively short supply in the region. East Asian economies are well endowed with highquality production workers to support the manufacturing sector, but they are not particularly rich in the kinds of human resources that support the ICT sector and infrastructure or the innovation activities that are crucial for KBEs. Korea’s education and training programs are targeted at supplying production workers and not to graduate the highly skilled software workers that are in high demand (Chapter 2). Indeed, a shortage of ICT workers has become a bottleneck for the development of the ICT sector and infrastructure in East Asia. The problem is especially serious in latecomer developing economies such as Thailand and Indonesia, and it may possibly create digital divides, or an inability to support an ICT sector and infrastructure adequate for a KBE. Moreover, the tendency of firms or subsidiaries of MNCs operating in the region’s developing economies to outsource ICT-related operations to firms in ICT hubs such as Singapore propagates a vicious circle. It discourages economies such as Thailand or Indonesia from training and developing a domestic supply of ICT workers, and the continuing shortage of ICT-trained workers in those economies leads to more outsourcing (Chapter 5). In contrast, the Philippines has steadily increased the number of students in ICT-related fields and annually turns out 40,000 technology and engineering graduates, although their quality is not sufficiently high.7 The Philippines, along with India and Singapore, is in a more advantageous position than non-Englishspeaking countries such as Thailand because English language capability facilitates communication between local ICT workers and foreign clients or employers (Chapter 5). Raising the quality and quantity of higher education is necessary not only to meet the shortage of ICT workers but also to provide the region’s economies with a workforce that can create and apply new knowledge. East Asian economies successfully expanded their primary and secondary education capacity to supply the workers required for rapid industrialisation. These education systems have not encouraged creativity, however, because they typically emphasise rote memorisation. Moreover, the comparative neglect of higher education has constrained the innovation capability of these economies. There are large gaps in R&D capabilities between advanced economies and the NIEs and between the NIEs and other

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TABLE 1.5 Indicators of R&D Capacity

China India Malaysia Korea Singapore Japan USA

Enrolment Ratio in Tertiary Education (%)

R&D Expenditure as % of GDP

Number of Scientists and Engineers per Million Population

1993

1998

1985–95

4 6 25 48 38 30 81

0.7 0.7 0.4 2.7 1.8 2.9 2.5

350 149 500 2,636 2,728 6,309 3,732

Note: Enrolment ratio is the number of students enrolled divided by the population in the 22-24 age group. Source: The World Competitiveness Yearbook 1997 and 1999-2000.

developing economies (Table 1.5). The quantity of R&D workers in Korea is sufficient, but their quality is still inadequate (Dahlman and Andersson 2000). To ensure the availability of adequate human resources to realise the transition to a KBE, the region must adopt a new model of education and training that emphasises quality, creativity, lifelong learning, and total human resource development. In fact, East Asian economies have increased their efforts to upgrade the overall quality of their human resources. Securing an adequate supply of ICT workers is the top priority. The Singapore government has systematically directed its human resource development plan towards recruiting ICT service specialists and electronically delivering education and training. As early as 1985 its National IT Plan called for the development of ICT specialists and the IT 2000 Plan of 1992 also called for the acceleration of the development of ICT-related human resources. Moreover, the Infocomm 21 Masterplan of 2001 called for improving the environment for developing an Internetadept labour force by providing world-class education, training, and recruiting (Chapter 10). Upgrading human resources is also the major prescription against the emergence of digital divides. Latecomer developing economies in East Asia have high expectations that official development assistance (ODA)

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can increase the availability of education and training in ICT, and they seek the co-operation of advanced economies to this end (Chapter 5). One desirable characteristic for such training programs is that they have a builtin multiplier mechanism such that each wave of participants in turn trains a succeeding wave (Chapter 8). As it takes time to develop domestic manpower through training and education, some East Asian economies are resorting to importing knowledge workers as an immediate solution to the shortage. Singapore subsidises housing costs and gives tax deductions to employers that recruit overseas employees and is reviewing standards for granting work permits. Similarly, Malaysia is being flexible about granting work permits to help corporations recruit knowledge workers from overseas to the Multimedia Super Corridor (Chapter 5). Hong Kong has loosened restrictions on the immigration of scientists and engineers from the mainland. To overcome an anticipated shortage of 26,000 skilled workers in software and e-commerce, in May 2000 Korea liberalised its immigration policy by offering foreign ICT professionals a “gold card” visa that allows them to work in the country for up to ten years.8 A more basic, long-term solution to upgrading an economy’s human resources is to reform the education system. The agenda issues in this regard include the supply of creative human resources that support a KBE and lifelong learning for continuous renewal of knowledge. Singapore and Hong Kong are at the forefront of the region’s economies for having revamped their education systems to emphasise the process of learning rather than simple memorisation. Facilitating Industrial and Corporate Restructuring

In East Asia, industrial restructuring to adapt to a KBE has been focused on building up the ICT-related service sector to balance the over-dependence on hardware production. While private corporate efforts will mainly direct the shift towards the ICT and service sectors, government policies that strengthen innovation systems and improve efficiency in goods, labour, and capital markets are also essential. As industrial restructuring proceeds and the KBE becomes more pervasive around the world, an economy’s international competitiveness will turn on the organisational ability to use ICT effectively. In particular, ICT will become essential to corporations’ competitiveness, and their organisation must allow management to use this tool effectively. For East Asia, the main challenges with respect to corporate organisation are to

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restructure existing corporate organisations, to promote SMEs benefiting from network externalities, and to create pathways for new business formation. In Taiwan, locally owned firms, mainly SMEs, are already organised in networks, and these firms together with the accumulation of production and marketing capability in strategic industries are expected to propel future industrial development (Chapter 3). On the other hand, Korea needs to reorganise the chaebol into non-vertical network organisations to overcome the problems caused by their oligopoly control and to reinvigorate the economy. In East Asia, where corporate organisations are generally not well developed, start-up firms are a means to increase the supply of firms as well as to introduce more efficient forms of corporate organisation. Encouraging start-ups, particularly in the ICT sector, has become a major policy goal. Many East Asian economies have adopted measures to promote venture capital and new equity markets. Korea’s KOSDAQ market, introduced in 1996, took off after the Asian financial crisis.9 Hong Kong opened a special board, the Growth Enterprise Market (GEM), with more liberal listing requirements in 1999. Recently, Singapore shifted emphasis from encouraging existing domestic corporations to enter and grow in the high-tech manufacturing sector to promoting start-up activities in such areas as software, the Internet, biotechnology, and mobile communications. Funds offered through the Technopreneurship 21 Program in Singapore resulted in a record number of start-ups from 1998 to 2000 (Chapter 10). Need for a Comprehensive and Indirect Policy Framework

Governments should adopt comprehensive policies towards the KBE, not just narrowly defined ICT policies. They should address, for example, the supporting elements of a KBE. In fact, the East Asian NIEs clearly recognise the need for a comprehensive approach. For example, Infocomm 21 Masterplan is the government’s blueprint for making Singapore a regional centre of the digital economy by integrating the functions of an ICT hub with existing distribution and finance hub functions. The government is co-ordinating the implementation of its plan to develop Singapore into an ICT hub with other related policies regarding technology, inward FDI, manpower, and consumer education (Chapter 10). Likewise, the Korean government is also treating ICT policy as part of a broad KBE policy. Its Comprehensive Plan for Korea’s Transition to a KBE identified “thorough nationwide informatisation” as one of five Core Program Areas, which also included enhancing the innovation system, promoting knowledge-

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industries, revamping human resource development, and developing a safety net.10 In such a framework, the primary role for government is increasingly seen as an indirect one, that is, to establish a policy framework that favours strengthening the economy’s competitive and comparative advantages. For example, Korea is coming to see the undesirability of its earlier direct interventionist policies. Indeed, government fiscal incentives to nurture start-up firms exacerbated the consequences of the bursting of the ICT stock boom (Chapter 2). The governments of the later-developing economies of Southeast Asia have not yet adopted broad programs to guide them into the era of the KBE. So far, they have tended to focus policies on providing ICT infrastructure, such as the Nusantara-21 Project in Indonesia, the MMSC in Malaysia, and the Three Golden Projects in China. Positioning Strategically towards the United States and China

The worldwide transition to the KBE is leading the East Asian economies to adjust their international strategies, which once focused on Japan as a source of production technology and on the United States, Japan, and Europe as export markets. Now Japan’s impact on the external economies of the East Asian region is shrinking, and how each economy positions itself with respect to the United States and China is becoming more important (Figure 1.1). Korea, for one, seeks a spot in the middle, inbetween the global value chains that connect the high-tech development in the United States and the large and attractive domestic markets of China (Chapter 2). Japan’s impact on the other East Asian economies has declined since the beginning of the 1990s with the long slump in its domestic economy, its delay in implementing deregulatory measures, and its failure to adapt to ICT. On the other hand, the United States will continue to be critical to the East Asian economies for a long time as the major source of innovation in areas such as ICT, biotechnology, and finance, as the model for legal, accounting, and financial systems, and as a large market. China is emerging as a large market and as the largest manufacturing base in international production networks. The influence of the United States and China also arises because the English and Chinese languages are international standards that carry the benefits of external economies for the production of many ICT goods and services. In this environment, the Asian NIEs that have large populations of ethnic Chinese, such as Taiwan, Hong Kong, and

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FIGURE 1.1 International Externalities of East Asian Economies

China • China market • Chinese language

International Production Networks

United States • U.S. market • Information technology • Financial technology • Accounting and legal systems • Financial system • English language

Ethnic Chinese NIEs ASEAN ethnic Chinese enterprises

Japan • Production technology • Japan market

ASEAN

Singapore, and ASEAN enterprises that are owned and managed by overseas Chinese are positioned at the convergence of the different international externalities and serve as hubs for international business and technology transfer. Even the NIEs will depend on knowledge transfer from the advanced economies into the future, no matter how successfully they upgrade their indigenous innovation systems. One objective of the international strategy of East Asian economies in the KBE should be to link with the innovation systems in advanced economies. Linkage with the United States, the largest and most advanced knowledge pool in the world, is by far the highest priority. Linkages can take a variety of forms such as corporate relations in international production networks, sending students to advanced economies, networking with universities or research institutions in advanced economies, and soliciting the siting of international business schools.

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Taiwan’s links with the United States, and with Silicon Valley in particular, are essential to the existence of its PC and IC industries. Most of Taiwan’s PC output is OEM production for American brand firms, and more than half of the capacity of Taiwan’s IC foundries was devoted to U.S. client firms (Chapter 3). This trans-Pacific industrial connection is supported by the ethnic and social ties between Taiwanese and other ethnic Chinese residents in the United States and in Taiwan. In the areas of linguistic abilities and overseas educational experiences, which are crucial supports for an economy’s linkages with external innovation systems, the Asian NIEs are better situated than Japan. Their students score higher in English language proficiency and a larger percentage of their students study in the United States (Table 1.6). China is also reported to be experiencing a craze for learning English. The appropriate positioning of the East Asian economies with respect to China is evolving along with China’s economic development and the global transition to a KBE. How to cultivate the Chinese market and how to utilise the vast pool of human resources in China have become major strategic issues for firms in the NIEs. Taiwanese firms have been particularly successful in utilising the Chinese labour force by investing massively in

TABLE 1.6 Linkages with the U.S. Innovation System

Japan Korea Taiwan Hong Kong Singapore Malaysia Thailand Indonesia Philippines China Indonesia

Average Score on TOEFL July 1998– June 1999

Number of Students in the United States per 1,000 Population

501 535 510 524 – 536 512 545 584 562 583

0.37 0.94 1.44 1.53 1.26 0.71 0.25 0.07 0.04 0.04 0.04

Note: TOEFL is the Test of English as a Foreign Language. Source: Economic Planning Agency of Japan, Asian Economy 2000, and Ministry of Home Affairs, World Statistics 1999.

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southern China. Indeed, Taiwan is becoming concerned about the consequences of this success on its domestic industrial base. Despite the threat of hollowing out, however, Taiwan seems to have no option but to continue to gradually liberalise its high-tech investment in China. Proximity may give Korea entree to China’s vast market, especially in mid to high value-added areas that demand quality and accumulation of industrial skills, provided that Korea upgrades its economy so that it is not competing with China to supply the world with low-cost, labour-intensive goods.11 During the 1990s China developed several local concentrations of manufacturing industries and related supporting industries and emerged as a leading base for labour-intensive production activities. Now, most ASEAN economies compete with China in labour-intensive industries and China is an increasing threat because of its large supply of labour, both unskilled workers and knowledge workers, and its efficient industrial clusters. The appropriate responses for ASEAN must lie in such strategies as acceleration of AFTA to create a larger internal market, acceleration of domestic deregulation, and the upgrading of human resources. JAPAN’S RESPONSES TO THE KBE Competitive Challenges to Japanese Firms

The Japanese economy is behind in making the transition to the KBE. Among advanced economies, the United States, Australia, Denmark, Ireland, Holland, and Norway have achieved high economic performance by smoothly adapting to the KBE while France, Germany, Italy, Sweden, and Japan have performed poorly because of their delayed adaptation to a KBE (OECD 2000). Japan’s predicament is due to its failure to adequately prepare the five supporting elements of a KBE. Until recently, the inadequacies of Japan’s ICT infrastructure and its slow deregulation of telecommunications impeded Internet penetration, but the rapid spread of broadband access through DSL (digital subscriber line) has improved this situation significantly. Japan’s fundamental problems now come mainly from its sluggish accommodation to the transformation of international production and innovation systems under the emerging KBE and from the slow progress in organisational restructuring. Japanese firms have been slow to join in and develop their own international production networks of the kind that have emerged in the KBE. These networks revolve around the PC, ICT, and software industries, which utilise modular production technologies. Such industries consist of

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networks of independent firms, linked through technology standards such as operating systems and communications protocols, that produce and assemble individual components into final products. Modular industries have developed extensive international production networks in which China is the dominant base for manufacturing and which rely heavily on B2B transactions among the network nodes. These are very different from the networks that developed around integrated production technologies. Such traditional production networks consisted of a group of related companies that produced many non-standardised components and assembled them in a closely co-ordinated manner. These technologies are still effective in industries such as the automobile industry, where Japanese corporations perform well. In many ways, the characteristics that made Japanese corporations successful in the heyday of the integrated production technologies were not suited to modular technologies and the international production networks of the KBE. Japanese corporations’ primary strength has been in their ability to accumulate knowledge internally within their organisation and related corporations and to collaborate efficiently. They tend to use unique and non-standard production processes and components and they are extremely quality-oriented. These traits are opposite to the requirements of modular production technologies for open networks. As a result, Japanese corporations were not driven to take advantage of China’s supply of lowcost labour when it became available. The fundamental reason for the difficulty of Japanese firms in adopting modular production technology and the KBE, however, must be their slowness to change to flatter, networktype structures. On top of this, public concern about maintaining employment levels at home made it difficult for Japanese firms to move manufacturing processes to China. Moreover, Japanese-style management did not work as well in China, at least in labour-intensive industries, as did Taiwanese and Chinese management practices, which involve tighter discipline and larger economic incentives. Because of delayed restructuring and delayed transformation to horizontal organisational structures, Japanese industry is feeling strong competitive pressure from Taiwanese and other Asian firms that have adopted new business models suitable for networked organisations, such as EMS firms and IC foundries. Japanese firms are particularly threatened by Taiwanese firms that have taken on a central role as organisers of the manufacturing process in U.S.-led production networks and have aggressively utilised China’s low-wage labour.

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Moreover, Japanese firms have lost ground in innovation activities, which are the key element of the KBE for advanced economies. They are behind U.S. firms in the frontier technology areas of ICT and biotechnology. The lack of innovation capabilities has also constrained Japanese firms from evolving into broadly defined ICT-service areas such as financial services. Japan’s innovation system has fallen behind because Japan does not have internationally competitive universities, or dynamic, high-tech industrial clusters such as Silicon Valley and Hsinchu Science Park, or close links with other innovation centres such as Silicon Valley. According to the OECD, collaboration between universities and firms is strong in advanced economies that are performing well in the transition to the KBE, such as Canada, Denmark, the United Kingdom, and the United States, but it is weak in Germany and Korea as well as in Japan (OECD 2000). Moreover, language and culture constrain Japanese firms in accessing foreign knowledge, which has become essential in the age of the KBE. For their part, Japanese firms’ slow reorganisation to a network structure hindered their performance in innovation. Japan’s declining competitiveness as a location for corporate activity has also undermined its participation in international production networks and innovation capabilities. First of all, Japan lags behind the United States and the East Asian NIEs in many policy areas such as the deregulation of information and telecommunications infrastructure and in areas related to innovation systems such as the calibre of universities, industry-university co-operation, human resource development and import, and international linkages. Moreover, labour market immobility and inadequate functioning of corporate governance in Japan slowed the overall restructuring of industries and corporations to accommodate changing production networks and innovation systems. At the same time, Japanese corporations still have certain clear competitive advantages over the Asian NIEs and the advanced economies of the West. Japan is located much closer to China than the other advanced economies are and thus it is better situated to take advantage of China’s vast supply of human resources and dynamic market. Moreover, compared to the Asian NIEs, Japan has a much higher level of innovation capability and a much larger pool of knowledge workers, which are critical for a KBE. Japan also has many firms that possess established brand names. In addition, Japan has by far the most developed corporate organisations in East Asia although they need some modifications. It is no exaggeration to say that Japanese corporations are in the most enviable position, at least in

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East Asia, to be able to meet the demands of a KBE. Their main problem is a lack of determination to make the necessary changes. Agenda for Japanese Corporations to Adapt to the KBE and the New Economic Geography

Japan must respond to the emerging KBE not simply with an ICT strategy, but with a comprehensive strategy that includes adapting to international production networks, reinvigorating innovation systems, and facilitating industrial and corporate reorganisation. In the new economic geography of the KBE, Japanese corporations are squeezed between the innovationoriented American industries and the increasingly competitive alliances of OEM producers from the East Asian NIEs, many of them with manufacturing facilities in China. In manufacturing, Japanese corporations need to position themselves to compete against or outsource to the EMS vendors and foundries of the NIEs and production facilities in China, and in innovation they need to benchmark against American firms. Rather than competing directly with low-cost producers in the NIEs and China, they need to build complementary relationships with them by moving towards more innovation- and service-oriented activities. They should increase product differentiation through innovation and at the same time they should make themselves able to tap into the low-cost production capabilities and pools of knowledge workers in these economies by building stronger and closer linkages with them. The traditional strategy of Japanese corporations to make high-quality products, cheaply, in large quantity has ceased to be effective as a basis for competitive strength because many of these products are maturing to become like commodities, which can be produced more cheaply by East Asian contract manufacturers operating in China. Japanese corporations are now forced to choose whether to compete as low-cost manufacturers or to compete by offering differentiated products. To succeed as low-cost producers, they need to pursue economies of scale in global markets and to do this they need to capture a large share of China’s market. To succeed as providers of differentiated products they need to enhance their capability for innovation and to expand the service side of their businesses. In reality, Japanese corporations need to follow both approaches, but they should emphasise product differentiation, which is particularly necessary in order to develop complementary relationships with industries in China. Even if Japanese corporations focus on product differentiation, however, they

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need to improve their linkages with international production networks so as not to nullify their achievements in innovation with failures on the manufacturing side. This two-pronged approach means that Japanese corporations must adjust their production networks in three ways. First, they need to accelerate their reorganisation into less centralised structures and their introduction of ICT-based systems such as SCM and B2B e-commerce. To make the most of SCM and B2B transactions by networking with other firms, they need to use standardised parts and components and reduce the excessive emphasis on quality that necessitated their use of specialised parts and components and resulted in uncompetitive product prices. To do this, Japanese corporations need to reorganise both their internal operations and their inter-corporate relationships such as keiretsu. Second, they need to make greater use of China as a base for low-cost production. And third, to pursue economies of scale with commodity products, they need to seek mergers and strategic alliances to increase their scale of operations, utilise contract manufacturers such as EMS providers and foundries, and invest in large, strategic markets such as China. To increase their share of China’s market, Japanese corporations should invest in local marketing and R&D facilities in China by attracting knowledge workers. In fact, many Japanese corporations have already initiated such changes in their production networks to meet the challenge from American and East Asian corporations. They have pursued mergers and strategic alliances to reduce costs, changed their design and production systems, reviewed their parts and components procurement, shifted production to China, dismantled their vertical structures, and networked with external corporations. Japanese commodities producers in the steel, paper and pulp, chemicals, and semiconductor memory industries have carried out a number of mergers and strategic alliances. With regard to unbundling and networking, electronics firms such as Sony and Matsushita Electric have started to separate the production function from the product development and marketing functions. They have formed separate firms or departments that specialise in production to compete directly with EMS firms. Moreover, Japanese corporations are renewing efforts to utilise the production capability of China through both direct investments and contracted manufacturing. Some Japanese corporations such as Matsushita have even started to invest in local R&D facilities in China to develop products targeted at the domestic market. At the same time, Matsushita concluded an agreement with TCL Corporation of China to market Matsushita’s

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products in China, and Sanyo has entered a strategic alliance with Haier to market Sanyo’s products in China and Haier’s products in Japan. Japanese corporations have not taken as significant steps to strengthen their innovation capabilities or expand their service businesses, although such moves should be the mainstream response to a KBE in high-wage countries such as Japan. In the ICT industries, some Japanese firms, such as NEC and Fujitsu, have moved to emphasise software and services over equipment production. Other Japanese corporations should reassess their view of the KBE and move away from too heavy orientation towards hardware. To become more innovation-oriented, Japanese corporations should put more emphasis on product differentiation, concentrate corporate resources by changing to network-type organisations, and improve incentives for innovative employees. More fundamentally, Japanese corporations need to develop relationships with high-tech start-up firms, increase their cooperation with universities, and pursue strategic alliances as ways to improve their innovation capability by connecting more closely with the national innovation system. Japanese corporations should also enhance their linkages with firms in China and with firms in the East Asian NIEs, which share some of the same interests as they catch up to Japan. Such linkages should facilitate Japanese corporations’ participation in international production networks and help them avoid being bypassed by corporations from the United States and the NIEs. In this context, Japanese corporations should support the government’s moves to form free trade areas with the East Asian NIEs. They should remember how, earlier, American ICT corporations formed international production networks as a strategic way to escape their dependence on vertically integrated Japanese electronics firms for key components. Japanese corporations can respond in two ways to the deterioration of Japan as a desirable and competitive location for production. They can lobby the government to improve the situation and they can increase their presence in other countries. To some extent, circumstances will force them do the latter, specifically, to shift production to China. There is close interaction among players in an innovation system, and it is difficult for one player to function effectively apart from its domestic innovation system. This is particularly true for Japanese corporations, which are handicapped in becoming more multinational by language ability. Japanese corporations will not be able to restore their international competitiveness

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unless their domestic competitive base for innovation is raised through improvements in university, particularly postgraduate, education, lifelong education, language and business education, transportation and telecommunication infrastructures, and goods and capital markets. Thus, Japanese corporations should increase their efforts to lobby for policies to improve these underlying conditions for competition and innovation within Japan. Notes 1 2

3

4

5 6 7

8

9

10

11

“Older, Wiser, Webbier”, The Economist, 30 June 2001. H. Varian and P. Lyman. 2000. “How Much Information? Executive Summary”, in Berkeleyan, (downloaded on 7 November 2001). Network externality means that the value to each member from participating in a network increases as the number of participants increases. Reuters, 23 April 2001, cited in presentation by the Ministry of Commerce, Industry and Energy, “Overview of e-business in Korea” on 31 October 2001, . Dahlman and Andersson 2000, p. 105. Dahlman and Andersson 2000, p. 103. Based on a survey by Semiconductor and Electronics Industries in the Philippines, Inc. (SEIPI). See Chapter 6. “Seoul to offer long-term visas to high-tech overseas talent”, Korea Herald, 1 May 2000. . I. Shin, “Evolution of the KOSDAQ Stock Market”, Paper presented at the AT10 Researchers’ Meeting. Tokyo, 7–8 March 2002. See Cheonsik Woo, KDI, “Road to a KBE: the Case of Korea”, 2000 Annual Bank Conference on Development at . Cheonsik Woo, “Industrial Upgrading of Korea: Process, Prospects, and Policies”, in Industrial Restructuring in East Asia: Towards the 21st Century, edited by S. Masuyama, D. Vandenbrink, and S-Y Chia (Singapore: Nomura Research Institute and Institute of Southeast Asian Studies. 2001), p. 277.

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References:

Brynjolfsson, Erik, and Lorin M. Hitt. 2001. “Beyond Computation: Information Technology, Organizational Transformation, and Business Performance”. Downloaded from on 5 May 2001. Borrus, M., D. Ernst, and S. Haggard. 2000. International Production Networks in Asia: Rivalry or Riches? London: Routledge. Dahlman, C., and T. Andersson, eds. 2000. Korea and the Knowledgebased Economy: Making the Transition. Paris: Organisation for Economic Co-operation and Development and World Bank. Kuroda, Atsuo. 2001. Meido in Chaina [Made in China]. Tokyo: Toyo Keizai Shimposha. Mann, C., and D. H. Rosen. 2001. The New Economy and APEC. Singapore: APEC Secretariat. Downloaded from on 20 November 2001. Organisation for Economic Co-operation and Development (OECD). 2000. A New Economy? The Changing Role of Innovation and New Technology in Growth. Paris: OECD. ———. 2001. The New Economy: Beyond the Hype. Paris: OECD. Also available to download from .

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PART I ICT Paving the Way to a Knowledge-based Economy

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Reproduced from Towards a Knowledge-based Economy: East Asia’s Changing Industrial Geography, edited by Seiichi Masuyama and Donna Vandenbrink (Singapore: Institute of Southeast Asian Studies, 2003). This version was obtained electronically direct from the publisher on condition that copyright is not infringed. No part of this publication may be reproduced without the prior permission of the Institute of Southeast Asian Studies. Individual articles are available from http://bookshop.iseas.edu.sg > POLICY DIRECTION 43 KOREA:< CURRENT SITUATION AND

2 ICT in KOREA Current Situation and Policy Direction Dongseok Kim OVERVIEW AND BACKGROUND

Korea’s development paradigm is now at a crossroads. Strong capital accumulation and growth in labour inputs, for which the government was a critical resource-mobiliser and manager, underpinned the economy’s impressive growth in the past. Towards the mid-1990s, the limits of this input-driven, statist model of development began to loom in various symptoms such as mounting trade deficits, rampant credit growth by financial institutions, and excessively leveraged, overextended chaebols (Korean business conglomerates). Nonetheless, the majority of Korean people remained inattentive to or unaffected by these symptoms, whether out of lack of awareness, self-indulgence, or conflict of interests — a good example of a system failure. With the onset of the financial crisis in late 1997, however, there came a dramatic turnaround. Facing the imminent danger of a complete economic meltdown or collapse, Koreans started to look at their problems anew and from a critical perspective. As the crisis deepened and grave structural problems emerged, an increasing number in Korea came to recognise those problems as deeply rooted in the long-standing development paradigm.1 Even though the economy started to show signs of revival by early 1999, concern remained over whether it could ever ride out of the crisis completely and find its way back to a super-growth track. Meanwhile radical change underway beyond the economy’s borders attracted the minds of Korean society — a change in the production, exchange, and use of goods and services driven by what can be described as a “knowledge revolution”.

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FIGURE 2.1 Rise of the Age of the Knowledge-based Economy

Advent of the Age of Knowledge-based Economy Intensified Competition & Collaboration around Innovative Activities

Incessant, Accelerating Changes and Increased Uncertainties

ICT Revolution

Expansion & Linking of Knowledge Workers

Acceleration of Technological Progress

Productivity Improvement

Accumulation & Diffusion of Knowledge & Innovation Capability

Formation of Intergrated, Global Economy Sophistication & Diversification of Demands

Increase of International/Interregional Trade

Maturing of Industrial Capitalism Source: KDI and MOFE 2000.

The background, facades, and dynamism of the knowledge revolution and emerging knowledge-based economy are well known by now (Figure 2.1). The most important dynamo of the knowledge revolution is widely seen to be the revolutionary changes in information and communications technology (ICT). Advances in ICT are dramatically affecting economic and social activities, as well as the acquisition, creation, dissemination, and use of knowledge. These advances affect the way in which manufacturers, service providers, and governments are organised and how they perform their functions. Increased access to ICT is affecting the way people work, learn, play, and communicate. As knowledge becomes an increasingly important element of competitiveness, use of ICT is reducing transaction costs, time, and space barriers, allowing the mass production of customised goods and services, and substituting for limited factors of © 2003 Institute of Southeast Asian Studies, Singapore

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production. With ICT use becoming pervasive and its impacts transformational, it has become an essential backbone of the knowledgebased economy. To support Internet-based economic activities, countries need to ensure competitive pricing of Internet services and provide an appropriate legal infrastructure to deal with online transactions. The ICT sector is a principal growth enabler of the knowledge economy and it will be critical to Korea’s endeavour to become a knowledge-based nation powered by creativity and innovation.2 The ICT sector performs a dual role. It provides the platforms and infrastructure for processes and transactions in the knowledge economy. At the same time the output of the ICT sector accounts for a large part of the knowledge economy. The Korean government and people have been quick to recognise the importance of the global ICT revolution and to formulate a strategy to ensure that the country moves ahead to gain all possible benefits from that revolution. For instance, Korea’s Development Plan for Knowledge–Based Economy, articulated and implemented in 2000, emphatically points to ICT as a “core” policy area alongside education and human resource development, R&D and the national innovation system, a social safety net, and industrial upgrading. In parallel, the Ministry of Information and Communication (MIC) has prepared a blueprint for an information society, Cyber Korea 21, which sets out vision, goals, and actions aimed at securing a leadership position for Korea in the global knowledge economy.3 Helped partly by such policy initiatives and support, Korea has performed impressively in many areas of the information infrastructure sector, especially Internet access and mobile telecommunications. Back in 1997, Korea did not compare very well to advanced countries in respect to information infrastructure, but the gap has been reduced dramatically over the past three years. Korean companies are now market leaders in many segments of the hardware and telecommunication equipment markets and they possess strong competencies in these areas. Korea also has a welleducated workforce and a number of other advantages. To preserve this position, however, the country needs to move towards a more efficient model of ICT provision and services. Indeed, a large part of the rapid growth in Korea’s ICT sector has come from the hardware side, especially related to mobile telecommunications. The challenges and opportunities in the future, on the other hand, lie in the service side. ICT services (such as programming and software services) and ICT-enabled services (such as e-commerce, call centres, and remote engineering) are expected to be the growth engines in the global ICT and © 2003 Institute of Southeast Asian Studies, Singapore

ICT Industry

Information and Communication Equipment

Telecommunications Services

© 2003 Institute of Southeast Asian Studies, Singapore

Broadcasting

continued on next page

• terrestrial, cable, and satellite broadcasting

Value-added

Wired telecommunications equipment

enhanced fax data network value-added network service on-line information processing, etc.

• • • •

Resale

telephone switching system transmission equipment telegraphic equipment electric wire optical fibre cable LAN equipment, etc.

voice resale Internet phone re-billing service call aggregation service premise telecommunications service, etc.

• • • • •

• • • • • • •

• wired (local, long-distance, international, public, leased lines, ISDN, telegram, etc.) • wireless (cellular, PCs, paging, satellite, etc.)

Facility-based

TABLE 2.1 Categorisation of Korea’s ICT Industry

46 DONGSEOK KIM

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Production of Software and Computer-related Services

• • • •

Electronic components • • • •

• transceivers (terrestrial, cable, and satellite) • broadcasting equipment and components

Broadcasting equipment

packaged software computing services multimedia content development off-line DB production and information retrieval service, etc.

semiconductors integrated circuits electronic tubes parts, etc.

• computer systems (PC, notebook, workstation, etc.) • peripheral equipment (auxiliary storage, input and output devices, main memory, etc.)

• wireless telecommunications terminals and system • wireless and satellite telecommunications equipment, etc.

Information equipment

Wireless telecommunications equipment

Source: KAIT, Statistical Yearbook of Information and Communication Industry, 2000.

ICT Industry

Information and Communication Equipment

TABLE 2.1 – cont’d KOREA: CURRENT SITUATION AND POLICY DIRECTION 47

48 DONGSEOK KIM

knowledge economy. Relative to its performance in the hardware sector and relative to competitors such as Singapore and Ireland, Korea has not been as successful in ICT services. Although a number of policy initiatives and laws have been (and are being) put in place, the present public policy framework and business environments are not sufficient to conduce the desired form and level of private initiative in the highly risky and uncertain ICT service sector. The rest of this chapter goes as follows. The next section briefly describes the ICT industry in Korea, focusing on aggregate statistics and the government’s policy direction. The third and fourth sections deal with electronic commerce in Korea and the digital divide. The concluding section provides a set of policy recommendations for promoting ICT industry and thus for enhancing Korea’s international competitiveness. Major statistics on the ICT industry in Korea are given in the Appendix. KOREA’S ICT INDUSTRY

While there is not yet a standard definition of the ICT industry around the world, the three sectors of the “ICT industry” in Korea are information and communication services, manufacturing of information and communication equipment, and software manufacturing and computer-related services (Table 2.1). Industry-wide Indicators

The ICT industry in Korea grew rapidly during the 1990s, even during the economic crisis, with an average annual growth rate above 20 percent for 1995–2000. The industry’s share of GDP rose from 5.7 percent in 1995 to 13.1 percent in 1999 and stood at 12.9 percent in 2000. Its contribution to GDP growth was about 40 percent in 1999 and is estimated to be around 50 percent in 2000 (Table 2.2). The rising share was due to the rapid growth of mobile telecommunication service and the expansion of Internet use in Korea. Personal computers, mobile telephones, and information and communication services played a major role in the growth of the ICT industry in recent years. The ICT industry has made other positive contributions to the Korean economy: • The steady decline in the producers’ price index (PPI) for the ICT industry has played a major role in price stabilisation. For instance, in 1998 due to exchange rate depreciation and to economy-wide uncertainty, © 2003 Institute of Southeast Asian Studies, Singapore

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TABLE 2.2 Contribution of ICT Industry to Korea’ s Economic Growth, 1995–99 (Percent)

Real GDP growth rate ICT industry Other Contribution of ICT industry to GDP Growth

1995

1996

1997

1998

1999

8.9 1.7 7.2

6.8 0.9 5.9

5.0 1.9 3.1

–6.7 1.7 –8.4

10.7 4.3 6.4

19.4

13.9

38.2

—

40.4

Note: Contribution to growth = increase in real value-added in ICT industry/increase in real GDP. Source: KDB 2000.

the overall PPI rose by 12.2 percent, but the PPI for the ICT industry rose by only 4.5 percent. In 2000, the overall PPI rose by 2.0 percent while the PPI for the ICT industry declined by 4.3 percent. • The ICT industry has been a major factor in total investment in machinery and equipment. The share of machinery and equipment investment going to the ICT industry grew from 36.6 percent in 1999 to 43.1 percent in 2000. Production

As in many countries, output of the ICT industry in Korea grew rapidly during the 1990s, from merely US$12 billion in 1990, to US$85 billion in 1999, and to an estimated US$112 billion in 2000.4 In 1999 three-quarters of the industry’s output (US$63 billion) was information and communication equipment, 20 percent (US$17 billion) was information and communication services, and 5 percent (US$3.9 billion) was software (Figure 2.2). The average annual growth rate of the ICT industry during the 1990–2000 period exceeded 25 percent. Employment

The number of companies and employment in the industry grew steadily over the past decade, except in 1998 during the crisis. There were 12,000 companies and 520,000 employees in the ICT industry in 1999 (Table 2.3). © 2003 Institute of Southeast Asian Studies, Singapore

50 DONGSEOK KIM

FIGURE 2.2 Production of ICT Equipment and Services by Sector , 1987–99

US$ millions

90,000 80,000 70,000 60,000 50,000

Telecommmunication Services ICT Equipment Software and Computer-related Services

40,000 30,000 20,000 10,000 0 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

Source: KAIT, Statistical Yearbook of Information and Communication Industry, various issues.

TABLE 2.3 ICT Industry Employment by Sector, 1997–99 (Number of persons)

ICT industry total Information and communication services Information and communication equipment Software and computer-related services

1997

1998

1999

412,952 111,309 255,305 46,338

403,064 107,644 243,910 51,510

521,200 122,306 357,830 41,064

Source: KAIT, Statistical Yearbook of Information and Communication Industry, various issues.

© 2003 Institute of Southeast Asian Studies, Singapore

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Imports and Exports

From 1995 to 1999, ICT industry exports grew at average annual rate of 5.9 percent while imports grew at a rate of 12.3 percent per year. The main export items were wireless communication equipment, computers, and software, while the main import items were electronic components and wired communication equipment. Mobile communication terminals, optical disk drives, LCDs, and low-price computers made the greatest contribution to export growth. In 1999 the ICT industry contributed 27.8 percent of total export revenues and 56.1 percent of the total balance of payments in 1999. These shares increased to 29.7 percent and 94.6 percent in 2000, implying that most of Korea’s trade surplus for the year 2000 came from the ICT industry. ICT industry exports by sector for 1996 to 1999 are shown in Table 2.4. Subscriber Networks

Currently, there are four main types of subscriber network available in Korea: • Dialup and integrated digital services network (ISDN): The leaders are KT, Dacom, iNet, and Hanaro. Access speed is 9.6–56 Kbps for dialup service and 64–128 Kbps for ISDN lines with PPP access.

TABLE 2.4 ICT Industry Exports by Sector, 1996–99 (US$ millions)

Communication equipment Information equipment Electronic components Broadcasting equipment Software Total

1996

1997

1998

1999

Average Annual Growth Rate (1996–99)

2,411 4,707 22,285 160 22 29,585

2,854 5,320 22,832 193 51 31,250

3,405 4,669 22,219 178 53 30,525

6,046 7,267 26,241 343 53 39,948

35.9 15.6 5.6 28.9 34.1 10.5

Source: KAIT, Statistical Yearbook of Information and Communication Industry, various issues.

© 2003 Institute of Southeast Asian Studies, Singapore

© 2003 Institute of Southeast Asian Studies, Singapore

Source: MIC, .

Korea Telecom Dacom Hanaro Thrunet Dreamline Onse Unitel SK Telecom Other Total for all providers Share of all Internet subscribers

2,258,377 52.3%

104,876

673,656

1,479,845

ADSL

1,480,844 34.3%

33,953

34,795 464,825 806,723 54,846 85,702

CATV

62,547 550,366 12.7%

7,772

414,647 65,400

LAN

17,113 0.4 %

7,400

9,713

Satellite

13,639 0.3%

13,125

514

B-WLL

TABLE 2.5 Subscribers with High-Speed Internet Access by Type of Service (As of 31 January 2001)

1,904,719 100,195 1,151,606 806,723 159,722 93,474 7,400 33,953 62,547 4,320,339 100.0%

Total Subscribers for All Services

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• CATV: Cable broadcasting in Korea began in May 1995 and by 1998 the number of subscribers exceeded 2 million. Commercial Internet access through the CATV network was first offered by Thrunet in 1998 and the market grew rapidly in 1999 and 2000. • Asynchronous digital subscriber line (ADSL): Hanaro offered the first commercial ADSL service in April 1999, immediately followed by KT. Considering the fact that access speed declines rapidly when the distance from the switching system exceeds 3.5 km, ADSL can be competitive in Korea because of high residential concentration and population density. • Leased-line and other services: Leased-line is a connection between user and switching system using a telephone line, DSU, and router. The market has been monopolized by Korea Telecom, but increasing demand has drawn new companies into the market. Korea also has a commercial satellite communication service. The number of subscribers to high-speed Internet access services has grown astonishingly rapidly in recent years. The market size exceeded 4 million subscribers in late 2000 and is still growing fast (Tables 2.5 and 2.6). About 8.5 percent of Koreans subscribe to a high-speed network compared to 0.4 percent of the population in Japan and 1.0 percent in the United States. The average monthly charge for high-speed Internet access in Korea is about US$30.

TABLE 2.6 Subscribers with High-Speed Internet Access, June 2000 – January 2001

2000

2001

June July August September October November December January

Number of Subscribers

Monthly Growth Rate (%)

1,574,908 1,871,730 2,207,017 2,626,466 3,033,821 3,560,362 4,017,492 4,320,339

18.8 17.9 19.0 15.5 17.4 12.8 7.5

Source: MIC, .

© 2003 Institute of Southeast Asian Studies, Singapore

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Sector-by-Sector Description

Information and Communication Services

Facility-based communication, which comprises around three-quarters of total sales of information and communication services, has grown at a rate of 20 percent per year since 1995 due to the rapid expansion of wireless communications such as cellular phones and PCs. Wireless communication service has mushroomed 72 percent since 1993, and 1999 sales of US$76 billion surpassed sales of wired communication service. Sales of cellular phone service increased 31 percent in 1999 and sales of PC services increased 167 percent, as the number of subscribers increased by 64 percent and 69 percent, respectively (Figure 2.3). The market for wired communication services already seems saturated and its growth has slowed. Meanwhile the demand for leased lines and ISDN services is growing rapidly, leading to the expectation of far more subscribers wanting high-quality services.

FIGURE 2.3 Annual Growth Rate in Sales of ICT Services, 1991–99

100% Value-added Service 80%

60%

40%

20% Facility-based Service 0% 1991

1992

1993

1994

1995

1996

-20%

1997

1998

1999

Broadcasting

Source: KAIT, Statistical Yearbook of Information and Communication Industry, various issues.

© 2003 Institute of Southeast Asian Studies, Singapore

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Value-added communication service has led the growth of the total information and communication service sector for the past few years. Value-added communication network service had the largest share and the highest growth rate compared with PC communication service, Internet service provider (ISP), online data service, and electronic data interchange (EDI). While facility-based and value-added communication services showed steady growth even during the economic crisis in 1998, broadcasting service declined 11 percent in 1998 due to decreased advertising. Growth picked up to 7 percent in 1999. Total broadcasting service sales amounted to US$2.4 billion in 1999, with 46.9 percent coming from terrestrial service and 33.5 percent from cable broadcasting. The market is expected to go through turbulent change in the future with the launching of digital and satellite broadcasting services. Information and Communication Equipment Manufacturing

The information and communication equipment sector showed 23 percent growth and sales of US$59.5 billion in 1999, due to the economic recovery and increased domestic and foreign demand as well as increased subscribers and expanded market for high-speed Internet access services. Communication equipment production comprises more than 20 percent of the information and communication equipment industry, and production of wired communication equipment grew 6 percent while wireless equipment grew 25 percent. Of all wired communication equipment, telephones and switching systems staggered, while production of optical cable and transmission systems increased considerably. Nevertheless, increased demand for high-speed data transmission combined with increased investment by service providers will expand the market for switching and transmission systems. There is no doubt about the steady growth of the wireless communication equipment market in the foreseeable future. The US$11.6 billion of information equipment produced in 1999 was 38 percent higher than the previous year. Production of peripheral equipment, which comprises about 70 percent of information equipment production, increased by 13 percent, while output of personal computers and workstations increased by 145 percent due to increased domestic and export demand. Production of electronic components also increased in 1999, with 21 percent growth and total sales of US$38 billion, due to stabilised memory prices and increased market for LCDs. © 2003 Institute of Southeast Asian Studies, Singapore

56 DONGSEOK KIM

With investment in satellite broadcasting almost completed in 1998, the market for broadcast equipment stabilised. Nevertheless, production increased by 23 percent in 1999, mainly due to increased export of satellite broadcasting equipment and domestic sales of broadcasting equipment. Software Production and Computer-related Service Sector

Production of software and computer-related services amounted to US$4.1 billion in 1999, which accounts for merely 7 percent of the ICT industry’s total output. More than 70 percent of this amount was from the computerrelated service sector, meaning that the share of software manufacturing (packaged software) was less than 30 percent. Furthermore, a substantial portion of this was local sales by foreign companies such as Oracle, Microsoft, SAP, IBM, and HP. Production of software by domestic companies was estimated at much less than US$1 billion. The software and computer-related service sector has been growing rapidly in recent years, at a rate almost twice that of the information and communication equipment and service sectors. New technologies are emerging in several fields. This has led to a consensus among experts that the sector will make a considerable contribution to the Korean economy in the near future. Level of Technology in Korea

Many experts agree that the level of technology in Korea’s ICT industry is 60 to 70 percent of that in advanced countries. Although Korea has advanced-level technologies in some fields, such as TFT-LCD and CDMA, overall it is about two to three years behind advanced countries (Table 2.7). As of 1998, Korea ranked fifth in the world in the total number of patents and fourth in U.S. patents held by foreign countries. Most Korean patents were in the field of memory manufacturing (262 cases), followed by TV and optical transmission technology. Korea is weak, however, in core fields, such as data processing, communication, and networking technologies, which form the base of information technology, and it is urgent to acquire generic technologies in the field (Table 2.8). Insufficient professional manpower is an obstacle to the continued development of Korea’s ICT industry. Although there was a slight oversupply of ICT labour in 1998 (after excess demand during 1996 and 1997), most workers are high school or vocational school graduates, and © 2003 Institute of Southeast Asian Studies, Singapore

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there is serious excess demand in the market for workers with bachelor’s, master’s, and doctorate degrees.

TABLE 2.7 Korea’s Technology Lag in Major Fields Years behind Advanced Countries

Major items Internet, security

Optical communication Digital broadcasting Wireless communication

Computer and software

Fundamental technology Information appliances

• • • • • • • • • • • • • • • • •

Network equipment Electronic commerce Information security Switching system Transmission system Digital broadcasting Signal processing IMT-2000 Satellite broadcasting Usage of electronic wave High-capacity server PDA Content Optical and wireless communication Core components Home server Home gateway

3

0~3 1~2 1~3

1~3

2~3 New market

Source: ETRI 2001.

TABLE 2.8 U.S. Patents in ICT Held by Korea, Taiwan, Japan, and United States (Number of patents)

Network Wired communication Data processing

Korea

Taiwan

Japan

United States

9 98 60

16 80 34

192 818 1,076

272 2,478 3,184

Source: U.S. Patent Office, 1999.

© 2003 Institute of Southeast Asian Studies, Singapore

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Five-Year Plan for ICT Development: 2000–2004

In 1998, recognising the utmost importance of the ICT industry in Korea’s future economic growth and national competitiveness, the government established a Five-Year Plan for ICT Development: 2000–2004 (Figure 2.4). The government’s ICT policies, mostly based on this plan, include the following core fields: • Next-generation Internet technology. The goal is to make the Internet environment 1,000 times faster by 2004. The private sector will undertake development of network and equipment building, operation, and management while the public sector will be involved in development of basic technology and industry, universities, and research institutes together will work on applications. • Optical communication. The goal is to acquire open optical exchange technology and to develop terra-bit optical communication element. Optical communication technology, which is the building block of ICT infrastructure, will be developed jointly by the government and communication service providers.

FIGURE 2.4 Schematic View of the Five-Year Plan

Vision Building a creative knowledge-based country through advanced ICT

Goals World-class information base: 1,000 times faster Internet technology Growth of ICT industry: US$100 billion exports by 2004

6 Core Fields • • • • • •

Next-generation Internet Optical communication Digital broadcasting Wireless communication Software technology Computer technology

Source: MIC 2000.

© 2003 Institute of Southeast Asian Studies, Singapore

2 Core Aspects

Core components Basic technology

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• Digital broadcasting. The goal is to acquire 3-D audio and video technologies. Production and editing technologies, which determine broadcast quality, will be developed in such a way that the result can be combined with software technology and directly utilised as broadcasting content. • Wireless communication. The goal is to maintain competitiveness in the field of wireless communication, especially IMT-2000. According to the Five-Year Plan, the government will invest US$911 million and lend US$1,457 million and the private sector will invest US$393 million in matching funds. The total investment according to the Plan amounts to US$3,289 million. Investment in core components and basic technology will be US$394 million, and the goal is to alleviate dependence on foreign core components and technologies which has been the main structural obstacle in Korea’s ICT industry. At the same time, the government plans to improve institutional conditions, manpower, and standardisation. The government expects that, when successfully accomplished, the Plan will increase ICT industry production by US$38 billion and add 220,000 jobs. Communications Infrastructure

The first official plan for building communication infrastructure was the Framework Plan for an Information Super Highway established in June 1993. The government formed a committee for the Plan in May 1994 and the final blueprint was finished in March 1995. The total cost of the Plan was estimated at US$31 billion for the period 1995–2010 (Table 2.9). Because of the rapid development of information and communication technologies in the mid-1990s, the government decided to accelerate the Plan. The second phase, originally scheduled to be finished by 2002, was sped up by two years. In July 2000, 118 high-speed exchanges and 173 subscriber switching facilities were installed initiating nationwide ATM service, and in December 2000 a nationwide high-speed information highway connecting 144 nodes with optical cable at speeds of 155 Mbps to 5 Gbps was completed. The entire network extends to 19,988 km, with 342 optical transmitters (Figure 2.5). The third and final phase includes enriching the backbone and ATM networks, developing IMT-2000, and connecting the wired and wireless networks together. This phase, originally planned for 2003–2010, is now

© 2003 Institute of Southeast Asian Studies, Singapore

© 2003 Institute of Southeast Asian Studies, Singapore

Source: MIC, .

Public sector Private sector

High-speed country network High-speed subscriber network Wireless communication network Test Research and development Total 419 774

136 409 0 19 629 1,192

Phase 1

382 6,050

175 5,921 0 24 311 6,432

Phase 2

689 23,073

328 13,123 9,449 63 799 23,762

Phase 3

TABLE 2.9 Cost Breakdown for Constructing Korea’s Information Super Highway (US$ millions)

1,489 29,897

639 19,453 9,449 106 1,740 31,386

Total

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FIGURE 2.5 Information Super Highway, December 2000

Chooncheon

Seoul Incheon

Suwon

Cheongju

Daejon

Daegu Jeonju

Masan

Pusan

Gwangju

622 Mbps ~ 5 Gbps Cheju

155 ~ 622 Mbps

Source: Ministry of Information and Communication. http//www.mic.go.kr

expected to be finished by 2005. At that time 95 percent of Korean households, about 15.3 billion households, will have high-speed wired access to the network and 5 million subscribers will have wireless access by IMT-2000. © 2003 Institute of Southeast Asian Studies, Singapore

62 DONGSEOK KIM

ELECTRONIC COMMERCE IN KOREA

With a history of only about five years, electronic commerce in Korea is still in a basic stage in terms of technology and utilisation compared with advanced countries. Lotte and Dacom introduced the first business-toconsumer (B2C) sites in 1996 and Dacom began the first business-tobusiness (B2B) site in 1999. Unlike in many advanced countries where the main form of e-commerce is B2B, in Korea B2C and consumer-to-consumer (C2C) have been more important. In 2000, however, the share of B2B first exceeded that of B2C, and B2B’s share is expected to grow rapidly in the coming years. Also, 2000 saw the introduction of new technologies including a virtual reality system for viewing commodities, N-Commerce, which combines Internet and mobile communication, and several order and payments methods. Various payment methods introduced teenagers to e-commerce, and more fee-based sites began to appear in the content industry. The widely varying projections made by various organisations show that it is almost impossible to forecast the size of Korea’s e-commerce market, even for the near future (Table 2.10). Rapid Growth of B2B

B2B e-commerce started to grow rapidly in late 1999. According to a survey conducted by Electronics Daily and IntelResearch, 12.2 percent of 707 domestic companies listed on the Korean stock market had already built e-commerce sites in 2000 while the remaining 87.8 percent were building or planning to build sites by 2001. Of companies that already had e-commerce sites, 46.5 percent reported theirs were B2C, 19.8 percent were B2B, and 33.7 percent were both B2C and B2B. The share of B2B sites is not yet substantial and there are not many “professional” B2B sites, but many companies reported they are moving from closed EDI to webbased sites. The Korean government together with industry and universities has already finished a unified product code system and is pursuing development of a standard electronic catalogue system. E-marketplace

The e-marketplace, also called online marketplace, electronic marketplace, or web marketplace, refers to a cyberspace where multiple buyers and

© 2003 Institute of Southeast Asian Studies, Singapore

© 2003 Institute of Southeast Asian Studies, Singapore

B2C B2B Total B2C B2C B2B Total B2C B2B Total B2C B2B Total Total Total Total

37 49 312

46

12 12 46 58

31 31 63 53 27 744 771 63 744 807 102 55 157 77 211 1,871

1999 71 142 213 117 48 1,265 1,313 213 1,265 1,477 228 236 465 170 791

2000

390 2,161

134 378 512

2001

725 4,491

236 866 1,102

2002

Source: National Computerisation Agency (NCA), National Informatsation White Paper, 2000.

LGERI IDC WEFA

ECA

KECP

InterPark KAIT

Anderson Consulting

1998

1,350 8,913

378 1,732 2,110

2003

TABLE 2.10 Comparison of Forecasts of the Size of Korea’ s E-commerce Market (US$ millions)

15,673

591 3,307 3,898

2004

866 5,591 6,457

2005

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64 DONGSEOK KIM

sellers meet in N:N form, rather than in the traditional 1:N or N:1 forms. E-marketplaces are classified according to who manages the market (seller, buyer, and broker), according to direction of market integration (vortal or vertical portal, hortal or horizontal portal, and mega-market), and according to market structure (pyramid-type and butterfly-type). Most e-marketplaces in Korea are based in a specific industry and built by joint ventures between off-line leaders in the industry and providers of e-marketplace solutions. As of May 2000, about 100 e-marketplaces had already been built or were being built in Korea (Table 2.11). Nevertheless, the e-marketplace in Korea is still in its infancy. There are no outstanding leaders, which probably is due to the traditional relation between large companies and their subcontractors. E-commerce in the Public Sector

The Korean government is trying to expand e-commerce in the public sector. For example, the Supply Administration plans to computerise all procurement processes for the public sector by 2001, and the Ministry of National Defence and the Ministry of Construction and Transportation each plan to build CALS (computer-aided acquisition and logistics support or commerce at light speed), by 2002 and 2005, respectively. On the other hand, the share of procurement by e-commerce by public enterprises is quite low, and the Ministry of Planning and Budget established a plan to increase it to 50 percent by 2001. B2B Solution Market

It is expected that the B2B solution market will increase at a rate of 100 percent per year over the next several years. Foreign solution providers such as SAP (from Germany) and Oracle and i2 Technology (from the United States) have entered the Korean market and other foreign companies are strengthening their activity. B2B solution developers and vendors are trying to build sites with their own solutions that combine buyers and sellers. Obstacles

The main obstacles that Korea has to overcome in order to promote e-commerce are:

© 2003 Institute of Southeast Asian Studies, Singapore

KOREA: CURRENT SITUATION AND POLICY DIRECTION

TABLE 2.11 Korean E-marketplaces Industry General Steel

Construction

Heavy industries Food/beverage Electronics

Chemistry Trade

Textiles/apparel

Transportation distribution Medical services/ pharmaceuticals MRO Materials

e-marketplace industrader.com metal-i.co.kr iSteelAsia.com tradesteel.com steelnmetal.com con21.co.kr buildersnet.co.kr econs.com e-village(LG) metplaza.com (Samsung) heavyindustryxchange.com engineM.com e-ProduceOne.com www.icbank.co.kr electria.com partsN.com www.chemcross.com chemround.com koreaok.com dreammart.com findkorea.com ec21.net kotra.co.kr koreasources.com Fatex.com webmarketplace.co.kr TplusF.com, fashionb2b.co.kr fakos.com logispia.com Carecamp.com pharmsnet.com Pharmsia.com DreamXchange.com MRO e-business macro21.com partec21.com superB2B.com cyberunion.co.kr

Source: NCA, National Informatisation White Paper, 2000.

© 2003 Institute of Southeast Asian Studies, Singapore

65

66 DONGSEOK KIM

• Insufficient network infrastructure, incomplete standardisation, and low level of technology in such fields as payments, security, authorisation systems, and ASP. • Imperfect institutional system, e.g., in consumer protection, copyright, taxation, and tariffs. • Poor content, low differentiation, and low profitability. • Insufficient transportation, circulation, and distribution systems to back up e-commerce. • Insufficient statistics, which hinders efficient decision-making by both the government and the private sector. Government Policy

Over the past several years the government has put much effort into promoting e-commerce as a means of enhancing national competitiveness. In 1997 it announced the Plan to Promote CALS/EC for Enhancing National Competitiveness, in which the critical measure was to unify government administration which was scattered over many ministries. In 1999 and 2000 the legislature enacted a number of new laws in the field of e-commerce. The government’s broadest and most effective step, however, was the Comprehensive Plan for Promotion of E-commerce, which was announced in 2000. This plan addressed five policy areas: • Institutional Improvement: Enact new laws and refine policies regarding electronic financial trade, e-commerce, dispute settlement, electronic signature and authorisation, privacy protection, consumer protection, tax support, etc. • Infrastructure: Perform labour market survey, improve communication network, improve standardisation, launch pilot distribution system, etc. • Public Sector: Survey and expand e-commerce utilisation in the public sector and reform applicable laws. • Industry: Expand support for e-commerce utilisation in the private sector, support construction of e-commerce system in eight major industries, etc. • Trade: Build a cyber-trade map, host a cyber-trade fair, enact laws regarding e-trade, etc. In addition, the government announced the E-commerce Statistics Development Plan to address the problem of redundant efforts by multiple organisations and to enhance the sharing of statistics.

© 2003 Institute of Southeast Asian Studies, Singapore

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THE DIGITAL DIVIDE

The “digital divide” refers to the situation in which information accessibility and utilisation become unevenly distributed by economic, regional, and cultural circumstances. A digital divide may emerge not only within a single country, a “domestic digital divide”, but also across countries. With a “global digital divide” lower access to information in developing countries may lead to lower national competitiveness.

TABLE 2.12 Digital Divide in Korea by Personal Characteristics

Gender Male Female Education Middle school or less High school College or more Monthly income Less than 1 million won 1~2 million won 2~3 million won 3~4 million won More than 4 million won Age 50 or over 40–49 30–39 20–29 10–19 Residence Metropolitan Urban Rural Total

Number of Responses

Computer Ownership (%)

Subscription to ISP (%)

Usage of Internet (%)

1,522 1,478

67.8 64.1

42.8 35.5

45.1 28.8

473 1,403 543

46.3 60.9 80.7

16.3 28.2 62.8

1.9 21.8 62.4

241 1,402 1,035 224 88

36.1 61.1 75.0 82.1 79.5

20.7 33.3 45.9 54.9 62.5

24.5 31.8 43.1 48.2 53.4

510 551 760 722 457

51.2 78.8 60.7 65.0 77.5

19.8 37.2 33.8 48.2 58.0

4.9 17.2 29.5 60.0 73.3

1,471 1,183 346 3,000

69.1 64.3 58.4 66.0

43.4 37.1 28.6 39.2

39.4 35.8 31.5 37.1

Source: ICC 2000.

© 2003 Institute of Southeast Asian Studies, Singapore

68 DONGSEOK KIM

Domestic Digital Divide

A domestic digital divide means that subgroups of the population have differential access to and utilisation of information. The domestic digital divide is usually measured by comparing utilisation of computers, the Internet, and other information services by gender, vocation, and/or age. In 2000 the Korea Information and Communication Centre (ICC) conducted a survey of 3,000 persons concerning their possession of PCs, subscription to ISPs, and Internet usage by gender, educational background, income, age, and residence (Table 2.12). The survey reveals a serious digital divide problem with respect to education, income, age, and residence. According to another survey, the digital divide in Internet usage across age groups is widening significantly (Figure 2.6). Government Efforts

The current policy direction of the Korean government to reduce the domestic digital divide consists of (1) building sufficient ICT infrastructure, FIGURE 2.6 Digital Divide by Age (Share of Age Group Using the Internet) percent 70

Aged 10-19 Aged 30-39

60

Aged 50-59 50

40

30

20

10

0 October 1999

March 2000

Source: ICC 2000.

© 2003 Institute of Southeast Asian Studies, Singapore

August 2000

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(2) improving the information and communication environment, and (3) ICT education. • Increase support for ICT infrastructure providers for rural regions and improve access to ICT equipment and services for the disabled and the aged. • Build regional information centres and increase support for low-income groups, e.g., in the form of equipment and discounted communication charges. • Provide free ICT education programs aimed at low-income groups, disabled, elderly, young householders, and people in rural regions. Global Digital Divide

The most frequently used indicator of the digital divide among countries is the number of Internet hosts, which is one measure of information access or the level of “informatisation”. As of late 1999, the average number of Internet hosts per 100,000 persons in OECD countries was 21 times that in Asian countries and 2.7 times that in Korea. Although Korea is not as far behind the OECD average as most of its Asian neighbours, many experts agree that it will be difficult for Korea to reduce this gap in a short period. The number of Internet hosts in Korea exploded from 14,681 in 1994 to 406,974 in 1999, and the number of Internet domains surged from 192 to 207,023 in the same period. Also, the number of Korean Internet users increased from 310 million in 1998 to 1,086 million in 1999, a growth rate of 250 percent. Even so, the level of ICT and Internet usage in Korea is much lower than in developed countries and even in other countries such as Taiwan and Singapore (Tables 2.13 and 2.14). On another dimension, investment in ICT infrastructure, Korea’s US$40.4 per capita investment in 1999 was far below the US$115.5 average for advanced OECD countries. POLICY RECOMMENDATIONS FOR PROMOTING KOREA’S ICT INDUSTRY

The ICT industry will be the main engine for the growth of Korea’s economy and for the transition to a true knowledge-based economy in the future. Although the economy seemed to have recovered from the economic crisis and grew quite strongly in 1999, the situation changed in late 2000 and early 2001, mainly due to the economic downturns in the United

© 2003 Institute of Southeast Asian Studies, Singapore

© 2003 Institute of Southeast Asian Studies, Singapore

0.0 0.0 0.0 0.1 0.2 0.6 4.4 7.6 0.2 0.4 0.8 1.6 2.8 4.4 9.8

Number of Internet Hosts per 1,000 Persons

Source: NCA, National Informatisation White Paper, 2000.

1993 1994 1995 1996 1997 1998 1999 2000

Number of Internet Domains per 1,000 Persons 83 100 120 137 151 169 221

Number of PCs per 1,000 Persons

TABLE 2.13 Informatisation in Korea, 1993–2000

2 3 8 16 35 67 232 294

Number of Internet Users per 1,000 Persons

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TABLE 2.14 Informatisation in Selected Economies, 1998

United States Canada UK Japan Singapore Taiwan Korea Malaysia

Number of PCs per 1,000 Persons

Number of Internet Hosts per 1,000 Persons

Number of Internet Users per 1,000 Persons

499 400 323 272 344 178 150 78

87.15 53.53 22.63 11.03 13.45 16.71 9.84 1.93

37.4 15.4 18.0 11.1 14.7 14.3 13.5 3.0

Source: NCA, National Informatisation White Paper, 2000.

States and Japan. In particular, decreased demand for ICT products in the United States and Japan had a critical impact on the Korean economy. Almost 50 percent of ICT production is exported, and the balance of payments in the industry occupies most of the country’s BOP. Furthermore, exports are concentrated in a few countries, particularly the United States and Japan, and on a few items. The government has recognised the importance of the ICT industry to Korea’s economic growth and to raising Korea’s international competitiveness. It has devoted great effort to promoting the ICT industry in recent years. Even so, it cannot be said that the government’s promotion efforts have been completely successful. In promoting the ICT industry, as in promoting other industries, the role of government should be limited to providing public goods and infrastructure, for these are the areas where the market does not work properly and investment is risky. A precious lesson from the recent downfall of the KOSDAQ market and the failure of venture policy is that conventional industrial policy in the form of direct financial or tax supports is no longer effective and that it is best to leave evaluation and screening to the private sector. In most advanced countries, governments pursue indirect macroeconomic policies by playing the role of rule-setter and leave capital allocation to the markets. © 2003 Institute of Southeast Asian Studies, Singapore

72 DONGSEOK KIM

Provision of Public Goods and Infrastructure

Here, we discuss five forms of public goods and infrastructure through which the government could support Korea’s ICT industry indirectly: (1) communication networks, (2) institutional infrastructure such as laws, rules, and regulations, (3) standardisation infrastructure which facilitates active transactions among economic agents, (4) knowledge databases accumulated in the public sector, and (5) R&D investment in basic and fundamental technologies. Communication Infrastructure

High-speed communication networks and equipment, which are an essential infrastructure of the ICT industry, usually require enormous investment and carry high risk, which discourages private investment. Fortunately, the government in Korea has been diligent in this area of public support for the ICT industry, for example, taking an active role in building the Information Super Highway. It is essential that it keep assigning utmost priority to investment in communication infrastructure. Institutional Infrastructure

The ICT revolution resulted in a substantial decrease in transaction costs and increase in economy-wide efficiency. At the same time, it created new problems, mainly in the area of electronic commerce, including consumer protection, privacy, intellectual property, electronic signature, authentication, and verification. These new problems cannot be settled by existing institutions. The government needs to enact new laws and regulations to build the institutional infrastructure to minimise the negative impact of these problems. Korea’s institutional infrastructure is still insufficient despite the various new and revised laws enacted in 1999 and 2000. While it is almost impossible to build institutional infrastructure ahead of technological development, Korea should seize the benefit of the “late mover’s advantage” by learning from advanced countries. Standardisation

Standardisation is an essential infrastructure that enables active transactions, particularly in electronic commerce. A few examples are electronic signature systems, electronic catalogues, and unified product code systems. © 2003 Institute of Southeast Asian Studies, Singapore

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Standardisation is also a typical public good, and thus needs governmental intervention and investment. At present the degree of standardisation in electronic commerce is relatively low, especially for e-marketplaces and it awaits substantial investment by the public sector. Accumulation of Databases

If the number of databases is a gauge of a knowledge-based society, then Korea is far behind advanced countries in this area. The government’s main plan to invest in knowledge databases is contained in Cyber Korea 21, which was launched in 1999 and placed high priority on building databases. The three phases of the Cyber Korea 21 Plan were construction of an academic research information database to take place in 1999–2000, building an economic and industrial information database in 2001, and developing a general and policy information database in 2002. The final goal of the plan is to build a National Union Knowledge Database and to participate in international sharing of the databases with other countries. R&D Investment in Fundamental Technologies

The ultimate goal of promoting the ICT industry is to acquire basic and fundamental technologies and to enter the advanced stage of economic development. Unfortunately, however, Korea is far behind advanced countries in terms of basic and fundamental technologies. R&D in basic and fundamental technologies typically requires large amounts of highrisk investment funds. For this reason it is usually performed by the public sector. The United States is expected to maintain its leading position in basic and fundamental technologies for the time being. Since Korea is not likely to be able to catch up in a short period, it should devise strategic plans by concentrating investment on the fields with the greatest potential. Hence, investment projects should be selected on the basis of their applicability to various other fields. Korea’s strategic R&D investment plan must take into consideration the strategies of other countries and expected future technology developments. Development of new technologies usually follows an evolutionary process, and technology forecasts by domestic and foreign experts must be incorporated into the plans. Korea should pay particular attention to the development strategies of Asian countries. For instance, Singapore plans to become an ICT manufacturing and finance hub based on well-equipped communication infrastructure and top-end ICT manufacturing while Hong © 2003 Institute of Southeast Asian Studies, Singapore

74 DONGSEOK KIM

Kong also has a plan to become a finance, ICT, and distribution hub in East Asia. Informatisation of the Public Sector

Informatisation of the public sector is an efficient policy for promoting the ICT industry and yields numerous benefits. First, the public sector generates a substantial portion of demand in the ICT industry in the early stage of informatisation, and the public sector can serve as a “test bed” for technologies newly acquired by the private sector. Second, informatisation of the public sector has a demonstration effect, in e-commerce in particular, in the sense that it is an effective means to spread and accelerate economywide computerisation and e-commerce. Third, informatisation of the public sector enhances the productivity, transparency, and quality of service delivered to the public. Indirect Policy Tools

Direct intervention in resource allocation by the government results in efficiency loss when the market is operating properly, which also applies to the ICT industry. In other words, direct financial and tax support is less efficient than indirect policy, such as creating a better macroeconomic and financial environment where companies with better technology and profitability have more access to capital. Also, the economic impact of new technologies largely depends on the economic environment and mechanism. For example, many studies have revealed that the pervasive effect of new technologies can be maximised when the markets are efficient and that introducing new technologies may even have negative effects, such as reducing employment, when markets are not efficient. It is crucial then that the government creates an environment in which financial resources are allocated according to market principles, in which free entry and exit are guaranteed, and in which product, labour, and financial markets are efficient. Digital Divide and Labour Policy

The government’s active intervention is necessary to stem the widening digital divide in Korea in recent years. The first aspect of tackling the problem is to improve welfare and ensure regionally balanced development, which is certainly a job for the public sector. The second aspect is to form © 2003 Institute of Southeast Asian Studies, Singapore

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a basis for “informatising” the population and thus promoting the ICT in the long run. There is excess demand for workers in the ICT industry in Korea, as in many other countries, and this situation is expected to last for the time being. Although domestic education and training systems focus on hardware and low-skilled workers, the serious excess demand is for software and high-skilled workers. Furthermore, college-level education programs are not appropriate to the demands of the industry. The government’s role must be to target on improving the marketability and efficiency of the existing labour force and improving labour market flexibility. Notes 1

2

3

4

While the financial crisis in Korea was triggered by the regional contagion, capital flight from the local currency, and a weak financial system with poor prudential regulation and supervision, it was in large part also a corporate crisis, driven by excessive corporate debt and associated structural problems (OECD 1999). While in principle globalisation and free information flows may make it easier to narrow the knowledge gaps across countries, they could actually bring about a widening of the knowledge gap or a “knowledge divide” disfavouring the less advanced and less prepared nations. Cyber Korea 21 laid out an ambitious set of targets to be met by 2002 to ensure that Korea becomes one of the top-ten nations in information infrastructure and industry. Cyber Korea 21 highlights the importance that the country’s leaders attribute to information infrastructure and sets out a number of significant policy goals. However, it suggests a role for the government that may be beyond what is appropriate in such a dynamic sector where technology and the speed and flexibility of the private sector may make strong government orchestration a hindrance rather than an asset. Throughout the chapter, monetary terms are expressed in U.S. dollars. Figures were converted using an exchange rate of 1,270 won per U.S. dollar.

References

Cheong, S. 2000. “Challenges and Development Strategies for Korea’s Information and Communication Industry”. KDB Monthly Bulletin. Seoul: Korea Development Bank. © 2003 Institute of Southeast Asian Studies, Singapore

76 DONGSEOK KIM

Electronics and Telecommunications Research Institute (ETRI). 2001. Comparison of Technology Levels between Korea and Advanced Countries. Seoul: ETRI. Information Culture Centre of Korea (ICC). 2000. A Survey on Informatisation: 2000. Seoul: ICC. Korea Association of Information and Telecommunication (KAIT). Statistical Yearbook of Information and Communication Industry. Seoul: KAIT. Various issues. Korea Development Bank (KDB). 2000. IT Industry. Seoul: KDB. Korea Development Institute (KDI) and Ministry of Finance and Economy (MOFE). 1999. A New Paradigm for the Knowledge-Based Economy: Vision and Strategy for the 21st Century. Seoul: KDI. Korea Information Society Development Institute (KISDI). 2000a. A Study on Improving Regulatory Framework in Information and Communication Sector. Seoul: KISDI. ———. 2000b. Current Situations and Trend in B2B Electronic Commerce. Seoul: KISDI. ———. 2000c. International Comparison of Digital Divide and Internet Pricing. Seoul: KISDI. ———. 2000d. Long- and Mid-Term Cooperation Strategy for Information and Communication Industry in Northeast Asia. Seoul: KISDI. ———. 2000e. Mid-Term Market Forecast of Information and Communication Industry: 2000~2004. Seoul: KISDI. Korea Institute of Science and Technology Evaluation and Planning (KISTEP). 1997. The Global Economy in the 2010s and New Technologies in Korea. Seoul: KISTEP. LG Economic Research Institute (LGERI). 2000a. “Global Digital Divide”. LG Economy Weekly. Seoul: LGERI. ———. 2000b. Advent of Digital Economy and Implication on Korean Economy. Seoul: LGERI. Ministry of Information and Communication (MIC). 1999. Cyber Korea 21: Vision of Informatisation for Building a Creative Knowledge-Based Country. Seoul: MIC. ———. 2000. Five-Year Development Plan for Information and Communication Technology. Seoul: MIC. National Computerisation Agency (NCA). National Informatisation White Paper. Seoul: NCA. Various issues. ———. 1999. International Cooperation and National Strategy in Electronic Commerce. Seoul: NCA. ———. 2000a. Korea Internet White Paper. Seoul: NCA. © 2003 Institute of Southeast Asian Studies, Singapore

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National Computerisation Agency (NCA). 2000b. Study of Comprehensive Measures for Solving Digital Divide. Seoul: NCA. ———. 2000c. Trend of Institutional Framework in Electronic Commerce in Major Countries. Seoul: NCA. National Statistical Office (NSO). 2000. E-Commerce Statistics Development Plan. Seoul: NSO. Organisation for Economic Co-operation and Development (OECD). 1999. Asia and the Global Crisis: Industrial Dimension. Paris: OECD. Websites

Electronics and Telecommunication Research Institute (ETRI). . Korea Association of Information and Telecommunication (KAIT). . Korea Development Institute (KDI). . Korea Information Society Development Institute (KISDI). . LG Economic Research Institute (LGERI). . Ministry of Information and Communication (MIC). . Ministry of Finance and Economy (MOFE). . National Computerization Agency (NCA). . National Statistical Office (NSO). .

© 2003 Institute of Southeast Asian Studies, Singapore

Telecommunication services Facility-based Resale Value-added Broadcasting Information and communications equipment Wired communications equipment Wireless communications equipment Information equipment Broadcasting equipment Electronic components Software and computer-related services Total 5,864 4,634 – 153 1,076 13,599 1,343 732 2,352 262 8,910 757 20,219

1993 6,685 5,214 – 186 1,285 19,471 1,431 977 3,171 222 13,669 924 27,079

1994 8,845 6,321 – 284 2,240 30,402 1,854 1,778 4,987 1,087 20,696 1,319 40,567

1995 11,660 8,910 – 399 2,351 33,042 3,801 3,222 5,031 1,244 19,745 2,102 46,804

1996

TABLE 2.A1 Production of ICT Equipment and Services, 1993–99 (US$ millions)

APPENDIX STATISTICS ON THE ICT INDUSTRY IN KOREA

13,513 10,167 – 781 2,564 43,291 4,278 6,551 7,701 460 24,300 2,759 59,562

1997

14,249 11,140 43 860 2,205 51,629 3,940 7,269 8,411 586 31,423 3,688 69,566

1998

17,114 13,490 95 1,172 2,356 63,464 4,158 9,076 11,590 723 37,917 4,102 84,680

1999

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© 2003 Institute of Southeast Asian Studies, Singapore

Telecommunication services Facility-based Resale Value-added Broadcasting Information and communications equipment Wired communications equipment Wireless communications equipment Information equipment Broadcasting equipment Electronic components Software and computer-related services Total 5,864 4,634 – 153 1,076 10,403 932 725 1,468 139 7,139 789 17,078

1993 6,685 5,214 – 186 1,285 14,286 1,097 1,069 2,409 97 9,622 939 21,909

1994 8,845 6,321 – 284 2,240 21,077 1,546 1,823 3,897 958 12,854 1,505 31,428

1995 11,660 8,910 – 399 2,351 26,510 3,516 3,474 3,646 1,211 14,664 2,310 40,480

1996 1997 13,513 10,167 – 781 2,564 36,016 4,330 6,131 5,435 426 19,693 3,027 52,555

TABLE 2.A2 Domestic Sales of ICT Equipment and Services, 1993–99 (US$ millions)

14,249 11,140 43 860 2,205 37,800 3,356 5,565 4,887 548 23,444 3,867 55,916

1998

17,114 13,490 95 1,172 2,356 50,614 4,237 5,771 7,710 474 32,422 4,362 72,089

1999

KOREA: CURRENT SITUATION AND POLICY DIRECTION

© 2003 Institute of Southeast Asian Studies, Singapore 79

Information and communications equipment Wired communications equipment Wireless communications equipment Information equipment Broadcasting equipment Electronic components Software and computer-related services Total 14,363 982 569 2,564 257 9,991 20 14,383

1993 20,210 1,002 788 2,777 308 15,335 16 20,227

1994 31,721 1,270 932 3,933 359 25,227 17 31,738

1995 29,564 1,429 982 4,707 160 22,285 22 29,585

1996

TABLE 2.A3 Exports of ICT Equipment and Services, 1993–99 (US$ millions)

31,198 1,323 1,531 5,320 193 22,832 51 31,250

1997

30,472 1,150 2,255 4,669 178 22,219 53 30,525

1998

39,897 1,247 4,799 7,267 343 26,241 53 39,950

1999

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© 2003 Institute of Southeast Asian Studies, Singapore

Information and communications equipment Wired communications equipment Wireless communications equipment Information equipment Broadcasting equipment Electronic components Software and computer-related services Total 9,306 331 559 1,165 62 7,188 71 9,377

1993 12,017 475 934 1,572 97 8,938 40 12,056

1994 16,344 756 995 2,137 145 12,311 323 16,667

1995 19,244 979 1,379 2,520 103 14,263 350 19,594

1996

TABLE 2.A4 Imports of ICT Equipment and Services, 1993–99 (US$ millions)

21,484 1,391 370 2,294 148 16,681 408 21,893

1997

18,023 659 772 1,470 148 16,975 215 18,239

1998

26,190 1,333 1,268 3,122 76 20,391 330 26,520

1999

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© 2003 Institute of Southeast Asian Studies, Singapore

5,057 650 10 1,399 195 2,802 –51 5,006 8,194 527 –146 1,205 211 6,397 –23 8,170

1994 15,377 514 –63 1,796 214 12,916 –307 15,071

1995 10,320 450 –397 2,187 58 8,022 –328 9,992

1996

Source: KAIT, Statistical Yearbook of Information and Communication Industry, various issues.

Information and communications equipment Wired communications equipment Wireless communications equipment Information equipment Broadcasting equipment Electronic components Software and computer-related services Total

1993 9,714 –69 561 3,026 45 6,151 –357 9,357

1997

TABLE 2.A5 Balance of Payments in ICT Equipment and Services, 1993–99 (US$ millions)

12,449 491 1,483 3,199 31 7,244 –163 12,286

1998

13,707 –86 3,531 4,144 267 5,850 –277 13,430

1999

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Reproduced from Towards a Knowledge-based Economy: East Asia’s Changing Industrial Geography, edited by Seiichi Masuyama and Donna Vandenbrink (Singapore: Institute of Southeast Asian Studies, 2003). This version was obtained electronically direct from the publisher on condition that copyright is not infringed. No part of this publication may be reproduced without the prior permission of the Institute of Southeast Asian Studies. Individual articles are available from < http://bookshop.iseas.edu.sg >

TAIWAN: FROM AN INDUSTRIALISING ECONOMY TO A KBE 83

3 Taiwan’s Transition from an Industrialising Economy to a Knowledge-based Economy Shin-Horng Chen and Meng-chun Liu INTRODUCTION

The export-oriented trajectory of Taiwan’s industrialisation has been well documented, but this model of past economic development does not fit the current economic reality in Taiwan. Since the early 1990s, pioneered by some developed countries, the international economic landscape has shifted significantly towards a knowledge-based economy (OECD 1996).1 In pursuit of a knowledge-based economy (KBE), the developed countries as well as some newly industrialising countries (NICs) including Taiwan have been reorienting their competitive strategies. As a result, economic activity in Taiwan is now undergoing a qualitative change. For one thing, although Taiwan is widely known as an NIC, manufacturing’s share of the economy has been shrinking since the mid1980s. Manufacturing declined from an all-time peak of 39.4 percent of gross domestic product (GDP) in 1986 to a low of 26.4 percent in 1999. The service sector, by contrast, has followed a constantly rising trend and now accounts for 66.7 percent of Taiwan’s GDP. These changes in the position of the manufacturing and service sectors might be considered a sign of Taiwan’s transition towards a KBE, but they do not illustrate the underlying qualitative changes in economic activity that are taking place. As defined by the OECD (1996), a KBE is an economy in which the production, distribution, and use of knowledge are the main drivers of growth, wealth-creation, and employment across all industries. It could be said that in a KBE all economic activities have something to do with knowledge, although to a differing degree. As the contribution of knowledge

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84 SHIN-HORNG CHEN AND MENG-CHUN LIU

overtakes that of other economic goods in economic activities the transition to a KBE may involve fundamental structural changes. Information technology (IT) is such an important dimension of a KBE that it deserves special attention (OECD 2000). This chapter examines two aspects of IT in Taiwan’s KBE. On one hand we consider how Taiwanese manufacturers of IT products are transforming themselves to become knowledge-intensive. On the other hand, we look at the extent to which the application of IT has permeated the economy and the impact it has had on the economy as a whole. More specifically, the chapter is structured as follows. We begin by looking at the KBE as an abstract concept and by analysing the structural implications of a KBE. Then we compare Taiwan’s progress in moving towards a KBE structure to the progress made in other economies. In the next section we describe the transformation of the PC and IC (integrated circuits) industries in Taiwan from providers of manufacturing-based subcontracting services into providers of integrated service packages. This discussion highlights the importance of intangible capabilities in industrial upgrading. We turn from the transition in the manufacturing sector to take a brief look at the extent of IT applications in the economy and present our econometric estimate of the effect of IT on labour productivity in Taiwan. Finally, we offer some concluding remarks. CONCEPTUALISATION OF A KNOWLEDGE-BASED ECONOMY

The term “knowledge-based economy” has drawn considerable attention in both academic and political arenas, but its exact meaning is not entirely clear. Since knowledge is an intangible good, in its most basic form a KBE should be qualitatively different from an economy based on materials or on manufacturing. Elsewhere (Chen and Liu 2000), we related the characteristics of a KBE to the unique features of knowledge. Here we summarise that conceptualisation. First, as knowledge has become increasingly important as an economic good, the distance between knowledge and economic activities has shrunk. An example at issue is the debate on the “third mission” of institutions of higher education (Etzkowitz et al. 2000). Second, knowledge as an input generates scale and scope economies, but the magnitude of these economies depends on the speed at which knowledge depreciates and becomes obsolete as well as on market size. Therefore, speed and first-mover advantage are central aspects of industrial competition in the KBE era. Third, as knowledge is increasingly integrated into economic output, giving rise to the

© 2003 Institute of Southeast Asian Studies, Singapore

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dematerialisation of final products, the boundaries between manufacturing and services and between hardware and software blur. For example, Wise and Baumgartner (1999) describe several cases in which U.S. manufacturers moved downstream to integrate the service function to become more profitable. At the extreme, some aspects of industrial and economic activities may become weightless. Fourth, information technology and networks, which are central to the creation, distribution, and utilisation of knowledge, will become necessary conditions for industrial development in the era of the KBE. Information technology is a general-purpose technology and is viewed as the key driving force in the current techno-economic paradigm (Freeman and Perez 1988). Hence, it is generally agreed that the emergence of the so-called “new economy” in the United States has much to do with communications and information technology (OECD 2000). Finally, a KBE is characterised by the globalisation of a wide range of corporate value-added activities. The outreach of capital and production by multinational companies (Michalet 1991) and, more recently, spreading technology (Patel and Pavitt 2000 and Sigurdson 1990) drove globalisation. In addition, the information technology network, which is by nature global and real-time, will enable firms to synchronise supply chains and to organise cross-border corporate activities more effectively. As a result, globalisation means more than just the international division of labour in production. There are further grounds to argue that the greatest impact of the KBE concept is on the organisation of production around the world. In a KBE, a firm is a producer, repository, and user of knowledge, producing or acquiring knowledge and putting it to use efficiently. Each firm’s competitive advantage lies in its stock of knowledge, and because firms possess idiosyncratic knowledge they are likely to be heterogeneous. Nonknowledge inputs to production, including labour and capital, tend to be more equally available to all firms in an economy compared to the rare and uneven distribution of knowledge. Furthermore, with the globalisation of capital markets and the accessibility to cheap labour through foreign direct investment (FDI), non-knowledge inputs may have lost their countryspecificity as well.2 Thus, a firm must base its sustainable competitive advantage on the knowledge it possesses rather than the primary inputs it commands. The organisational separation of innovation from production may become the norm in a KBE. Although the knowledge used to invent a product can be useful in the manufacture of that product, and vice versa, it does not pay an innovator to invest in the manufacturing function unless it is unable to

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86 SHIN-HORNG CHEN AND MENG-CHUN LIU

realise the value of the innovation through outsourcing. In fact, contract manufacturers invariably perform the production function at a lower cost than innovators because they can exploit economies of scale by sharing their manufacturing capacity with more than one client. In order to make a perfect product, the innovator usually needs to share some knowledge with manufacturers, and conversely some of the manufacturer’s knowledge can aid in product innovation. Knowledgesharing works best in co-operative relationships because knowledge is intangible and sharing entails organisational learning. In a KBE, therefore, alliances are an important form of business organisation and an important source of learning and innovation (Powell, Kogut, and Smith-Doerr 1996). Sharing knowledge outside the organisation may be more efficient than accumulating knowledge internally because of the “non-rivalry” nature of knowledge, which allows the one who partakes of the knowledge to pay only a small marginal cost to compensate the owner. Acquiring knowledge through exchange or alliance may also be more efficient than acquiring the firm that owns the knowledge, which entails acquiring non-essential assets along with the knowledge. In sum, a KBE is characterised by alliance capitalism. Product innovation involves an assortment of knowledge related to various stages of the value chain. Knowledge applied to manufacturing, marketing, and customer services is complementary to the knowledge used in product innovation. Vertical integration of the innovation function in the value chain is only justified, however, if internalisation is the best way to acquire the relevant knowledge, and this is not often the case. Since product innovations address the needs of customers, the knowledge most valuable to product innovation is that obtained from interacting with customers, in other words, marketing. Therefore, product innovation combined with marketing may be the optimal mix of services for a firm to offer. Nike, Reebok, and Calvin Klein are typical examples of this innovatormarketer combination in the traditional industries of footwear and apparel. The trend towards innovation and marketing becoming the core functions of the firm is even taking place in the high-technology industries. In the information industry, for example, integrated device makers (IDMs) including Apple, Compaq, Dell, and Motorola have partitioned themselves from manufacturing, which they delegate to contractors. The driving force of innovation in the semiconductor industry has been the so-called “fabless” designers which rely on foundry service providers to actually make the chips.

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Meanwhile, contract manufacturers are being required to perform customer service functions in addition to producing and delivering products. So-called global logistics has prevailed mainly because knowledge of supply-chain management is as important to the manufacturer’s success as is knowledge of the production process. Therefore, the division of labour in a KBE tends to reflect the distribution of knowledge. Firms perform production activities in line with their heterogeneous endowments of knowledge and the knowledge-content of production. Country-specific advantages based on material inputs are secondary factors in determining the distribution of production around the world. This discussion suggests that the emergence of a KBE may undermine the formation of traditional oligopolies and give rise to a situation of rival industrial networks each comprised of multiple firms with different knowledge bases. In many cases innovations inherently comprise a “technical system”, a set of interdependent products that are consumed jointly. Because of network externalities and product compatibility, successful innovations for technical systems entail intensive interfacing among actors with different knowledge- and skill-bases in an “innovation network” (Windrum 1999). Consequently, such innovations often result from the collective efforts of inter-related firms. Moreover, the value chain need not be completely internalised within any individual firm. At the same time, as we argued above, more and more division of labour in a KBE is determined by knowledge rather than by material-based inputs. As a result, technology sourcing has been driving firms to internationalise their R&D (Cantwell and Santangelo 1999, Gerybadze and Reger 1999, Niosi 1999, and Zander 1999) and to form inter-firm partnerships (Delapierre and Mytelka 1998). Firms can build sustainable competitive advantage based on knowledge by leveraging and aligning both their internal and external networks on an international scale. This KBE scenario calls into question the continued applicability of the “flying geese hypothesis” — the Japanese version of the product life-cycle thesis. Kojima (1978) introduced this hypothesis to champion the role of Japanese outward investment in shaping the industrialisation process in East Asia. It asserts that through FDI Japan introduces to neighbouring countries industries with declining advantage within Japan. In due course, other countries, such as Taiwan and Korea, follow suit, resulting in a sequential pattern of industrial development in East Asia led by Japan. In a KBE, unlike a traditional manufacturing-based economy however, speed, innovation, networking, and global reach are the basis of competitiveness,

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and relocation through technology transfer or access to lower cost material inputs are not the primary motivations for established firms to look across national borders (Niosi 1999 and Zander 1999). Although firms in developed countries generally stand at the apex of the international knowledge pyramid, in this new era they may have to outsource more and more knowledge, even from second-tier countries, in order to establish across-the-board competitive advantages. This means that firms in less advanced countries such as Taiwan may play a significant role in international innovation networks even during the early stage of the product life cycle. As a result we are less likely to observe a regular, sequential, flying-geese pattern of industrial development. TAIWAN’S PROGRESS TOWARDS A KBE

The Council for Economic Planning and Development (CEPD) examined the importance of knowledge-based activities in Taiwan’s economy using the OECD’s definitions of knowledge-based industries (KBI).3 According to the CEPD, in 1996 KBIs generated 40.6 percent of Taiwan’s GDP TABLE 3.1 Knowledge-based Industries in Taiwan (Percent)

All Industries

1991 1994 1996 1991 1994–96 1991–96

100.0 100.0 100.0 9.8 10.2 9.9

Knowledge-based Industries

Knowledge-based Manufacturing Industries

Share of GDP 37.7 6.1 39.2 5.7 40.6 6.8 Growth rate in nominal value-added 11.2 7.6 12.1 20.5 11.5 12.6

Knowledge-based Service Industries 31.7 33.5 33.7 11.9 10.6 11.3

Note: Knowledge-based manufacturing industries include aerospace, computer and dataprocessing equipment, pharmaceutical, telecommunications, semiconductors, scientific instruments, automobiles, electrical equipment, chemical products, machinery, other transport equipment. Knowledge-based service industries include transport and storage, communication services, finance, insurance, and real estate, commercial services, social and personal services. Source: Council for Economic Planning and Development based on Input-Output Tables.

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TAIWAN: FROM AN INDUSTRIALISING ECONOMY TO A KBE 89

(Table 3.1). This was substantially less than the 50.9 percent average GDP share of KBIs in the OECD countries. Nevertheless, it was larger than 37.7 percent of GDP that Taiwan’s KBIs generated in 1991. Moreover, KBIs averaged 11.5 percent annual growth in nominal value added from 1991 to 1996, well above the 9.9 percent average growth rate for all Taiwanese industries combined. KBIs in Taiwan grew particularly rapidly from 1994 to 1996 due to the phenomenal expansion of the semiconductor industry. According to this classification, the core of Taiwan’s KBE is the service sector, which comprises the lion’s share of Taiwan’s KBIs. But looking only at the share of output from the so-called “knowledge-based” service industries may give a misleading picture of the economic importance of knowledge-based activities in Taiwan. Knowledge or information is not in fact a significant input in the production of services in Taiwan. The amount of knowledge or information inputs utilised by the service industries TABLE 3.2 Information Intensity of Selected Service Industries

Academic research Insurance Transport Printing and publishing Finance Hotels Public service Leasing Food service Real estate Foreign trade Retailing Wholesale trade Medical service Entertainment Legal and accounting Advertising Storage

Information Services Utilised (NT$ million) 1

Value-added (NT$ million) 2

Information Intensity (%) 1/2

642 3,591 1,979 1,033 5,658 441 7,866 305 1,209 1,411 2,162 3,550 2,052 1,048 163 52 194 20

22,566 170,756 118,591 67,949 485,361 42,027 852,936 42,342 173,141 217,122 417,221 709,163 434,634 246,376 76,706 25,421 133,163 23,896

2.85 2.10 1.67 1.52 1.17 1.05 0.92 0.72 0.70 0.65 0.52 0.50 0.47 0.43 0.21 0.21 0.15 0.08

Source: Service industries defined at three-digit level. Data from 1996 Input-Output Tables Taiwan.

© 2003 Institute of Southeast Asian Studies, Singapore

90 SHIN-HORNG CHEN AND MENG-CHUN LIU

can be measured by the information services, including software, Internet services, data exchange, and e-commerce services, that they purchased (outsourced). The ratio of information services utilised to value added gives a measure of the knowledge-intensity or “information content” in an industry (Table 3.2). In Taiwan the two service industries (three-digit level) with the highest knowledge intensity are academic research, with an information content of 2.85 percent, and insurance, with an information content of 2.10 percent. Four industries — transport, printing and publication, finance, and hotels — have information content between 1 and 2 percent, and information inputs of industries such as retail and wholesale trade, foreign trade, and medical services comprise only about 0.5 percent of value added. This measure understates the true information content because it counts only outsourced, or purchased, inputs of information services. Nevertheless, even allowing for the downward bias, the information content of Taiwan’s service industries appears to be low. Taiwan’s knowledge-base is stronger on the manufacturing side than it is on the services side. Wu (2000) compared the manufacturing sectors of Taiwan and selected OECD countries according to four categories of technology-intensity (high, upper medium, lower medium, and low). Hightechnology manufacturing accounted for 19.5 percent of total manufacturing value-added in Taiwan, exceeding the share in major OECD countries (Table 3.3). Moreover, Taiwan’s high-tech manufacturing sector grew at an average annual rate of 11.79 percent in real terms from 1991 to 1997, far outpacing the high-tech manufacturing sectors in most OECD countries. Even in Korea — East Asia’s high-flyer — high-tech manufacturing registered only 3.81 percent annual growth during this period. Technology trade for Taiwan’s knowledge-based manufacturing industries is not impressive, however. Taiwan’s technology imports far outweigh technology exports for the six major knowledge-based manufacturing sectors (Table 3.4). The technology trade deficit is particularly large for the electrical and electronics products industry, which comprises Taiwan’s dynamic information products and semiconductor sectors. Clearly, there is room for Taiwan to upgrade its knowledge-based manufacturing industries as well as knowledge-based services. To evaluate the progress Taiwan has made towards a KBE in an international context we followed a multidimensional approach. Following work by the OECD (1999) and APEC (2000), we collected data on KBErelated indicators for thirteen countries and grouped the indicators under five broad headings: KBE economic structure, information and communications technology (ICT) infrastructure, knowledge investment,

© 2003 Institute of Southeast Asian Studies, Singapore

© 2003 Institute of Southeast Asian Studies, Singapore

16.0 14.7 9.7 12.2 13.9 18.5 19.5

Source: Rong-I Wu 2000.

United States Japan Germany France United Kingdom Korea Taiwan

1997 share

1.37 0.03 –4.59 0.61 –0.08 3.81 11.79

1991–97 growth

High Technology

31.9 34.1 38.0 28.8 30.7 29.0 25.2

1997 share 2.91 0.32 –1.69 0.14 1.35 1.14 3.01

1991–97 growth

Upper Medium Technology

21.7 27.6 32.1 28.8 21.1 30.9 34.0

1997 share 1.63 0.17 –0.61 –0.23 0.66 –2.23 1.23

1991–97 growth

Lower Medium Technology

30.4 23.9 20.2 30.2 34.3 21.6 20.9

1997 share

0.19 –0.41 –3.09 0.07 0.60 –5.96 –1.95

1991–97 growth

Low Technology

TABLE 3.3 Composition and Growth of Manufacturing Sector by T echnology Intensity in Selected Economies (Percent)

TAIWAN: FROM AN INDUSTRIALISING ECONOMY TO A KBE 91

© 2003 Institute of Southeast Asian Studies, Singapore

Note: * denotes deficit in international technology trade. Source: MOEA.

0.0608

930.02

779.77

0.0503*

873.47

97.29 69.01 28.27

920.79 19.05 901.74

Chemical Products

740.56

19.68 0.08 19.61

Technology sales To Taiwan Technology exports (TX)

Technology trade deficit (TX – TM) Total technology trade (TX + TM) Intra-industry trade in technology

906.11 145.94 760.17

Technology purchases From Taiwan Technology imports (TM)

Chemical Materials

0.1743

396.42

327.32

35.39 0.85 34.55

373.75 11.88 361.87

Metal Products

0.0155

475.66

468.27

39.01 35.31 3.69

545.97 74.01 471.96

Mechanical Equipment

0.0480

30,148.42

28,700.86

2,026.32 1,302.54 723.78

31,604.51 2,179.87 29,424.64

Electrical & Electronics Products

–

–

– – –

4,877.04 41.67 4,835.37

Transportation Equipment

TABLE 3.4 Technology Trade by Knowledge-based Manufacturing Industries, 1998 (NT$ millions)

–

–

– – –

58.84 7.86 50.98

Precision Equipment

92 SHIN-HORNG CHEN AND MENG-CHUN LIU

© 2003 Institute of Southeast Asian Studies, Singapore

–1.13 –0.54 –0.49 –0.68 –1.73 –1.05 –0.78 1.83 3.89 0.90 0.44 –0.15 –0.51 7/13 0.54 2.10 –0.15 0.02 –2.16 –1.78 –2.63 1.06 –0.51 1.58 0.00 3.27 –1.36 10/13

ICT –0.63 –0.50 0.90 0.78 –2.19 1.97 –1.56 0.28 –1.33 3.35 –0.49 0.35 –0.93 10/13

K-investment

Note: For each factor, the average score among all thirteen sample countries is zero.

Australia Canada France Germany Italy Japan Korea Netherlands Singapore Sweden United Kingdom United States Taiwan Taiwan’s Rank

KBI –0.92 –0.59 –0.58 0.16 –1.86 1.09 –0.48 –0.26 –0.09 1.43 –0.60 3.09 –0.38 7/13

K-enterprises

0.05 0.98 –1.13 –0.71 –0.60 –1.95 –2.01 0.79 –0.04 –0.28 0.69 3.09 1.11 2/13

K-institutions

TABLE 3.5 Factor Scores from Principal Component Analysis of KBE Indicators for Selected Economies

TAIWAN: FROM AN INDUSTRIALISING ECONOMY TO A KBE 93

94 SHIN-HORNG CHEN AND MENG-CHUN LIU

knowledge enterprises, and knowledge institutions (see Appendix). In order to summarise these multiple dimensions of a KBE we used Principal Components Analysis to calculate a factor score for each country for each of the five headings. Generally speaking, judging from these factor scores, Taiwan has not made as much progress towards becoming a KBE as many other countries (Table 3.5). In terms of KBE economic structure (KBIs), Taiwan ranked only seventh while Singapore ranked highest. Taiwan ranked tenth in ICT infrastructure behind top-ranked United States. Taiwan also placed in the bottom half of the thirteen countries in terms of knowledge investment (tenth) and knowledge enterprises (seventh). In stark contrast to its low ranking on these factors, however, Taiwan ranked second only to the United States in terms of knowledge institutions. Figure 3.1 summarises the KBE factor rankings of four countries: Japan, Korea, the United States, and Taiwan. The United States has FIGURE 3.1 KBE-related Indicators for Japan, Korea, United States, and Taiwan

KBI

4 2 0 K institutions

ICT

-2 -4

K enterprises

Japan

K investment

Korea

U.S.

© 2003 Institute of Southeast Asian Studies, Singapore

Taiwan

TAIWAN: FROM AN INDUSTRIALISING ECONOMY TO A KBE 95

progressed further than the other countries in terms of ICT infrastructure, knowledge enterprises, and knowledge institutions. Japan’s KBE strength lies in knowledge enterprises and, particularly, knowledge investment, where it even ranks above the United States. Taiwan and Korea are generally playing catch-up in all areas, but Taiwan seems to be ahead of Korea and also ahead of Japan in terms of knowledge institutions. These observations must be qualified by some well-known limitations of indicators (OECD 1999, p. 8), but we can tentatively conclude that Taiwan needs to systematically address all major KBE-related dimensions in order to make further progress in transforming to a knowledge-based economy. IT HARDWARE: EVOLUTION OF CONTRACT MANUFACTURERS INTO INTEGRATED SERVICES MANUFACTURERS

IT hardware is the mainstay of Taiwan’s knowledge-based manufacturing industry. Taiwan’s strength lies in the PC-related information products and IC (semiconductor) subsectors. To compete in such fields, firms need more than low-cost materials; they need advantages collectively known as “intangible capabilities”. For one thing, Taiwan’s achievements in the PC and IC industries have to do not just with manufacturing muscle, but also with the ability of local firms to leverage and align local and international networks. PC Industry

In 1999, Taiwan was the third largest producer of PC-related products worldwide, with a significant number of Taiwanese-made products such as motherboards, scanners, monitors, and notebook computers enjoying a healthy global market share. Taiwan’s characteristic local industrial clusters and their role in the growth of the domestic PC industry have been deeply analysed (Hobday 1995, Kawakami 1996, and Kraemer et al. 1996). But local agglomeration alone no longer accounts adequately for the dynamics of Taiwan’s PC industry because the way in which the industry is organised globally has changed as the global production network has come to the fore. In this regard, an important milestone in the development of Taiwan’s PC industry was the outreach by local firms starting from the late 1980s. Their outward investment was directed initially towards Southeast Asia and more recently towards China and elsewhere in the world. Offshore production of Taiwan-based PC firms grew from US$973 million in 1992

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96 SHIN-HORNG CHEN AND MENG-CHUN LIU

to US$18.86 billion in 1999, which was 47.29 percent of total production. It follows that the volume of export orders received by local firms diverged more and more from their actual exports (Chen and M.C. Liu 2000). According to our observations the divergence widened in 1997, and this had to do with the changing role of Taiwanese firms in the global production network. Along with the PC industry’s drive to reduce production costs, leadtime to market, and inventory costs came a profound change in the manufacturing system and inter-firm competition in the industry. It became commonplace for components to be sourced from a global network of suppliers and for final assembly to be done within the end-market (Angel and Engstrom 1995 and Borrus and Borrus 1997). Specifically, major brand marketers moved to adopt outsourcing and order-based production, which greatly rationalised their global supply chain, and hence altered their contractual relationships with Taiwanese firms. Compaq, for example, pioneered the so-called optimised distribution model, which, in essence, aimed to allow customers to choose what they wanted, when, and how, at the lowest prices. There are three facets to this operational model. First, in order to narrow the gap between supply and demand, production must be to fill orders (build-to-order, or BTO) rather than to meet forecasts. Second, in order to meet the variety of customer demands, producers must not only build-to-order but also configure-to-order, making customised products in specific quantities. Third, vendors must undertake final assembly, bringing together a set of subassemblies produced and delivered by subcontractors. In addition, Compaq imposes a “98-3” operation formula on subcontractors, requiring them to collect 98 percent of the components and parts needed for production within three days of the order and to ship the product within six days of the order. Such contractual arrangements with global leaders in the PC industry prompted Taiwanese IT firms to upgrade their position within the global production system. Taiwanese firms began to shoulder the essential functions of co-ordinating the global supply chain for their orignal equipment manufacturers’ (OEM) customers. For example, under its new business model, Compaq outsourced every element of the value chain except marketing to Taiwanese subcontractors. In doing so, Compaq turned its inventory costs completely over to these subcontractors, who were also required to produce and deliver subsystems on tight schedules and in tune with the vagaries of market demand. The Taiwanese firms had to ensure that everything was synchronised up and down the supply chain. In order to do this they had to participate in cross-border supply chain

© 2003 Institute of Southeast Asian Studies, Singapore

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management, logistics operations, and after-sales services, and to coordinate all of these activities they had to form a quick-response global production and logistics network, or “global logistics” (Chen and Liu 1999 and Schive 2000). From Taiwan’s perspective, the essence of this development is that local IT firms are transforming from stand-alone OEM manufacturers into providers of integrated service packages encompassing a wide range of value-chain activities. Basically, Taiwan’s IT firms are no longer pure contractors; they also engage in product design and interact intensively with OEM customers to strengthen their learning and innovation capabilities. For example, Delta maintains five R&D centres around the globe and has started to refer to itself as an original design manufacturer. In addition to moving into R&D, Taiwan’s IT firms have also enhanced the value of their manufacturing services by integrating forward into customer services. For instance, Taiwan’s largest notebook computer maker, Quanta, offers a “Taiwan Direct Shipment” (TDS) service to its customers in a BTO arrangement. With TDS, end consumers can monitor the status of their orders through the electronic data interchange (EDI) service provided by brand marketers or local sales agents. A customer can follow from day one to day seven, as production progresses from materials preparation to final assembly. It is estimated that the TDS service has increased the value of Quanta’s product by US$30–50 per piece (Huang 2000, pp. 73–4). IC Industry

Currently Taiwan’s IC industry is the fourth largest in the world, behind only the United States, Japan, and Korea. In several significant ways the industry in Taiwan differs from that in the other three. Unlike Korea, which specialises in the production of dynamic random access memory (DRAM), Taiwan produces a much wider variety of IC chips, and dominates in foundry services, capturing around 70 percent of the global market share. In addition, in contrast to the vertically integrated conglomerates that dominate the industry in Korea and Japan, Taiwan’s IC industry consists of many small firms specialising in a narrow range of the value chain, such as IC design, mask production, foundry service, packing, and testing. In fact, Taiwan’s flock of some 127 IC design houses put it second behind only the United States in that segment. In a sense, Taiwan’s IC industry is organised as an industrial network system with a strong connection to Silicon Valley, the worldwide centre of the IC market and IC technology.

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98 SHIN-HORNG CHEN AND MENG-CHUN LIU

For one thing, the development of Taiwan’s IC industry has been driven by organisational innovation, with foundry services created as a market niche to specialise in production for external customers. Local entrepreneurs made this choice deliberately as a way to avoid the risks associated with the market volatility of DRAM. Although Taiwan has some brand name producers, foundry services accounted for 53 percent of local IC production in 1999. By disintegrating the IC value chain, the emergence of foundry services in Taiwan facilitated the proliferation of small- and medium-sized firms engaged in other market segments, such as IC design, testing, and packaging, which gave rise to a balanced and vertically disintegrated industrial structure. Despite the lack of structural vertical integration, however, we see several indications of a trend towards “virtual” vertical integration among local firms. First, the domestic sales ratio in Taiwan’s IC industry increased from 39.5 percent in 1996 to 54.7 percent in 1999 (Table 3.6). The ratio is now higher in Taiwan than in other major countries and regions, such as North America (44.8 percent), Japan (51.8 percent), and Europe (43.6 percent). Second, the subcontracting relationships in the value chain tend TABLE 3.6 IC Industry Statistics for Taiwan and the World, 1996–99

World IC output (US$ billion) Growth rate (%) Taiwan Output (US$ billion) Market share (%) Output (NT$ billion) Growth rate (%) IC design (NT$ billion) IC fabrication (NT$ billion) Foundry service (NT$ billion) IC packaging (NT$ billion) IC testing (NT$ billion) Product revenue (NT$ billion) Domestic sales ratio (%) Domestic market (NT$ billion) Exchange rate (NT$/$US)

1996

1997

1998

1999

114.9 –8.9

119.5 4.0

109.0 –8.8

126.6 16.0

6.85 5.96 188.2 9.5 21.8 125.6 56.0 35.8 5.0 91.4 39.5 203.6 27.49

7.60 6.36 247.9 31.7 36.3 153.2 84.2 47.8 10.6 105.3 47.0 235.5 32.64

8.80 8.07 283.4 14.3 46.9 169.4 93.8 54.0 13.1 122.5 49.7 274.4 32.22

13.49 10.66 423.5 49.4 74.2 264.9 140.4 65.9 18.5 198.7 54.7 345.7 31.40

Source: ERSO ITIS Project May 2000 and Taiwan Statistical Data Book, 2000.

© 2003 Institute of Southeast Asian Studies, Singapore

TAIWAN: FROM AN INDUSTRIALISING ECONOMY TO A KBE 99

to be localised. For example, local contracts accounted for 91.2 percent of revenue in Taiwan’s IC design houses in 1999, compared to 72.3 percent in 1998. Likewise, around 98 percent of the products of Taiwan’s fabless designers were packaged locally in 1999. Third, almost 70 percent of the ICs designed by local fabless designers are for the information industry, indicating a strong connection between the IC and information sectors in Taiwan. In essence, the development of Taiwan’s IC industry has, to a large extent, come to resemble the scenario of the flexible specialisation thesis (Piore and Sable 1984). Fabless IC design houses proliferated in Taiwan in part because access to external fabrication capacity lowered the barriers to entering the IC design market. In addition, the concentration of IC and computer-related firms in the Hsinchu Science-based Industrial Park generated agglomeration effects that allowed those firms to exploit the benefits of proximity and outsourcing. Therefore, even though they specialise in one segment of the value chain or another, IC firms in Taiwan are networked by social and business connections. Moreover, Taiwan’s IC industry is closely connected with the industry centre in Silicon Valley. While the United States ranks first among the four largest IC-producing countries (the United States, Japan, Korea, and Taiwan) with regard to R&D intensity, Taiwan ranks first and the United States fourth with regard to capital expenditure intensity (Table 3.7). This points to an interesting pattern emerging in the international division of labour in the IC industry. Taiwan’s strength lies in foundry services, which depend on substantial investment in fabrication capacity. The U.S. IC firms, on the other hand, tend to concentrate on R&D, design, and marketing functions, which are backed up by access to Taiwan’s foundry service capacity. In fact, more than half of Taiwan’s foundry capacity in 1998 was used to serve U.S. customers, and most of the top ten fabless makers in the United States have been clients of Taiwanese foundries. TSMC, the world’s largest foundry service provider, shares resources and information with its customers, considering them as partners. Each year, TSMC informs its customers of the foundry’s plans for the development of process technology over the next five years. This information helps TSMC’s customers ensure that the proposed process technologies can support the future development of their products. This sharing of resources and information not only facilitates close, long-run relationships with customers, but also helps reduce the uncertainty on both sides over technology development. Another facet of the connection between the IC industry in Taiwan and in the United States is the intensive interchange between specialists in

© 2003 Institute of Southeast Asian Studies, Singapore

100 SHIN-HORNG CHEN AND MENG-CHUN LIU

TABLE 3.7 R&D Intensity and Capital Expenditure Intensity of the IC Industry in the United States, Japan, Korea, and Taiwan, 1995–99 (Percent)

R&D intensity United States Japan Korea Taiwan Capital expenditure intensity United States Japan Korea Taiwan

1995

1996

1997

1998

1999

9.7 6.6 – 7.0

11.6 6.5 7.9 6.9

12.1 6.6 11.6 8.8

13.9 6.5 12.9 9.1

– – – –

20.7 16.1 25.7 31.9

22.8 20.8 40.1 63.4

17.5 20.2 51.0 63.4

18.0 18.0 26.0 73.0

14.0 16.0 26.0 68.0

Notes: R&D intensity is the ratio of R&D expenditure to sales expressed as a percentage and capital expenditure intensity is the ratio of capital expenditure to sales expressed as a percentage. Data refer to fiscal year. Source: ITIS (Industrial Technology Information System) project database.

both countries. Underlying this exchange are Taiwanese and Chinese expatriates, who have played important roles in establishing the transPacific social and business networks that have proved crucial in connecting Taiwan’s production system with advanced market knowledge and technology (Saxenian 1997 and Kim and Tunzelmann 1998). Apart from the ethnic social network, the fact that the IC industrial systems in both Taiwan and Silicon Valley are decentralised and network-based facilitated the interchange. This type of industrial system encourages the pursuit of multiple technical opportunities, heavy reliance on outsourcing, and interorganisation knowledge flows (Sanxenian 1997). Similarity in industrial structure makes networking between Silicon Valley and Hsinchu Sciencebased Park, the centre of Taiwan’s IC industry, much easier and more intensive. Such industrial networking as exists in Taiwan’s IC industry has benefited from recent innovations in IT. First, by reducing the uncertainty and transaction costs involved in purchasing from the best outsiders, IT reduces large firms’ advantage from centralised purchasing and in-house suppliers. Second, technological changes have resulted in smaller production runs, increasing the feasibility of product changes and allowing small, specialised

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firms to exploit fragmented product markets on the strength of their flexible response. In addition, the IC industry is following the PC industry in moving rapidly towards order-based production. Leading IC firms in Taiwan are championing the concept of the “virtual factory” by deploying the Internet and Extranet to link electronically with their customers and suppliers. Despite their substantial size and dominant position in foundry services, Taiwan’s two leading foundry service providers have never attempted vertical integration. United Microelectronics Corporation (UMC) spun off its IC design operations before entering the foundry service market, and neither UMC nor TSMC has attempted to enter the field of IC assembly or testing. Indeed, vertical integration in production is not the right response to the new challenges of a KBE. As innovation has become globalised and knowledge has spread around the world, the increasing need is for the integration of knowledge. The emergence of the “system on a chip” (SOC) is the IC industry’s response to this need. SOC integrates several individual chips — each of which contains distinct intellectual properties (IP) — to perform systemised functions such as those in cameras or computers. Knowledge integration differs from knowledge creation, and it spawns different kinds of organisations. The increasing complexity of SOC designs induced the creation of modules of various design technologies, known as silicon intellectual property (SIP), which can be used as building blocks for SOC. Most SIPs are owned by the fabless makers, and foundry service providers are a natural place to verify the value and “fabricability” of SIPs. For example, TSMC offers its clients a free library and SIP-verification service. The emergence of SOC has also given rise to “chipless” IC firms, which do business without a fab and without owning a chip. Chipless firms simply provide an array of SIPs, saving clients the cost of dealing with many individual owners of various IC designs that incorporate certain intellectual property. Taiwan’s largest SOC firm, VIA, bought the CPU (central processing unit) design departments of two American companies, Cyrix and IDT, and turned them into chipless units.4 IT SOFTWARE: PENETRATION AND PRODUCTIVITY IMPACT

IT hardware production is one part of the knowledge-based economy, but the more important part is software and applications. Traditionally, hardware production has been the core of Taiwan’s IT industry, but in the KBE era software and applications are getting more emphasis because they are more knowledge-based. The Internet, digital convergence, and

© 2003 Institute of Southeast Asian Studies, Singapore

© 2003 Institute of Southeast Asian Studies, Singapore

20 70 1 65 35 0.02 146 20 3.6

47 1,000 15 4 2 45 20 0.02 13 14 3.0

18 9,000

Japan 1999

10 0.08 4 25 10 0.32 35 15 2.3

48 6,000

Singapore 1999

3.5 0.005 9 25 4 0.02 5 9 1.6

21 8,000

Korea 1999

Source: Market Intelligence Centre, Institute for Information Industry. Internet penetration from Nua Internet Survey.

Internet penetration per capita (%) Network usage cost (NT$ per month) Deployment of broadband networks (% per 100 Internet users) Local web pages (% of global total) IT production value (global rank) Value-added ratio of IT products (%) Share of firms applying information intensively (%) Tele-education per capita (% per 100 inhabitants) Avg. entertainment expenses on Internet (US$) Share of government services available online (%) E-commerce (% of GDP)

United States 1999

TABLE 3.8 Indicators of IT Application in Selected Economies

4 0.2 3 30 4 0.05 14 10 2.1

22 5,260

1999

96 4 3 40 31 9 447 70 9

NA 700

2004f

Taiwan

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telecommunications liberalisation are among the driving forces of this trend. After looking at various measures of the penetration of software and applications in Taiwan’s economy, we evaluate the economic impact of IT by estimating a production function. A few points summarise where Taiwan stands with respect to the penetration of IT applications compared to other economies. Generally speaking, Taiwan is far behind the United States (Figure 3.1) and, together with Korea, it remains somewhat behind Japan and Singapore (Table 3.8). Taiwan outperforms the other NICs, Singapore and Korea, in IT production and the value-added ratio of IT products, but it lags some distance behind the United States and Japan in those areas. The gap between Taiwan and the two leading countries may be mainly attributable to software, since software accounted for only 6.92 percent of IT production in Taiwan in 1999. Compared with Japan and Singapore, not to mention the United States, Taiwan is particularly weak in the deployment of broadband networks, the share of firms that have applied IT intensively, and the proportion of government services that are accessible online. These weak areas are expected to improve in the very near future. A study by the Institute for Information Industry (2000) projects that broadband network coverage in Taiwan will reach 96 percent by 2004, putting it on a par with the United States, Japan, and Singapore. Also by that time, around 30 percent of firms in Taiwan are expected to be seriously applying IT. The study projects that e-commerce will account for 9 percent of Taiwan’s GDP in 2004. We are interested in how the more extensive application of IT in the Taiwan economy projected for the next few years will affect productivity. Although IT has been widely touted as the driving force behind emerging paradigm shifts, relevant empirical research is sparse (Antonelli 1998), especially for countries such as Taiwan. We follow Antonelli’s approach to calculate the output elasticity of IT services in Taiwan based on a standard production function with IT services as a specific factor of production in addition to labour and capital. Our estimate of the production function for Taiwan is based on input/output data for 120 industries for 1996, the latest available. The labour productivity function is a simple mathematical transformation of the production function. Its econometric specification is: (1)

ln(Y/L) = a + b ln(K/L) + c ln(ITS/L) + d S + e S*ln(ITS/L) + ε, where Y K L

is value added, is capital stock estimated from investment data, is labour costs,

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104 SHIN-HORNG CHEN AND MENG-CHUN LIU

ITS S ε

is inputs of IT services purchased by each industry, is a dummy variable designating service sectors, and is an error term.

Y/L in equation (1) refers to labour productivity, K/L is the capitallabour ratio, and ITS/L refers to IT services intensity. This econometric specification achieves two things. First, it yields an estimate for the output elasticities of capital and of IT services. Second, the coefficient on the interaction term, S*ln(ITS/L), distinguishes the particular effect of IT intensity on labour productivity in the service industries. Y, K, L, and ITS are measured in millions of NT dollars. Both Y and ITS come from inputoutput statistics and K and L come from industrial census data. From OLS estimates of equation (1) we make three observations (Table 3.9). First, the output elasticity of IT services is positive (0.79) and larger than that of capital (0.14) for Taiwan industry as a whole. Given the robustness of the coefficient estimates (significant at the 5 percent level), we can conclude that inputs of IT services have contributed to raising the productivity of Taiwan industry. Second, the negative and significant coefficient on the interaction term, S*ln(ITS/L), implies that IT service inputs have a smaller effect on labour productivity in the service sector than they do in the non-service sector. Third, the significantly negative coefficient on the dummy variable S indicates that labour productivity is lower in the service sector than in the non-service sector. Antonelli (1998) tended to explain such productivity enhancement effects in terms of localised technological change and national innovation systems. We are reluctant to go that far in the case of Taiwan because the knowledge base there seems too small to be described in these terms. It is sufficient

TABLE 3.9 OLS Estimates of Labour Productivity Function Constant

lnK/L

lnITS/L

S

S * lnITS/L

Coefficient estimate t-value

5.46 18.80*

0.14 2.41*

0.79 16.40*

–3.86 7.87*

–0.62 6.16*

R2 F No. of observations

0.77 94.41* 120

Note: * indicates significance at the 5-percent level.

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for us to say that IT significantly reduces the costs of communication and hence facilitates economic efficiency in transactions and production, which in turn promotes economic growth (Jovanovic and Rob 1989). Our empirical results can also be discussed in the context of the “IT productivity paradox”.5 While Kraemer and Dedrick (2000) found no positive correlation between IT spending and productivity in a sample of Asian countries, our results indicate that IT services do have a significant impact on industrial productivity in Taiwan. CONCLUSION

Industrialisation has been considered an important means of structural adjustment to promote economic welfare in developing countries and material-based manufacturing has been in the spotlight as its driver. With the concept of a KBE emerging as a new stage in economic development, however, the spotlight is shifting. Since knowledge is an intangible good, a knowledge-based economy is qualitatively different from a material- or manufacturing-based economy. Value-added arising from non-materialbased advantages should be a central concern of industrial development in a KBE. The OECD defined high-technology industries as an essential part of a KBE. More important than technology-content to a KBE, we argue, is the operational content of industries. According to Quinn (1988), broadly defined services interface intensively with manufacturing to promote valueadded throughout the economy. In addition, the important connections between services and innovation are increasingly recognised — both the role of services in facilitating innovation and the economic impact of service innovations (Hauknes 1998). Our case studies of the PC and IC industries in Taiwan showed that the implications of a KBE for the manufacturing sector extend well beyond a shift to production of hightechnology goods. In the underlying environment of globalisation, these industries are evolving in Taiwan from manufacturing-based subcontractors towards providers of integrated service packages. In this process, networking is important on two accounts. First, the long-standing contractual relationships between Taiwanese firms and the global brand marketers facilitated reciprocal and concurrent knowledge flows between the two sides, which in turn helped build up Taiwan’s capabilities. This upgrading, together with the outreach by Taiwanese PC firms, made it possible for them to take on the essential function of co-ordinating the global supply chains of their OEM customers. Second, electronic networking is becoming

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more and more important in linking PC and IC firms in Taiwan with the global supply chain and in increasing their value-added. As indirect support of this argument, we showed empirically that inputs of IT services have significantly raised Taiwan’s industrial productivity, especially in the manufacturing sector as a whole. Even so, Taiwan remains far behind the global leaders in the transition to a KBE. After all, for one thing, brand marketers are in the driver’s seat of the global PC industry. To further its own transition to a KBE, Taiwan needs to readjust its economic activities to become more software- and service-based and to become more innovation-oriented. Notes 1

2 3

4 5

Here, we consider the term “knowledge-based” economy to be interchangeable with other terms that refer to this development, such as “New Economy” (OECD 2000) and “Network Economy”. Wage differentials between countries may remain. The OECD (1999) defined categories of knowledge-based industries (KBIs) as a means of benchmarking member countries’ transition to KBEs. KBIs include both knowledge-based manufacturing (manufacturing industries involving high- and medium-high technology) and knowledge-based services (service activities that are intensive users of high technology and/or have a relatively highly skilled workforce). The OECD definition of KBIs is useful because it is based on the existing industrial classification system, but it can overstate the importance of knowledge-based activities because it neglects the qualitative changes in value-added activities across industries. Commonwealth, 25 May 2000, pp. 132–33. Robert Solow once noted that he could see the impacts of IT everywhere, except in productivity. R. Solow, “We’d better watch out”, New York Times (Book Review), 12 July 1987, p. 37.

References

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Asia Pacific Economic Co-operation (APEC). 2000. The Promotion of Knowledge-Based Industries in the APEC Region. Singapore: Asian Pacific Economic Co-operation. Borrus, M., and Z. Borrus. 1997. “Globalisation with Borders: The Rise of Wintelism and the Future of Global Competition”. Industry and Innovation 4(2): 141–66. Cantwell, J., and G.D. Santangelo. 1999. “The Frontier of International Technology Networks: Sourcing Abroad the Most Highly Tacit Capabilities”. Information Economics and Policy 11:101–23. Chen, S.H., and D.N. Liu. 1999. Strategic Alliances in the Context of Competition Policy (in Chinese). Final report to Industrial Development Bureau. Taipei: Chung-Hua Institution for Economic Research. ———. 2000. “Taiwan’s Active Role in the Global Production Network”. In Weathering the Storm: Taiwan, Its Neighbours, and the Asian Financial Crisis, edited by P. Chow and B. Gill. Washington, D.C.: Brookings Institution Press. Chen, S.H., and M.C. Liu. 2000. “The Knowledge-based Economy and Information Technology: The Taiwanese Perspective”. Paper presented at the ASEAN Roundtable 2000, “New Development Paradigms in Southeast Asia: The Challenge of Information Technology”, National University of Singapore, Singapore, 12–13 October. Cohen, W.M., and D. Levinthal. 1989. “Innovation and Learning: The Two Faces of R&D”. Economic Journal 99: 569–96. Delapierre, M., and L.K. Mytelka. 1998. “Blurring boundaries: New Interfirm Relationships and the Emergence of Networked Knowledge-based Oligopolies”. In The Changing Boundaries of the Firm: Explaining Evolving Inter-Firm Relations, edited by M.G. Colombo. London and New York: Routledge. Electronics Research and Service Organization (ERSO). 2000. Almanac of the Semiconductor Industry in Taiwan. Hsin-Chu: Industrial Technology Research Institute. Etzkowitz, H., A. Webster, C. Gebhardt, and B. Terra. 2000. “The Future of the University and the University of the Future: Evolution of Ivory Towers to Entrepreneurial Paradigm”. Research Policy 29: 313–30. Freeman, C., and C. Perez. 1988. “Structural Crises of Adjustment, Business Cycles and Investment Behavior”. In Technical Change and Economic Theory, edited by G. Dosi et al. London: Pinter. Gerybadze, A., and G. Reger. 1999. “Globalisation of R&D: Recent Changes in Management of Innovation in Trans-national Corporations”. Research Policy 28(2–3): 251–74.

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Hauknes, J. 1998. Services in Innovation - Innovation in Services. SI4S Synthesis Paper. Oslo: STEP Group. Hobday, M. 1995. Innovation in East Asia: The Challenge to Japan. Aldershot, U.K.: Edward Elgar. Huang, Chin-yung. 2000. E-Economy. Taipei: China Times. Institute for Information Industry. 2000. The Upgrading of Taiwan’s Information Strength. Final Report to the Council for Economic Development and Planning. Taipei: Institute for Information Industry. Jovanovic, B., and R. Rob. 1989. “The Growth and Diffusion of Knowledge”. Review of Economic Studies 56(4): 569–82. Kojima, K. 1978. Direct Foreign Investment: A Japanese Model of Multinational Business Operations. London: Croom Helm. Kawakami, M. 1996. “Development of the Small- and Medium-sized Manufacturers in Taiwan’s PC Industry”. CIER Discussion Paper Series 9606. Taipei: Chung-Hua Institution for Economic Research (CIER). Kim, S., and N. Tunzelmann. 1998. Aligning Internal and External Networks: Taiwan’s Specialisation in IT. Brighton: SPRU, University of Sussex. Kraemer, K.L. et al. 1996. “Entrepreneurship, Flexibility, and Policy Coordination: Taiwan’s Computer Industry”. The Information Society 12: 215–49. Kraemer, K., and J. Dedrick. 2000. “Information Technology in Southeast Asia: Engine of Growth or Digital Divide?”. Paper presented at the ASEAN Roundtable 2000, “New Development Paradigms in Southeast Asia: The Challenge of Information Technology”, National University of Singapore, Singapore, 12–13 October. Michalet, C. 1991. “Strategic Partnerships and the Changing Internationalisation Process”. In. Strategic Partnerships: States, Firms and International Competition, edited by L.K. Mytelka. London: Pinter. Niosi, J. 1999. “The Internationalisation of industrial R&D from Technology Transfer to the Learning Organization”. Research Policy 28(2–3): 107– 17. Organisation for Economic Co-operation and Development (OECD). 1996. The Knowledge-Based Economy. Paris: OECD. ———. 1997. Internationalisation of Industrial R&D: Patterns and Trends. Paris: OECD. ———. 1999. OECD Science, Technology and Industry Scoreboard 1999: Benchmarking Knowledge-Based Economies. Paris: OECD. ———. 2000. Is There a New Economy? First report to the OECD Growth Project. Paris: OECD.

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Patel, P., and K. Pavitt. 2000. “National Systems of Innovation under Strain: The Internalisation of Corporate R&D”. In Productivity, Innovation and Economic Performance, edited by R. Barrell, G. Manson, and M. O’Mahony. Cambridge: Cambridge University Press. Piore, M., and C. Sable. 1984. The Second Industrial Divide. New York: Basic Books. Powell, W.W., K.W. Kogut, and L. Smith-Doerr. 1996. “Inter-organisational Collaboration and the Locus of Innovation: Networks of Learning in Biotechnology”. Administrative Science Quarterly 41: 116–45. Quinn, J.B. 1988. “Technology in Services: Past Myths and Future Challenges”. In Technology in Services: Policies for Growth, Trade and Employment, edited by B. Guile and J.B. Quinn. Washington, D.C.: National Academy Press. Saxenian, A. 1994. Regional Advantage. Cambridge and London: Harvard University Press. ———. 1997. “Transactional Entrepreneurs and Regional Industrialisation: The Silicon Valley-Hsinchu Connection”. Paper presented at the Conference on “Social Structure and Social Change: International Perspective on Business Firms and Economic Life”, Academia Sinica, Taipei, 9–10 May. Schive, C. 2000. “Global Logistics: A New Way of Doing Business in Taiwan”. Paper presented at the Global Entrepreneurship for the New Millennium Conference, Syracuse University, New York, 20–23 August. Schumpeter, J.A. 1942. Capitalism, Socialism and Democracy. New York: Harper and Brothers. Senker, J., and W. Faulkner. 1993. “Networks, Tacit Knowledge and Innovation”. Paper presented at the Second International Conference on Advances in Sociological and Economic Analysis of Technology, University of Manchester, U.K., April. Sigurdson, J. 1990. “The Internationalisation of R&D: An Interpretation of Forces and Responses”. In Measuring the Dynamics of Technological Change, edited by J. Sigurdson. London: Pinter. Solow, R. 1987. “We’d better watch out”. New York Times (Book Review), 12 July, p. 36. Sturgeon, T. 2000. “Turn-key Production Networks: A New American Model of Industrial Organization”. Industrial Performance Centre Working Paper. Massachusetts Institute of Technology. Windrum, P. 1999. “The MERIT Report on Innovation Networks in Ecommerce”. Prepared for SEIN (Simulating Self-organising Innovative

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Networks) Workpackage 4. EU TSER (Targeted Socio-economic Research) Programme. Wise, R., and P. Baumgartner. 1999. “Going Downstream: The New Profit Imperative in Manufacturing”. Harvard Business Review (SeptemberOctober): 133–41. Wu, Rong-I. 2000. “Competitiveness Analysis of Taiwan’s Industrial Technology”. Paper presented at the Conference on the Measurement of Industrial Technology Competitiveness in the Knowledge-Based Economy, Taipei, 23–24 August. Zander, I. 1999. “How Do You Mean Global: An Empirical Investigation of Innovation Networks in the Multinational Corporation”. Research Policy 28(2–3): 195–213.

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APPENDIX TABLE 3.A1 KBE Indicators for Principal Component Analysis

Dimension KBI

ICT

K-investment

K-institutions

Indicator • Ratio of service exports to GDP (%), 1998 • Proportion of high-technology exports to manufacturing exports (%), 1998 • Net inflow of FDI (% of GDP), 1998 • Ratio of knowledge-based industries to GDP (%), 1996 • Internet host density per 10,000 inhabitants, 1999 • Cellular mobile subscriber density per 100 inhabitants, 1999 • Telephone main line density per 100 inhabitants, 1999 • International telephone call charges (US$ per 3 minutes in peak hours to US) • Personal computer penetration per 1,000 inhabitants, 1998 • Gross domestic expenditure on R&D (% of GDP), 1999 • Public expenditure on education (US$ per capita), 1995 • Total R&D personnel per capita full-time work equivalent per 1,000, 1997 • Company-university co-operation, Survey • Number of patents registered in the US • Business enterprise R&D expenditure (% of GDP) • Human Development Index, 1998 • Venture capital, Survey • Stock market capitalisation (US$ billions), 1998 • Creation of firms, Survey

Data Source WDR 1999 WDR 1999 WDR 1999 STIS 1999 ITU ITU ITU WCY 1999 WCY 1999 STIO 2000 WCY 1999 WCY 1999 WCY 1999 Wu 2000 STIO 2000 WCY 1999 WCY 1999 WCY 1999 WCY 1999

Source: WDR1999: World Bank, World Development Report 1999/2000; STIS: OECD 1999, Science, Technology and Industry Scoreboard; ITU: International Telecommunication Union, ; STIO: OECD 2000, Science, Technology and Industry Outlook; WCY1999: International Institute of Management Development, 1999, World Competitiveness Yearbook; Wu 2000: Rong-I Wu, 2000, “Competitiveness Analysis of Taiwan’s Industrial Production”.

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Reproduced from Towards a Knowledge-based Economy: East Asia’s Changing Industrial Geography, edited by Seiichi Masuyama and Donna Vandenbrink (Singapore: Institute of Southeast Asian Studies, 2003). This version was obtained electronically direct from the publisher on condition that copyright is not infringed. No part of this publication may be reproduced without the prior permission of the Institute of Southeast Asian Studies. Individual articles are available from < http://bookshop.iseas.edu.sg >

112 XIAODONG LI

4 The Internet Revolution in China Current Situation and Future Outlook Xiaodong Li We are now at a historical stage of dramatic change, and the Internet Revolution is a crucial force driving this change. In the short time since it emerged in the latter half of the last century the Internet has begun to transform the world just as the Industrial Revolution was a fundamental force of social change 200 years ago. With surprising speed the Internet is penetrating all aspects of our lives — the way we work, play, shop, learn, communicate, and take care of our families and ourselves. Electronic mail, the World Wide Web, and easy-to-use Internet multimedia applications, are largely responsible for those changes. The Internet Revolution is beginning to have as tremendous an impact on business activities as it has had on individuals. The Internet will soon allow people to transcend the barriers of time and distance and take advantage of global markets and business opportunities not yet even imagined. It will open up an entirely new domain of socio-economic possibility and progress, and bring human beings into an unprecedented age of networked intelligence. NEW OPPORTUNITIES AND CHALLENGES Emerging Development Opportunities

The speedy expansion of the Internet is opening opportunities for all developing countries including China. Through this network China can be better positioned to combine its intelligence, knowledge, and creativity for breakthroughs in the creation of economic growth, social development, and human ingenuity. The Internet offers China a so-called latecomer’s advantage to catch up with and even surpass advanced technology and to modernise its economy.

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The Internet’s potential as a tool of economic development stems mainly from Internet-based business activities. • The growth of the Internet has created a huge virtual market, comparable in size to the traditional visible market. The Internet gives enterprises access to this vast global market in which to sell their outputs and to purchase inputs. • The Internet opens the possibility for enterprises to compete in global markets and co-operate with firms around the world. In particular, small and medium-sized enterprises can increase their international competitiveness by co-operating with multinational enterprises and benefiting from their expertise in management and logistics. • By facilitating direct interaction between consumers and suppliers the Internet reduces management and transactions costs and improves productivity and management efficiency. • The new competitive environment of the Internet challenges enterprises to improve organisation and management to become more productive and efficient. The Coming Challenges

For a number of reasons the rapid expansion of the Internet on the back of continuing economic globalisation may pose more serious challenges for China than for other countries. Shock to the Social System

China’s basic social system was established under the conditions of a planned economy. Although it has changed somewhat since the opening and reform policy was implemented, the fundamental social management and organisation have not yet adjusted to suit a market economy. The Internet Revolution, which is basically market-driven, could severely shock this immature system. Pressure of Global Competition

With the Internet Revolution and globalisation, more and more companies are becoming international giants because of their advanced management, huge capital, global operation strategy, and competitiveness. The mergers of telecom companies and the emergence of global information technology (IT) giants are examples of this phenomenon. In contrast, most of China’s

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large enterprises are state-owned and unable to compete globally because of low productivity and poor management. Although they have been undergoing reform for many years, progress has been slow and these enterprises will be particularly vulnerable to international competition once China enters the World Trade Organisation (WTO). Mounting Employment Pressure

On one hand, the application of IT and networking has undoubtedly expanded employment. This was the experience in the United States where the economy entered a long period of prosperity following emergence of the Internet and a remarkable New Economy with a high rate of growth and low rates of unemployment and inflation. But the Internet doesn’t necessarily mean more jobs, because the more that the Internet and networking enhance productive efficiency, the more jobs will be lost in traditional industries. This impact will be felt especially in developing countries, where traditional industries predominate. China is such a country with mostly labour-intensive industries. At the same time China has a huge population, and most of the 17 million young people that join the labour force every year are from the countryside and lack education, skills, qualities, and abilities that are needed in the information age. A digital divide clearly exists between China’s urban and rural areas. Challenge to Economic Security and Social Stability

The Internet’s promises of prosperity and efficiency will come partly through linking more closely with other economies, but along with these benefits will come such problems as attacks by hackers, computer viruses, and breaches of privacy and information security. At the beginning of 2000, a hacker attacked websites in China along with Yahoo and other popular sites, resulting in great financial loss and sending a great shock around the country. The fact that we cannot determine where and when these dangers will occur, because they lurk in every corner of the world, only increases anxiety. The Internet poses a special anxiety for China. As Fan Xing, a research fellow at the Centre for Strategy and International Studies (CSIS), pointed out: Widespread applications of Internet-related technologies tend to create an environment in which political and economic activities are decentralised and fragmented, generating a serious government concern

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that China’s political leadership and administrative oversight may therefore be weakened or downgraded when they need to be reinforced.1

With certainty, the Internet will deeply revolutionise China’s society, economy, and technological system in the new millennium. The drive by public officials to apply IT and the frenzy of private individuals to connect to the Internet present challenges as well as open opportunities for the political system and social-cultural legacies. Only nations that have prepared well to embrace the Internet Revolution will be able to seize its opportunities. China appears to be firm on taking the road towards the Internet wave, perhaps with its ancient heart and modern soul. INFORMATISATION: MEETING THE INTERNET WAVE

Rapid evolution of technology and strenuous economic integration after China’s opening and reform forced officials to rethink development strategies and to restructure industry and the regulatory framework. By the early 1990s they saw that China faced two tasks as a developing economy — industrialisation and informatisation — and they realised that the only strategic choice was to speed up industrialisation and simultaneously promote informatisation. They recognised, moreover, that informatisation could enhance industrialisation by applying advanced information technology to restructure traditional industries. In other words, the government came to view informatisation, the spreading of IT and Internet infrastructure, as a key to China’s future economic development. In 1993 the Joint Committee for National Economic Informatisation under the State Council proposed three “Golden Projects” as a first step towards informatisation. The Golden Bridge (Jin Qiao) Project was a plan to combine satellite and fixed-line public communication networks to build a backbone information infrastructure; the Golden Customs (Jin Guan) Project involved developing an information network to automate and centralise customs clearance and foreign exchange settlement; and the Golden Card (Jin Ka) Project aimed to advance electronic banking and credit card systems.2 Fast-growing Information Infrastructure

China’s enthusiasm to embrace information networks originated from urgent domestic needs and strong international pressure. The first three

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Golden Projects laid the foundation for the national information and communications infrastructure, or Information Superhighway. Now China has achieved standard levels of information infrastructure. As Lyric Hughes, president of Chinaonline, a Chicago-based website, pointed out two years ago: Business travellers to China can see the first wave of changes in China’s Internet expansion. Data ports have appeared even in nonluxury hotel rooms throughout China. Anyone with a PC, a modem and a phone line can access the World Wide Web in China.3

Under the Eighth Five-Year Plan (1991–95) China constructed twelve networks within various state-level departments including the Department of Finance, the Department of Railways, and the Department of Science and Technology. In 1995 China Telecom, the national public telephone network, established ChinaNet as the primary public gateway to the World Wide Web. Three other networks also offer direct Internet access: GBNet (Golden Bridge Network), CERNet (China Education and Research Network), and CSTNet (China Science and Technology Network). By the end of June 2000 China’s leased international connections totalled 1,234 million bits per second, an increase of 512 percent over June 1999 (Table 4.1). Six months later, at the end of 2000, total international bandwidth had more than doubled to 2,799 million bps. Since China put development of advanced communications and information on the fast track and encouraged Internet-based applications, the number of PCs with access to the Internet and the number of Internet users have increased rapidly (Table 4.2). By mid-2000 China had the third largest number of Internet users in the world, behind the United States, with 80 million users, and Japan, with 20 million users.

TABLE 4.1 Internet Bandwidth, 1998–2000 Bandwidth bits per second 1998, July 1999, July 2000, July

84.64 241 1,234

1998–00 Increase (%) – 285 512

Source: CNNIC, .

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0.10 0.20 0.33 0.67

1997 0.75 2.10

1998

Source: CNNIC, .

PCs with Internet access Internet users

1996 1.46 4.00

30 June 1999

TABLE 4.2 Internet Access and Users, 1996–2001 (Millions)

– 8.90

30 Dec. 1999

6.5 16.90

30 June 2000

– 26.5

30 June 2001 CHINA: INTERNET REVOLUTION

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TABLE 4.3 Mobile Phone Subscribers in the United States, China, and Japan

Number of mobile phone subscribers Subscribers per 100 inhabitants (1997)

United States

China

Japan

86 million 25.5

75 million 3.25

64 million 30.9

Source: Number: and ; rate: .

China also stepped up construction of the telephone network, and telephone exchange capacity has been growing by nearly 20 million lines per year. This is equivalent to the network capacity of one of the regional Baby Bell companies in the United States or to the total switching capacity of Australia’s national telephone networks. China ranked second only to the United States in the number of wireless mobile phone users (Table 4.3). It surpassed the United States in 2001. Embracing and Rapidly Developing Electronic Commerce

Electronic commerce (e-commerce) refers generally to transactions that take place online. E-commerce in China is still in the beginning stage, and there is a wide gap between China and advanced countries such as the United States. According to statistics from the Ministry of Information Industry (MII) in 1999 the total value of online transactions in China was RMB55 million (US$6.5 million). This was only 0.002 percent of total retail consumption and it was only 0.23 percent of the value of online sales in the United States in the same year (US$20.2 billion). Nevertheless, international observers believe that e-commerce has good prospects in China. For example, the International Data Group (IDG) recently reported that online business in China was about US$43 million in 1999, US$220 million in 2000, and estimated that it will climb to over US$11 billion within five years.4 (The discrepancy between the MII the IDG estimates of the volume of e-commerce may be due to differences in statistical measures.) Indeed, it would not be surprising if e-commerce gradually became one of China’s emerging industries as part of the government policy of opening and its efforts to merge with the global economy. Observers estimate that China reached the critical threshold of 20 million Internet users, the minimum deemed necessary to support electronic commerce, at the end of

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2000. The action of MII on 1 March 1999 to cut Internet connection fees by half and to lower fixed-line and long-distance telephone charges should further stimulate the volume of online transactions.5 Growth in domestic e-commerce will affect the direction of the global IT industry. According to one observer, “It is foreseeable that one day soon, 20–25 percent of the world’s Internet traffic will be in the Chinese language. The implication for software and hardware manufacturers, as well as content providers, is that a strategy for China has to be an integral part of their global success.”6 Priority Status for IT Manufacturing

Manufacture of IT hardware in China has been developing apace since 1990. Total output rose from nearly RMB70 billion (US$8 billion) in 1990 to more than RMB800 billion (US$100 billion) in 1999. IT hardware output increased 32 percent per year, and electronics and communication equipment was the fastest growing of China’s forty industrial sectors. Output of electronic computers and peripheral equipment rose 55 percent per year, while the growth rate for telephone exchange equipment was 52 percent. In 1999 output of electronic and communication products reached RMB58 billion (US$7 billion) and total sales about RMB56 billion (US$6.5 billion), which exceeded the combined sales of the traditional industries including textiles, chemicals, metals, and electric power. The IT industry contributed 19 percent to China’s real economic growth in 1999, exceeding the contribution of other sectors. In the same year, the government gave the IT industry priority status, because IT, and especially advanced communications and information products, will create the basis for China to meet the Internet wave. This was a significant change from the previous economic growth and structural adjustment model that had focused on traditional industrial sectors. Gradual Regulatory Adjustment — Deregulating Information Services

While the IT manufacturing sector developed quickly following its opening to foreign and private investment, the information service sector still lacks efficiency and quality because of delayed liberalisation. The urgent need for domestic economic growth and the challenges of the global information revolution finally forced officials to deregulate the information service sector. The experience of other countries illustrated that China could

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address both needs simultaneously by creating an information-friendly environment through regulatory policy and legislation. Such an environment protects the public interest, promotes investment and competition, and supports availability, diversity, high quality, and low cost of information services and products. Until the mid-1990s state-owned China Telecom was the only licensed provider of telecommunications services. After many discussions trying to balance the interests of all sides, the Chinese government issued a second licence to China Unicom in 1994. The government hoped that Unicom would become a telecom giant, creating a competitive environment in the telecommunications service sector. Unfortunately, because of China Telecom’s monopoly of the market, Unicom remains a small player. To establish a more competitive environment, first of all, the government must simplify the administration function. Since 1994, China has taken various other steps to improve the competitive environment in the information service sector. In the administrative restructuring of 1998, the government created the Ministry of Information Industry by merging the former Ministry of Telecommunication and Post, the Ministry of Electronic Industry, and the Ministry of Electricity as well as the network management function of the former Ministry of Broadcast, Film and Television. This reorganisation has been characterised as a move to transform policymaking from longterm planning to focus on deregulation. China promised to open its telecom market to foreign firms after concluding WTO-related agreements with the United States at the end of 1999 and with the European Union in the first half of 2000. These agreements strictly outline the process for opening the telecom market. Other important changes in the regulation and liberalisation of the telecom market occurred during 2000. Shanghai Telecom, a branch of China Telecom, signed a co-operation agreement with AT&T, representing the first foreign investment in the basic telecom sector. China Telecom was divided into four companies and several were issued new basic telecom licenses, bringing the total to seven. The government released “Telecommunications Regulations of the PRC”, which set down the basic administrative guidelines for telecommunications services. In 2000 it also issued several sets of rules relating to the management of the Internet, including “Measures for Managing Internet Information Systems”, “Website Management Regulations on Up-Load News Business”, and “Management of Electronic Broadcasts on the Internet”.

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Along with gradually opening up the telecommunications sector, the government has allowed rather wide access to the Internet. As one observer put it In terms of limiting access to sensitive materials on the Internet, this is a problem that is being grappled with by governments throughout the world. Access to certain sites has been blocked, but on the whole, due to the sheer volume of traffic, most censorship occurs after the fact. As elsewhere, there is concern that service providers could be held accountable for inappropriate material on their sites.7 NEAR-TERM PROSPECTS FOR ELECTRONIC COMMERCE

Advances in information technologies facilitate changes in economic structure and performance. The Internet, for example, tends to foster the growth of a new high-speed, knowledge-driven, and globally networked economic system. To put the Internet to work to help transform China’s economy and society, the government has focused in particular on developing e-commerce because of its remarkable characteristics, such as efficient, low-cost, time-independent transactions, rapid growth prospects, and strong market-extending ability (Table 4.4). In the early 1990s, when the Internet Revolution was beginning to take shape, China had access to almost the same technology as the United States and other advanced countries. Because of this, some Chinese optimistically expected that e-commerce would develop at the same pace in China as in the United States. Nevertheless, now China does lag behind the United States in e-commerce development (Table 4.5). TABLE 4.4 Status of E-commerce in China, 2000 Value of transactions (RMB million) Increase over 1999 Number of consumer websites Shopping Auction Distance education Number of agriculture websites

350 50% 1,100 800 100 180 >2,200

Source: Li Xiaodong, China’s Information Industry in 2000, The Economic Time (in Chinese), 16 February 2001.

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TABLE 4.5 Value of E-commerce Transactions in the United States and China, 1998–2003 (US$ billions) 1998 United States % increase China

51 – –

1999

2000

2001e

2002e

2003e

127 125.0 0.006

284 83.3 0.04

551 57.6 –

919 46.1 –

1,439 42.1 –

Source: US E-commerce Development and its Basic Point of Policy, Economic Daily (in Chinese), 9 April 2001.

Obstacles to E-commerce in China

Many aspects of China’s legal, social, and economic structure hinder the development of e-commerce. These include tariffs, taxes, electronic payment and foreign exchange management systems, protection of copyright, patent, trademark, and other property rights, protection of private information collection and utilisation, protection of national economic security, laws and regulations on e-commerce, information infrastructure, and security certification. Online Transaction Security

As China is still in the process of moving towards a socialist market economy, the infrastructure for protecting private information is not yet clearly established and the lack of security is real. Indeed, the greatest hindrance to e-commerce in China may be that security cannot be guaranteed. In a survey by China Internet Network Information Centre in 2000, 52 percent of respondents cited security as the thing that most concerned them about e-commerce.8 Online Payment Systems

Inadequate payment systems present another obstacle to the growth of ecommerce. By the end of 1999 all of China’s state-owned commercial banks had instituted online banking services in conjunction with the Golden Card project. Nevertheless, most e-commerce companies do not accept online payment and require payment by bank or postal remittance. They

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prefer traditional payment means because banks take as long as ten days to certify online payments and charge fees as high as 5 percent for credit card purchases. In addition, there are many restrictions, such as limitations on the purchase amount. Online banking services must be improved to accommodate and facilitate e-commerce transactions. Internet Access

The high cost of Internet access also hinders the development of e-commerce in China. Internet user fees in China are very high compared with those in other economies (Table 4.6). According to one report, an American could buy the same amount of information for less than one-twelfth of the cost to a Chinese Internet user (in terms of absolute currency cost), even though the average income in America is twenty times that in China. Moreover, dot-com companies complain vigorously that most of their operating revenues go to pay the high connection fees charged by China Telecom. Distribution System

Another crucial factor blocking the development of e-commerce in China is the absence of a rational commodity distribution system. Many dot-com companies have had to make agreements with express-delivery companies or establish their own delivery branches. These arrangements increase their operating costs and reduce the competitive advantage of online TABLE 4.6 Internet User Fees in Selected Economies (US$ per hour) User fees China Hong Kong Singapore Japan Australia Brazil South Africa

1.32 0.18 0.26 0.71 0.32 0.16 0.25

Source: .

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124 XIAODONG LI

transactions. The government has recognised the problem and plans to set up thirty modern large distribution centres in cities around the country. As these examples show, e-commerce in China is being thwarted not by technology, but by inadequacies in the commercial environment and infrastructure. The government must actively promote an environment that is conducive to online business and to put in place the necessary institutional systems to support e-commerce. The Role of Government

Even though technology and market forces will influence the growth of the Internet, government policies and regulations are critical determinants of the direction of its development. The government needs to take a lead in establishing national policies, objectives, and strategies for the development of nationwide telecommunications infrastructure and equitable use of public resources. Around the world, in successful market economies, the role of government involves providing financing and incentives for the development of information infrastructure and strategic projects, defining regulatory arrangements and institutional responsibilities, and resolving conflicting objectives and interests. Accountability, transparency, agility, and efficiency of government operations are required for governance of the information society. The Chinese government has adopted a macro-control approach towards e-commerce, in contrast to the micro controls that it exercised over industry under the traditional planned economy. For example, in 1999 it instituted the Government Online Project which encouraged the central government departments, commissions, and provincial and local governments to set up websites and supply information over the Internet. In 2000, the central government initiated the Enterprise Online Project to encourage state- and collective-owned enterprises to set up an Internet presence.9 Accelerating Modernisation of the Social System

The Internet Revolution has already had a tremendous impact on virtually all aspects of human life and social structure. China has not escaped this impact. Policy, regulations, and legislation need to be made and enforced to create an environment that suits the Internet and promotes its development. China is now accelerating the restructuring of its social system, primarily by developing entirely new systems. For example, the government has drafted a document defining the structure of e-commerce.

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CHINA: INTERNET REVOLUTION

125

The main principles of the China E-commerce Development Strategic Framework are:10 1. The role of government. We must give full play the macro-program and guidance to work out preferential policies for e-commerce development. Also, we must emphasise co-ordination among government departments in order to maintain consistent e-commerce policies, laws and standards. 2. The role of enterprises. As enterprises are the fundamental units of economic activity, we should actively encourage enterprise involvement in e-commerce. 3. Demonstration projects. We must set up demonstration projects in major industries, geographic regions, and enterprises. 4. Legislation and security. Government should strengthen legislation related to security of personal information and implement a security management system to ensure national economic security. 5. International co-operation. China should actively participate in international e-commerce co-operation and help to establish a coordinated and consistent global e-commerce environment. The Internet Revolution took off before China had established the legal and regulatory systems and institutional infrastructure that are suitable to the emerging market economy. While the Internet promises exciting development opportunities, to some extent the modernisation of the social system may be more important for developing countries than the upgrading of technology. A sign of China’s new approach is the Tenth Five-Year Development Plan released in September 2000, which departed from the practice of previous five-year plans and did not specify a target growth rate. The plan emphasises the wide utilisation of information technology and enhancing the availability and application of computers and networks. Moreover, the goal of accelerating e-commerce has been written into this high-level document for the first time. For these reasons, we believe the future of electronic commence in China will be bright. Notes 1

2

Fan Xing, “China Rises on the World’s Cyber Wave”, I-WAYS, Third Quarter 2000, p. 18. See , , and .

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126 XIAODONG LI 3 4

5

6 7 8 9

10

. Data from IDG cited in Frank Xing Fan, “Foreign Investment in China’s Internet Business: Forbidden, Forgiven, Forced Open?”, I-WAYS, 2000 Q1, p. 15. “China Slashes Telecom Fees”, Peoples’ Daily Online, 1 March 1999, . . . . According to the Trade Department of the State Economic and Trade Commission only 10 percent of state-run firms ran computer networks that could be used for digital business in March 1999. . Xiaodong Li, Scheme and Choice (in Chinese), Friendship Publishing House, 2000, p. 211.

© 2003 Institute of Southeast Asian Studies, Singapore

THAILAND: LINKING TO THE GLOBAL NETWORK ECONOMY 127

PART II Nurturing Network-Readiness

© 2003 Institute of Southeast Asian Studies, Singapore

00 SEAsians_ASEM.indd 10

9/18/14 10:52:23 AM

Reproduced from from Towards a Konwledge-Based Economy: East East Asia'sAsia’s Changing Industrial Geography edited by Reproduced Towards a Knowledge-based Economy: Changing Industrial Geography, Seiichi Masuyama and Donna Vandenbrink (Singapore: Institute of Southeast AsianofStudies, 2001) . This version was edited by Seiichi Masuyama and Donna Vandenbrink (Singapore: Institute Southeast Asian Studies, obtained direct from the publisher on condition that copyright is not infringed. No partisofnot this 2003).electronically This version was obtained electronically direct from the publisher on condition that copyright infringed. part of thiswithout publication may be reproduced without the prior permissionAsian of theStudies. Institute Individual of publication may beNo reproduced the prior permission of the Institute of Southeast Southeast Studies. articles are available from articles areAsian available at < http://bookshop.iseas.edu.sg >

THAILAND: LINKING TO THE GLOBAL NETWORK ECONOMY 129

5 Linking Thai “Brick-and-Mortars” to the Global Network Economy Somkiat Tangkitvanich THAILAND’S POSITION IN THE GLOBAL NETWORK ECONOMY

As a small country, Thailand has always adopted a policy to be open to the global economy. Thanks to this openness and its relatively stable macroeconomy, the country was successful in attracting foreign direct investment, together with the related production technologies, at least until the 1997 crisis. Based on its comparative advantage in cheap labour, the country established itself as a production centre in many manufacturing sectors, notably textiles, electronics, processed foods, and auto parts. Declining Competitiveness and the E-commerce Solution

Thailand’s international competitiveness is in jeopardy, however (Poapongsakorn and Tangkitvanich 2000). A study by the National Economic and Social Development Board (NESDB) and the World Bank (Atkins 2000) clearly indicates that many Thai industries are gradually losing competitiveness. The study analysed the cost structures of firms in seven manufacturing industries in Thailand and of firms in major competing economies. Compared to their competitors, most Thai industries have much lower margins, because of less skilled labour, lower product quality, higher materials cost due to higher reject rates, and poorer material yields (Table 5.1). In most industries, except leather products, Thailand has the lowest operating surplus as percentage of total output. As a result, Thai industries are at a disadvantage even before taking into account differences in marketing and administration costs. Thus, Thai manufacturers need to put priority on reducing production costs by upgrading labour skills, improving product quality through better quality assurance, and reducing

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130 SOMKIAT TANGKITVANICH

TABLE 5.1 Cost Structures of Thai Manufacturers and Their Main Foreign Competitors, by Industry (Share of output)

Food processing Thailand Korea Philippines Garments Thailand Korea Mexico Indonesia India Plastic products Thailand Korea Malaysia Rubber products Thailand Korea Malaysia Indonesia Leather footwear Thailand Korea Leather products Thailand Indonesia Korea India

Materials and Utilities (%)

Labour (%)

Operating Surplus (%)

73.0 60.7 64.3

5.8 8.5 5.7

21.3 30.9 30.0

71.4 50.9 46.0 60.8 71.2

19.2 17.3 25.5 12.3 5.7

9.3 31.9 28.4 26.8 23.1

68.0 57.6 64.1

9.8 9.0 11.9

22.2 33.5 23.9

78.9 52.3 71.4 79.5

4.6 13.3 8.3 4.5

16.5 34.3 20.3 16.0

55.6 53.3

19.2 19.4

25.2 27.3

55.3 64.0 66.6 88.1

15.7 7.8 10.1 4.4

29.0 28.1 23.3 7.5

Source: Atkins 2000.

material costs by lowering reject rates. Moreover, Thai companies must also increase their marketing and administrative efficiency. Firms, mainly in advanced economies, that have adopted information and communications technology (ICT) for supply chain management have found it to be an effective cost-reduction tool. Also, the introduction of ICT in a demand chain has significantly increased efficiency in managing

© 2003 Institute of Southeast Asian Studies, Singapore

© 2003 Institute of Southeast Asian Studies, Singapore

Source: Amin 2000.

Chemicals and pharmaceuticals Consumer packaged goods Computers and electronic equipment Defence and industrial Telecommunications equipment Media and advertising Paper Steel 11.2% 9.2% 8.3% 10.2% 8.3%

Average Cost Savings 3.9% 4.9% 4.0% 4.3% 3.3%

87.6 days 41.9 days 46.4 days 49.1 days 55.8 days

10–15% 10% 11%

29–39% 11%

10%

Cost Savings

Maximum Cost Savings

Reduction In Cash-to-cash Cycle Time

Goldman Sachs

Supply Chain Council

TABLE 5.2 Estimates of Savings from Electronic Supply Chain Management, by Industry

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132 SOMKIAT TANGKITVANICH

customer relationships and raised customer satisfaction. A study by the Supply Chain Council concluded that the introduction of ICT to inter-firm supply chain integration contributed to lower materials procurement costs and reduced cash-to-cash cycle time. For companies in OECD countries, the study estimated that using ICT in supply chain management resulted in cost savings of at least 10 percent and cycle-time reductions of 41–87 days (Table 5.2). Firms in developing economies such as Thailand should realise even greater cost savings from adopting business-to-business (B2B) e-commerce than do firms in OECD countries, which operate at a higher overall level of efficiency. The World Bank Office in Bangkok estimated the financial benefits of introducing electronic supply chain management (e-SCM) systems at a hypothetical electronic components assembly firm in Thailand (Amin 2000). The company was assumed to have annual sales of 100 million baht, with parts and raw materials procurement costs amounting to 65 percent of sales revenue and labour and administrative costs taking 10 percent. According to the analysis, if adopting electronic supply chain TABLE 5.3 Financial Impact of Introducing Electronic Supply Chain Management at a Hypothetical Thai Manufacturing Firm Baseline Case

Case with e-SCM

Case with 20% Sales Increase

Revenue Less materials cost Less labour and administrative cost

100.00 –65.00 –10.00

100.00 –61.75 –10.00

120.00 –78.00 –12.00

Equals: Gross profit Less depreciation Less interest

25.00 –10.00 –10.00

28.25 –10.00 –10.00

30.00 –10.00 –12.00

Equals: Pre-tax profit Less taxes (30%)

5.00 –1.50

8.25 –2.47

8.00 –2.40

3.50

5.78 65

5.60 60

Equals: Net Profit Increase in net profit (%) Source: Amin 2000.

© 2003 Institute of Southeast Asian Studies, Singapore

THAILAND: LINKING TO THE GLOBAL NETWORK ECONOMY 133

management reduced procurement costs by only 5 percent, the company’s earnings before interest, taxes, and depreciation (EBITDA) would increase 13 percent and its net profit would increase 65 percent. Thus, a 5 percent cost reduction from introducing ICT would mean a greater improvement in the firm’s bottom-line profit than would a 20-percent increase in sales volume (Table 5.3). It seems clear from the research on Thailand and other economies that to reduce costs and shore up its international competitiveness, the Thai manufacturing sector should urgently move to adopt ICT, especially B2B e-commerce. In other words, traditional Thai “brick-and-mortar” firms need to be turned into “click-and-mortars” and linked to the global network economy. Realities of the Network Economy

It is becoming difficult for less-developed economies to link up to the global network economy, however, because opportunities and wealth tend to concentrate in more advanced economies. In the Old Economy, concentration resulted only from economies-of-scale in production. In the new economy economies-of-scale also arise from the “network externality” effect whereby the greater the number of participants in a network, the more valuable the network becomes. Thus, the concentrating force of scale economies is coming from two directions. Scale economies in the production of ICT-related services, as well as the increasing cost of in-house ICT services and the need for qualified ICT personnel, make it more economical for companies to outsource their ICT operations or to consolidate them into a few centres. The application service provider (ASP) model, in which companies lease hardware and software via the Internet rather than purchase them outright, is one example of how economies-of-scale encourage concentration of production in the New Economy. Another example is Cisco Systems, a global supplier of routers and telecommunications equipment, which consolidated its call centres into four locations in different time zones instead of operating one in every country. Scale economies are also pushing multinational corporations (MNCs) to transfer ICT jobs from various local subsidiaries in Thailand and other economies in the region to Singapore, their regional operations hub. Thus, the employment and income opportunities of the network economy are concentrating in fewer and fewer geographical locations.

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134 SOMKIAT TANGKITVANICH

In the New Economy, the existence of network externality effects increases the value of common, shared standards, and this also leads to concentration of opportunities in certain economies. An obvious example is language, which is a standard for communicating. English is becoming the lingua franca of the network economy, with about 78 percent of the information in the Internet stored in English and most Internet transactions conducted in that language (OECD 1999). Countries where English is a national language are gaining a disproportionate share of the opportunities in the global network economy. For example, India and the Philippines have found niches as software production houses and call-centre hubs for multinational companies based on the linguistic legacy of their colonial past. Hence, opportunities and wealth are becoming concentrated in Englishspeaking innovation hubs, be they global such as the United States, or regional such as Singapore or Hong Kong. Start-up companies, research labs, and venture capitalists are agglomerating in these hubs, bringing with them technical and management know-how, financing, and business opportunities. On the other hand, non-English-speaking countries outside the innovation hubs have increasing difficulty attracting the means to connect to the global network economy. For example, from the point of view of investors, an e-commerce project in Thailand is not as attractive as one in an innovation hub because, although the Thai project is more difficult in terms of language and labour supply, the return is not higher to compensate for the greater difficulty. Nevertheless, Thailand has attracted foreign investment in several multimillion dollar e-commerce projects in recent years. For example, Singapore Telecommunications and Zesiger Capital Group, a U.S. venture capital firm, invested 1.2 billion baht (about $30 million) in PointAsia, an integrated operator for Internet access service, data centre, and B2B e-commerce. MIH, a South African company, invested an undisclosed but likely large amount in Internet KSC, another Thai Internet service provider. Few of these projects have generated profits, however. The domestic market for Internet-based services is as yet too small and Thailand is too isolated from the global economy to access a wider market. Moreover, limited investment and job opportunities in e-commerce and related businesses in Thailand drive Thai IT professionals overseas. (This issue is discussed in more detail later in the chapter.) To survive in the global network economy, Thailand must adapt quickly to new realities by getting rid of impediments restricting the adoption of

© 2003 Institute of Southeast Asian Studies, Singapore

THAILAND: LINKING TO THE GLOBAL NETWORK ECONOMY 135

e-commerce, searching for new sources of comparative advantage, and partnering with global and regional innovation centres. STATUS OF E-COMMERCE IN THAILAND Numbers of Computers and Internet Subscribers

According to a survey by the National Statistical Office there were about 928,000 computers in use in Thai households in the first quarter of 2001. This is equivalent to 5.75 computers for every 100 households or 1.48 computers for every 100 people. The same survey also found that there are currently about 3.54 million Internet users, a penetration rate of 5.64 percent of the population. The number of Internet users is 3.83 times the number of computer owners. Most users access the Internet from Internet cafés, schools, and workplaces rather than from their homes. According to a survey conducted by the National Electronic and Computer Technology Centre (NECTEC) at the end of 2000, 69.6 percent of Thai Internet users were located within Bangkok and its vicinity, with 10.9 percent of users in the Central region, 8.0 percent in the North, 5.7 percent in the North East region, and 4.7 percent in the South region. The geographical concentration of users is mainly due to the disparity of income and the gap in telephone penetration between Bangkok and outlying areas. The NECTEC survey also found that 50.3 percent of Thai Internet users are in their 20s, 23.2 percent in their 30s, and 15.6 percent are teenagers. Users are fairly evenly split by gender, with about 51 percent male and 49 percent female. E-commerce Development

Due to the low penetration of PCs and the Internet in Thailand, e-commerce is still in its infancy. Most Thais have no experience with business-toconsumer (B2C) e-commerce. According to the NECTEC survey, 80.9 percent of Thailand’s Internet population had never made online purchases of goods or services. Reasons consumers gave for not making online purchases included that they • • • •

cannot touch and feel the products (44.1 percent) are reluctant to divulge their credit card number (33.8 percent) do not trust online merchants (32.8 percent) are not interested in buying online (26.1 percent)

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136 SOMKIAT TANGKITVANICH

• do not have credit cards (25.3 percent) • feel that online shopping is too complicated (23.0 percent). Thai firms are as inexperienced with B2C e-commerce as are Thai consumers. A survey by Thailand Development Research Institute (TDRI) in May 1999 found that at least 383 Thai companies had a web presence, but 53 percent of these sites were merely for posting information about the company or advertising products. Only 32 percent of the websites offered online transactions, while 15 percent offered secure credit card payment. Among the goods offered for sale were electronics products, jewellery, books, and handicrafts. There are few Thai companies selling digital products, such as software, music, and information. Services provided online included Internet access and hotel reservations, although hotels cannot be booked in realtime. Currently only a few Thai websites provide online professional or business services. Successful e-commerce businesses such as Thai Gem (www.thaigem.com), an online jewellery store, are the exception rather than the norm. Experience with business-to-business (B2B) e-commerce is similarly limited. A few Thai companies have started to procure raw materials or to offer customer service over the Internet. One pioneer is Cement Thai (www.cementhaionline.co.th), a distributing arm of a Thai conglomerate that produces cement and construction materials. This company has recently linked its 40 plants and 520 distributors through its Extranet. Another example is The Value System (www.value.co.th), a leading ICT distributor, which has developed a highly sophisticated customer relationship management (CRM) system to provide online services to its customers. Thai online marketplaces have also started to emerge recently, including Food Market Exchange (www.foodmarketexchange.com), which specialises in food export (Appendix 5.1). GOVERNMENT INITIATIVES TO PROMOTE E-COMMERCE

The governments of the Asian newly industrialised economies (NIEs) — Korea, Singapore, Taiwan, and Hong Kong — have each set out a series of drastic policy measures to promote the adoption of e-commerce. These policies share the objectives of: • • • •

presenting realistic and explicit visions based on the actual situation; promoting the building of appropriate information infrastructures; developing institutional infrastructures; expanding access to the Internet;

© 2003 Institute of Southeast Asian Studies, Singapore

© 2003 Institute of Southeast Asian Studies, Singapore

Deputy Permanent Secretary of Ministry of Transport and Communications

• • • • •

•

Director General of Department of Business Economics Director General of Department of Post and Telegraph

Not yet decided

• • • • • •

Chair

Deputy Secretary General of National Economic and Social Development Board (NESDB) Governor of Bank of Thailand (BOT)

Source: e-Thailand Draft Concept Paper.

6. ASEAN Information Infrastructure

5. E-commerce Facilitation

3. International Economic Policy 4. Liberalisation

2. e-Government

1. e-Society

Working Group Sample Issues

Digital divide reduction ICT literacy Mobility of knowledge workers Delivery of government services Online government procurement Co-operation of private and public sectors in realising e-ASEAN Liberalisation in ICT-related goods, services, and investment Mutual recognition of digital signatures Intellectual property right protection Privacy protection Internet exchange and gateway Secure payment

TABLE 5.4 E-Thailand Working Groups and Issues

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138 SOMKIAT TANGKITVANICH

• • • •

supporting ICT innovation; expanding human resources; promoting digital government; and strengthening and expanding international linkages (Masuyama 2000).

The government in Thailand, in contrast, has not shown this kind of strong leadership. It has been slow to develop policy, the programs it has put in place are inadequate, and it has not addressed serious problems that are blocking the development of e-commerce. The Thai government has yet to adopt a comprehensive e-commerce strategy and only in the middle of 2001 did it begin to draft an information technology strategy. This strategy, called IT2010 and formulated by the National Information Technology Committee (NITC), has three major aims: 1. to facilitate access to information technologies by different segments of the society; 2. to promote the diffusion of e-commerce; and 3. to optimise service delivery, participation, and governance through electronic government. In conjunction with the e-ASEAN initiative, in 2000 NITC embarked on “e-Thailand”, a project designed to accelerate the diffusion of ICT in six areas: e-society, e-government, international economic policy, liberalisation, e-commerce facilitation, and ASEAN information infrastructure (Table 5.4 and Appendix 5.2). The Thai government has taken many initiatives to promote e-commerce development, but most are concerned with using ICT in the education and government sectors (Table 5.5 and Appendix 5.2). Existing programs to promote adoption of e-commerce in the private sector are still primitive. Government programs to raise awareness of e-commerce among private businesses, for example, typically focus on opportunities for online marketing of exports and online trading. They tend to ignore such benefits as cost savings through better supply chain management and improved customer relationship management. The government’s efforts to promote e-commerce need to be more focused and better designed. Similarly, programs that promote exports through e-commerce need to offer more added value than simply subsidised web-hosting services. The Thai government’s most important shortcoming with respect to e-commerce development, however, is that it has not yet dealt with several critical issues that are hindering its adoption. These problems include the

© 2003 Institute of Southeast Asian Studies, Singapore

THAILAND: LINKING TO THE GLOBAL NETWORK ECONOMY 139

TABLE 5.5 Government E-commerce Initiatives Organisation

Project and Main Activities

NECTEC

• SchoolNet Thailand: Connect secondary and high schools to the Internet • GINet: Link government agencies via a common secured Intranet • Government CIOs: Increase high-level officials’ awareness of the use of IT to provide government services • E-commerce Laws: Draft a set of E-commerce related laws, including E-transactions Act, Computer Crime Act, and Data Privacy Act UNINET: Provide high-speed Internet access to public universities Increase private sector awareness of e-commerce by training and seminars Provide subsidised web hosting services for exporters.

Agencies for University Affairs E-commerce Resource Centre Department of Export Promotion Department of Local Administration

KhonThai.com: Provide online services for household, birth, marriage, death registration

Source: TDRI.

monopoly in the Internet market, the shortage of qualified ICT personnel, inadequate legal infrastructure, limited number of third-party logistics providers, and the weak venture capital industry. We discuss the first two of these obstacles, which we consider to be the most serious, more fully below. OBSTACLES TO E-COMMERCE DEVELOPMENT IN THAILAND Monopoly in the Internet Market

Telecommunications is an indispensable infrastructure for e-commerce, but in many developing economies, monopoly in the telecommunications sector has handicapped access to the Internet. In Thailand, the Internet market is quite competitive at the domestic level, with eighteen Internet service providers (ISPs) competing for market share, but at the international level, the market is statutorily monopolised by the Communication Authority of Thailand (CAT), a state-owned enterprise. As a result, all domestic ISPs interconnecting to foreign operators need to go through CAT’s network.

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140 SOMKIAT TANGKITVANICH

This monopoly makes charges for Internet access services exorbitantly high. While the cost of dial-up Internet service in Thailand (excluding telephone connection charges) is comparable to that in other Asian economies (Figure 5.1), the cost of Internet connection via leased lines is about two-and-a-half to six times higher in Thailand than in Hong Kong, Japan, Malaysia, or the Philippines (Figure 5.2). The high cost of leased lines has many adverse consequences for Thailand. First, it limits the penetration of the Internet. In an earlier study, we found that the number of Internet hosts (computers connected to the Internet) in Thailand is significantly lower than in other countries with comparable GDP (Tangkitvanich and Nikomborirak 1997). Specifically our econometric analysis showed that a country with a competitive international telecommunications market will have 557 more Internet hosts for every billion dollars of GDP on average than a country with a monopolistic one. A second consequence of the high cost of leased lines is that it discourages businesses, especially small and medium-sized enterprises (SMEs), from adopting e-commerce models that require “always-on” connections. For FIGURE 5.1 Cost of 20 Hours of Dial-up Internet Access in Selected Asian Economies (September 2000)

US$ 12.00 $10.60 $9.60

10.00

$10.80

$9.90

8.00 $5.90

6.00 4.00

$3.50

2.00 0.00 Malaysia

Singapore

Hong Kong

Thailand

Source: TDRI.

© 2003 Institute of Southeast Asian Studies, Singapore

Philippines

Japan

THAILAND: LINKING TO THE GLOBAL NETWORK ECONOMY 141

FIGURE 5.2 Monthly Charge for 64-Kbps Internet Leased Line in Selected Asian Economies (September 2000)

US$ 1,600

$1,421

1,400 1,200 1,000

$880 $779

800 600 400

$526

$555

Malaysia

Philippines

$356 $233

200 -

Hong Kong

Japan

Korea

Singapore

Thailand

Source: TDRI.

example, few SMEs can afford to use B2B e-commerce applications software provided by application service providers (ASPs) because some of these applications require high-speed leased lines to function smoothly. Similarly, high leased line pricing deters SMEs from connecting with suppliers and logistics operators, a prerequisite for using ICT to manage supply chains more efficiently. For the same reason, B2C e-commerce operators cannot provide real-time responses to customer inquiries. Realtime hotel booking confirmation, for example, requires leased lines that allow system integration between the internal databases of hotels (the back end) and web servers (the front end). Other state interventions also raise the cost of Internet use in Thailand. For example, an ISP must give CAT one-third of its shares without any capital payment simply as a condition for receiving a concession to operate. According to our analysis, an ISP with an expected 30-percent annual internal rate of return (IRR) will mark up the price of Internet service by 20 percent to cover this condition (Tangkitvanich and Nikomborirak 1997). Clearly, in order to promote the use of the Internet and e-commerce, Thailand needs a competitive telecommunications market and a more

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reasonable regulatory regime. The best way to achieve these goals is to allow more competition from new entrants, both domestic and foreign, and to set up an independent regulatory body that works in the interests of consumers. Shortage of ICT Professionals

Human resources is another factor crucial to the success of e-commerce in a given economy. As the amount of online business activity increases so does the demand for skilled ICT personnel. For e-commerce to succeed, the supply of ICT workers must increase accordingly. The pool of qualified ICT professionals in Thailand today is very small. For example, fewer than ten Thais are Cisco Certified Internetworking Experts and fewer than five are professional Java programmers. Also, Thailand has virtually no ICT specialists who can configure and fine-tune complicated software such as Ariba’s e-marketplace software. Scarcity of this vital resource could jeopardise any efforts to increase the spread of e-commerce in Thailand. Economies all over the region are experiencing shortages of ICT manpower, and the job sections of most newspapers in Asia are thick with advertisements for ICT professionals. The situation will grow worse with time. Even India, which adds 200,000 new ICT professionals to the workforce every year, faces a shortage as demand is projected to reach 2.2 million new workers per year in 2008. Malaysia will require 15,000 more ICT workers by the end of 2000; Korea will need 50,000 more by 2002; and Hong Kong 17,000 by 2005 (Chanda 2000). Thailand may face the most serious shortage. In an international survey taken in 2000 Thailand ranked lowest in the availability of ICT skills both among six Asian economies and among all 49 economies surveyed (Table 5.6). Not only is the supply of ICT workers in Thailand small, but so is the demand. JobsDB.com, an online marketplace, posts announcements of professional job openings in six Asian economies. Only 12 percent of the 1,760 announcements posted on JobsDB.com for Thailand in January 2001 were for ICT-related jobs (Table 5.7). This was the lowest share of ICT-related job openings in the region. In January 2001 Singapore and Hong Kong accounted for more than 77 percent of the regional demand for ICT professionals. Indeed, the distribution of demand for and supply of ICT workers across Asia tends to support our hypothesis that ICT-related business opportunities are concentrated in a few innovation hubs. The similarity in the country rankings in Tables 5.6 and 5.7 suggests that the market for ICT

© 2003 Institute of Southeast Asian Studies, Singapore

THAILAND: LINKING TO THE GLOBAL NETWORK ECONOMY 143

TABLE 5.6 Availability of Qualified ICT Skills in East Asian Economies

Thailand Indonesia Malaysia Hong Kong Singapore Philippines

Score

Rank among 49 Sampled Economies

Rank among 6 East Asian Economies

4.369 4.414 5.325 5.905 7.373 7.873

49 48 36 28 7 4

6 5 4 3 2 1

Note: Scores were obtained by questionnaire surveys of executives in 49 economies who were asked “Are qualified ICT employees available in your country’s local market?” Maximum score is 10. Source: IMD 2001.

TABLE 5.7 Demand for IT Workers in East Asian Economies (January 2001)

Thailand Indonesia Malaysia Hong Kong Singapore Philippines

Total Job Announcements

IT-related Job Announcements

1,760 760 930 4,980 3,590 870

213 150 250 1,727 1,165 237

IT-related/Total Rank among 6 Announcements East (%) Asian Countries 12.1 19.7 26.9 34.7 32.5 27.2

6 5 4 1 2 3

Source: Compiled by TDRI from job announcements posted at in January 2001.

workers is larger in Hong Kong, Singapore, and the Philippines and smaller in Thailand, Indonesia, and Malaysia. Some Asian economies have addressed the shortage of ICT workers by taking steps to attract ICT-trained talents from abroad. For example, Singapore has announced plans to attract foreign skilled workers by cutting the cost of housing, providing tax deductions for employers who undertake

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overseas recruitment, and reviewing the eligibility criteria for employment passes. Similarly, in Malaysia under the Multimedia Super Corridor (MSC) Bill of Guarantees, companies granted MSC status have full flexibility to recruit knowledge workers from abroad. Thailand has yet to adopt a policy to encourage using foreign workers to meet its ICT manpower needs. Labour mobility confounds local efforts to increase the supply of ICT human resources by investing in training. A brain drain from less ITadvanced economies to more advanced ones is happening at an alarming pace. In particular, qualified Asian ICT professionals are being sucked away by growing demand and higher wages in the West, especially the United States. At least two companies in Thailand specialise in recruiting Thai ICT professionals to work in the United States. Moreover, labour mobility removes the incentive for Asian economies to invest in the socially optimal level of IT training. Spending more on training local workers simply increases the likelihood that they will seek jobs abroad. In other words, spillover benefits lead to a failure in the ICT labour market. The classic response to a spillover problem calls for government to intervene in the market to raise investment to a near-optimal level. Further thought reveals that the situation in the ICT labour market in Asia differs from the classic spillover problem, however. With international labour mobility, the spillovers span national borders. There is no supranational government that can intervene in this market and ensure an optimal level of this “global public good”. Thus, there is a real danger that the supply of ICT manpower in developing economies will remain inadequate and therefore that these economies will have difficulty linking up to the global network economy. NEED FOR REGIONAL CO-OPERATION

The foregoing analysis leads us to argue for a region-wide (if not global) approach to the development of ICT human resources in Asia. Because the problem involves spillovers between advanced and less advanced economies the solution must involve both as well. In other words, it requires regional co-operation. In this context we welcome the Japanese government’s “Comprehensive Co-operation Package to Address the International Digital Divide” (Japanese Government 2000). The goal of this package is to bridge the digital divide between and within Asian economies. Specifically, the package will extend to Asian economies over five years a total of US$15 billion in ODA (official development assistance), public funding, and non-ODA or other

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official flows (OOF). As stated in the G8 Kyushu-Okinawa Summit communiqué, the funding will be used for: • Raising awareness of ICT opportunities and contributing intellectually to policy and institutional building. • Developing and training human resources. During the next five years Japan will provide assistance, mainly in the form of technical cooperation, for the training of over 10,000 individuals. • Building ICT infrastructure and providing assistance establishing networks. • Promoting the use of ICT in development assistance. In particular, the package will promote the use of ICT in distance training, distance learning, and the provision of medical care. During the first phase, Japan will establish thirty core ICT centres. Whether Japan’s assistance program succeeds in closing the digital divide in Asia will depend on how it is designed and implemented. Overall the program should be designed to benefit both Japan and recipient economies. For example the assistance could be used to promote the adoption of ICT among SMEs in recipient countries in a way that fosters closer supply chain integration and better communications between the SMEs and their trading partners in Japan. At the same time, part of Japan’s assistance package should be directed towards needs of recipients that may not benefit Japan in the short run. In other words, a portion should be allocated to recipient economies to develop ICT according to their own agendas, and they should not be unduly restricted to utilising Japanese content or Japanese standards. For example, Thailand could use the Japanese funds to help realise the goal of the 1999 Education Act to provide all schools with computers and Internet access. This project is estimated to cost about 12.1–12.7 billion baht per year (Appendix 5.2). Approval of such projects should be determined on the basis of the costs and benefits to the recipient economies. Loan projects should be subjected to strict selection criteria and careful monitoring in cases such as Thailand’s, where the public debt is over 50 percent of GDP. References

Amin, Magdi. 2000. “Accelerating e-commerce Development in Thailand: Obstacles and Opportunities”. World Bank Office Bangkok (unpublished manuscript). Atkin, W. S. 2000. “Cost Structure of Major Thai Industries”. Final report

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presented to the National Economic and Social Development Board (NESDB) and the World Bank. Bangkok. August. Chanda, Nayan. 2000. “The Tug of War for Asia’s Best Brains”. Far Eastern Economic Review, 9 November, pp. 38–44. International Institute for Management Development (IMD). 2001. The World Competitiveness Yearbook 2001. Lausanne: IMD. Japanese Government. 2000. “Japan’s Comprehensive Co-operation Package to Address the International Digital Divide”. . Masuyama, Seiichi. 2000. “Hastening to Embrace the Internet Revolution in Asia”. NRI Papers No. 20. Tokyo: Nomura Research Institute. 1 December. . Organisation for Economic Co-operation and Development (OECD). 1999. Communications Outlook 1999. Paris: OECD. Poapongsakorn, Nipon, and Somkiat Tangkitvanich. 2000. “Industrial Restructuring in Thailand: A Critical Assessment”. In Industrial Restructuring in East Asia: Towards the 21st Century, edited by S. Masuyama, D. Vandenbrink, and S. Chia, pp. 109–38. Singapore: Institute of Southeast Asian Studies and Nomura Research Institute. Tangkitvanich, Somkiat, and Deunden Nikomborirak. 1997. The State of Internet Competition and Pricing in Thailand (in Thai). Bangkok: Thailand Development Research Institute.

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Appendix 5.1 Case Studies of B2B E-commerce in Thailand1 Food Market Exchange

Food Market Exchange (www.foodmarketexchange.com) is Southeast Asia’s first B2B e-marketplace in the food industry. It is also the first electronic marketplace in Thailand that is oriented towards export. The company is run by Biz Dimension, a major exporter of processed food and is supported by other leading food companies. Thus, it is a “sell-side” e-marketplace. Major products include frozen and canned seafood, rice and rice products, fruits, vegetables, and dairy products. Since its opening in September 2000, the marketplace has registered approximately 50 companies as sellers and 175 as buyers. Sellers are charged about $1,200 as a set-up fee, $120 as a monthly fee, and about 0.5–1.5 percent of sales value. From the perspective of sellers, the marketplace provides a low-cost sales channel that bypasses traditional brokers. It also provides web-based integrated services such as logistics, payment, and export credit. From the perspective of buyers, Food Market Exchange is a one-stop shop for food exporters from Thailand, a major food exporting country. From the beginning of operations until January 2001, total transactions on the marketplace have amounted to approximately US$2.4 million. In the near future the company aims to transact 5 percent of member companies’ export sales, which amounts to US$190 million per year. The Value System

The Value System (www.value.co.th) is a leading IT distributor in Thailand. The company was founded in 1988 by an overseas Taiwanese. It now has about 2,000 IT dealers as customers and annual sales of 3.3 billion baht. In 1998 it introduced a web-based customer relationship management (CRM) system to help customers view online catalogues, maintain their own accounts, download driver software, order products, and track the orders in real time.

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After less than two years in operation, the system now serves 1,500 registered dealers. Online sales still constitute only 15 percent of the total but are growing quickly. The system also enabled the company to reduce inventory from 60 to 20 days, to cut the cost of printing more than 5,000 catalogues per month, and to increase sales per employee from the 1997 level of 14.4 million baht to 18.62 million baht. Cement Thai

Cement Thai (www.cementhaionline.co.th) is a distributor of the Siam Cement Group, the largest conglomerate in Thailand specialising in producing cement and other construction materials. By the end of 2000, the company had more than 620 dealers all over the country with an annual sales volume of 48 billion baht. The company has a long history of using IT to increase productivity. It adopted an EDI trading system in 1988. Then in 1999 it set up a telephonebased call centre to support its customers. Finally in November 2000, it replaced the old EDI system with a web-based CRM system. Using the system, Cement Thai’s customers can maintain their accounts, view product availability, place orders, and track them online in real time. A few months after its introduction, the new system has about 520 registered dealers. As of January 2001, online sales accounted for 40 percent of total sales. The cost savings from the system over the next five years is estimated at 1.6 billion baht. The savings will arise from the reduction in the number of distribution centres, the reduction in telecommunication costs, and the increased efficiency of the distribution system. Note 1

These case studies are based on the author’s research commissioned by the National Electronic and Computer Technology Center (NECTEC).

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Appendix 5.2 E-commerce Initiatives in Thailand e-Thailand

In September 2000, the government set up an ad hoc subcommittee called “e-Thailand” under the National Information Technology Committee (NITC), with the National Electronic and Computer Technology Centre (NECTEC) acting as the secretariat. The subcommittee consists of twentythree members including nineteen governmental and four private-sector representatives. The Minister of Science, Technology and Environment chairs the subcommittee whose missions are broadly to: • Recommend to NITC how to effectively develop “e-Thailand” by taking into account related developments in the region, (e-ASEAN, APEC) and at the global level (G8, WTO), as well as the strengths and weakness of Thailand. • Monitor policy changes and initiatives concerning telecommunications, law, and human resource development at the regional and global levels. Under the draft concept paper, the e-Thailand subcommittee consists of six working groups: e-Society, e-Government, International Economic Policy, Liberalisation, e-Commerce Facilitation, and ASEAN Information Infrastructure. The working groups were approved by the Council of Economics Ministers in early October 2000 and have not yet made public any concrete plans. GITS and GINet

Government Information Technology Services (GITS) is a project to provide a high-speed secured communications network for all government agencies nationwide. The network, managed by NECTEC, is called the Government Information Network (GINet). The project is intended to be the core of eGovernment and all secured messaging for the government. Network security is provided by digital certificates issued by the GITS certification authority (CA) or the public key infrastructure (PKI). NECTEC has already

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started to procure equipment to set up the national PKI and dispatched staff for training. As of April 2000, the network linked twenty provinces through twenty points of presence (POPs), corresponding to the total number of telephone area codes. Offices of government agencies throughout the country can be connected to these POPs by dial-up Internet access. The initial bandwidth of the network backbone is 128 Kbps to every provincial POP and it can be upgraded to 2 Mbps if necessary. One important component of the GINet is the “IT Model Office”. The functions of the Office include issuing government personnel ID cards using smart cards, disseminating documents via an authenticated workflow system, and providing a document registration and management system for the Cabinet secretariat office to support future paperless Cabinet meetings and directory services. It is expected that, in the near future, GINet directory services can link government applications from many ministries that utilise common data, such as citizen ID numbers, location codes for particular districts or subdistricts, and company code numbers. Government CIO Program

Government Chief Information Officer (CIO) Program is aimed at increasing IT literacy among high-level governmental officers. The program was approved by the Cabinet in June 1998 and is currently run by NECTEC. According to the program, every governmental agency at the ministerial and the departmental level including every state-owned enterprise must appoint a CIO to oversee a unified IT development plan for its organisation. The government CIOs are supposed to work together to draft the country’s IT Action Plan. In 1999, NECTEC, in co-operation with the Office of Civil Service Commission (OCSC), gave six two-week training courses to about 200 government CIOs. Having been in operation for less than two years the program is perhaps too new to have had a tangible impact on the development of online government services. KhonThai.Com

The Department of Local Administration (DOLA), which is under the Ministry of Interior, is one of the most active organisations using the Internet to provide services to the Thai people. It has announced a new website that will enable the public to access services from state agencies.

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The site, called KhonThai.com (www.khonthai.com), will allow online registration of households, births, marriages, and deaths. (KhonThai means “Thai People”.) The department is currently co-operating with other government agencies including the Department of Land Transport, the Royal Thai Embassies, the Royal Thai Police, the Social Security Office, the Ministry of Education, the Ministry of Public Health, and the Ministry of University Affairs to provide a wider range of public services. Potential users of the site need to register to obtain IDs and passwords to access their personal data. KhonThai.com is already linked to the bureau’s nine centres in Bangkok, as well as to more than 500 other offices across the nation. It plans to connect all 1,077 registration offices soon in order to promote greater efficiency in service provision. The site will also provide free e-mail accounts, with 10 megabytes of space. The accounts will start with the letter “p”, and be followed by the 13 digits of the user’s ID card, as in “[email protected].” It is planned that in the future, individuals will be able to apply for or renew passports online without having to bring household registration documents to the Passport Division. By early next year, Thais living overseas will be able to conduct civil registrations electronically from sixty-one embassies abroad, as well as to use the site to check their right to vote in elections. The World Bank is providing technical assistance to DOLA on how to extend the scale and scope of the project. The project is very ambitious by Thai standards. Its future depends on the ability of the Ministry of Interior to smoothly co-ordinate with other government agencies and to secure sufficient budget. IT in Education

One major pillar for promoting IT in education is the SchoolNet Thailand project. The project is led by NECTEC with the assistance of the Telephone Organisation of Thailand (TOT) and the Communication Authority of Thailand (CAT). The goal of the project is to provide Internet connection to 5,000 schools in Thailand and to develop educational content for students and teachers. Currently the project connects about 1,900 schools to the Internet. Another major push for IT in education came from the 1999 National Education Act, which stipulates that the government must provide education technology to every student as quickly as possible. It is commonly understood that the Act requires the government to provide every school, public and private alike, with sufficient access to computers and Internet

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service. According to our preliminary study estimates, the cost of providing computer hardware is about 8.1–8.3 billion baht per year, assuming a student-computer ratio of 10 to 1. The introduction of Internet access will cost an additional 4 to 4.4 billion baht per year, assuming a bandwidth of 1 Kbps for every eleven students. Legal Development

In December 1998, the Thai government started to draft a series of laws to facilitate e-commerce and Internet use. The Cabinet appointed the NECTEC to co-ordinate the drafting process. So far, only the Electronic Transaction Law has been enacted. The law gives electronic messages equal legal status with paper documents and defines electronic signatures as equivalent to written signatures as an authentication tool. It also defines the scope of legal recognition of transmission and reception of electronic messages, time and place of such transmission. Other laws in the pipeline include the Computer Crime Act, the Electronic Funds Transfer Act, and the Data Protection Act.

© 2003 Institute of Southeast Asian Studies, Singapore

Reproduced from Towards a Knowledge-based Economy: East Asia’s Changing Industrial Geography, edited by Seiichi Masuyama and Donna Vandenbrink (Singapore: Institute of Southeast Asian Studies, 2003). This version was obtained electronically direct from the publisher on condition that copyright is not infringed. No part of this publication may be reproduced without the prior permission of the Institute of Southeast Asian Studies. Individual articles are available from < http://bookshop.iseas.edu.sg >

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6 Information Technology and E-commerce in the Philippine Economy Roberto de Vera and Peter Lee U The Philippine economy has progressed quickly through the stages of economic growth. From a predominantly agriculture-based economy, it swiftly became an industrial one. Soon after, the services sector got into gear, riding on the wave of strong growth in real estate before the Asian crisis and subsequently in telecommunications, financial services, and transport. The service sector now accounts for the largest share of output and has grown robustly in recent years (Tables 6.1 and 6.2). It has overtaken agriculture as the sector with the largest share of employment (Table 6.1). Between 1990 and 1999 the service sector rose from 44 of value added to 52 percent, while the industry sector declined from 34 to 30 percent of value added (World Bank 2001, Table 4.29). TABE 6.1 Shares of Output and Employment by Sector , 1996–2000 (Percent) Agriculture

Industry

Services

Share of Share of Share of Share of Share of Share of GDP Employment GDP Employment GDP Employment 1996 1997 1998 1999 2000H1

21.2 20.7 19.5 20.0 20.0

42.8 40.8 39.2 39.8 37.3

35.4 35.9 35.4 34.5 34.2

16.3 16.7 16.4 15.8 16.1

Source: Philippine Statistical Yearbook and Bureau of Labour.

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43.4 43.4 45.1 45.5 45.8

40.9 42.5 44.4 44.4 46.5

154 ROBERTO DE VERA & PETER LEE U

TABLE 6.2 Growth Rate by Sector, 1996–2000 (Percent)

1996 1997 1998 1999 2000H1

Agriculture

Industry

Services

GDP

4.1 2.6 –6.6 6.0 2.3

5.5 6.8 –1.9 0.0 4.0

6.4 5.5 3.5 4.1 4.4

5.6 5.4 –0.5 3.3 3.9

Source: Philippine Statistical Yearbook.

Just as quickly, the information age kicked off and the increasing use of computers and information technology (IT) in business and daily life is bolstering the service sector as the engine of growth for the Philippine economy. Like other Asian nations, the country is grappling with how to carry out a multifaceted transition from the Old Economy to the New Economy. This complex task needs productive collaboration between the government and private industry. HOW INFORMATION TECHNOLOGY FIGURES IN THE SERVICE ECONOMY

Information technology has come to play a driving role in the Philippine economy. Both IT hardware and software have become important export earners. In the year 2000, electronics components were the Philippines’ top export category with an f.o.b. value of US$3.6 billion.1 Exports of electronics and semiconductors reached US$30 billion in 2000 up from only US$3 billion in 1992 (Figure 6.1). A World Bank study ranked the Philippines among the countries with the most high-tech export structure (World Bank 2000b, pp. 18–19). Exports of computer software increased significantly during the 1990s, at a compound annual growth rate of 41 percent between 1993 and 2000 (Figure 6.2).2 In 2000, the Philippines exported US$657 million in computer software.3 The Philippines’ high-tech manufacturing sector was fuelled by foreign investment during the Ramos administration. Foreign firms such as Intel, Texas Instruments, Fujitsu, Hitachi, and National Semiconductor set up facilities. The software industry is also dominated by foreign firms, with multinational companies outsourcing programming, coding, and software

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FIGURE 6.1 Exports by Philippine Electronics and Semiconductor Industries, 1992–2000 US$ billions 35 30

30 25

25 20

20 15

15

11

10 5

8 3

5

4

0 1992

1993

1994

1995

1996

1997

1998

1999

2000

Note: Data for 2000 are through June. Source: Semiconductor and Electronics Industries of the Philippines, Inc.

FIGURE 6.2 Philippine Software Exports, 1993–2000 US$ millions 700

657

600 487

500 400

338

300

250 206

200 100

125 60

66

1993

1994

0 1995

1996

1997

Source: Bureau of Exports, Trade and Promotion.

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1998

1999

2000

156 ROBERTO DE VERA & PETER LEE U

development to the Philippines.4 An early entrant, U.S.-based Andersen Consulting (now known as Accenture) employs several hundred programmers and other tech workers at its Manila software solutions centre.5 Moreover, with the proliferation of the Internet and advances in telecommunications, the Philippines has found a niche in IT-enabled services and back office operations. Even more than a site for software development, it has become a prime place for multinational firms to locate call centres, customer service centres, and other such facilities. Overseas firms hire Filipinos to maintain legal records and deliver engineering designs and audio-visual content. U.S. hospitals and health management organisations (HMOs) outsource the transcription of medical records and settlement of insurance claims to the Philippines. AmericaOnline (AOL) runs an e-mail help centre, Barnes and Noble has an electronic publishing operation, and Caltex locates a finance and accounting support team in the Philippines.6 Labour Force is Key Resource

These multinational IT-related firms are attracted by the Philippines’ educated, low-cost, English-speaking labour force. The Philippines has a pool of 250,000 technicians and engineers, with 30,000 to 40,000 new technical graduates every year. Fourteen percent of the more than 286,000 college graduates entering the labour force in 1996, for example, had completed information technology or engineering degrees.7 MNCs find that workers in the Philippines require less time to train than do workers in some other Asian countries. Also, their wages are relatively low and the quality of output high. For example, the $5.50 daily rate that AOL’s service subsidiary pays college-educated workers in the Philippines is about the hourly rate paid to an unskilled worker in the United States.8 Moreover, educated, English-speaking Filipino workers can even mimic American accents. The Filipino recruits of multinational companies have worked so creditably that firms such as Caltex and Ford have posted many of them to regional branches outside of the Philippines. Future Challenges

With continued deregulation and globalisation, the Philippine economy is being challenged by stiffer competition, both domestic and foreign. The Philippines needs to maintain the competitiveness of its hardware manufacturing and software and service sectors to ensure that these IT-

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related businesses remain a driving force in the economy. It needs to increase value-added in the electronics industry by enhancing the capacity to carry out original design manufacturing.9 It needs to be able to compete with India in sophisticated software development and to increase its capacity to provide e-commerce and Internet application development. Moreover, the Philippines is just setting off on the transition towards an information-based, Internet-linked economy, and there is plenty of room for growth in this initial phase. Filipino consumers are just beginning to take advantage of the opportunities opened by the Internet and Filipino businesses are just moving to place orders, purchase inputs, and sell their wares on the Internet. In particular, demand should be strong for ancillary industries that provide the infrastructure that supports information technology for the New Economy. These industries include everything from hardware (computers and networking and telecommunications equipment) to software (business-to-business, or B2B software, web programming and design). The Info-structure

Thus, the future competitiveness of the Philippine economy depends critically on having the kind of infrastructure that overseas firms and local entrepreneurs need to succeed in IT-related and Internet-based businesses — that is, the “info-structure”, for the New Economy. This info-structure is also essential to give Filipino consumers and businesses access to global markets. Labour Force

To continue to make headway in IT-related services, software development, and hardware manufacturing, the country needs a continuing supply of educated, technically competent manpower. Since 1992–93 enrolment in IT and related programs has grown at a compound annual rate of 26 percent despite a decline in the total number of college graduates (Figure 6.3). The World Bank warns that the Philippines’ edge in manpower is not insurmountable, however (World Bank 1997). Furthermore, to move into higher value-added activities such as software development and hardware design, the Philippines must maintain and improve education in math and science. The focus should be on the primary and secondary levels. In recent tests Filipino school children have scored near the bottom in math and science compared with their peers in neighbouring countries.

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FIGURE 6.3 Students Enrolled in IT and Related Programs, 1992–2000

No. of students ('000) 400 350 300 250 200 150 100 50 0 1992-93 1993-94

1994-95

1995-96 1996-67

1997-98

1998-99

19992000

200001p

Source: Commission on Higher Education (CHED) and Department of Education, Culture and Sports (DECS).

Although strong demand by foreign firms for IT-related and back office services exacerbates the shortage of IT workers among domestic firms, it also stimulates efforts to train people with the IT skills needed for these jobs. Private companies and the government are working to maintain a steady flow of newly trained workers not only to supply the growing needs of local industry, but also to offset the annual drain of trained talent that goes abroad in pursuit of higher wages. Cisco Systems, together with the Philippine government and Ayala Corporation, has set up two academies to teach computer network design and operations. The government is encouraging private corporations to donate equipment to support computer training in public schools.10 Telecommunications

Telecommunications infrastructure in the Philippines improved greatly over the 1990s. With the ending of the monopoly of the Philippine Long Distance Telephone Company (PLDT) and the entry of private, and even foreign, service providers, the quality of service improved dramatically. Waits of five years for new lines have been reduced to one or two months.

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According to the National Telecommunications Commission, 5.4 million land-based telephone lines were installed from 1993 to 1997. Fixed-line telephone density quadrupled between 1993 and 1996 and almost doubled again by 1998 (Table 6.3). It has remained roughly stable since 1998.11 There are now over seventy providers of local exchange carrier service (Table 6.4).

TABLE 6.3 Telephone Densities in Selected Asian Economies, 1992–98 (Telephones per 100 persons)

Indonesia Korea Malaysia Philippines Thailand

1992

1993

1994

1995

1996

1997

1998

1.0 41.8 11.2 1.2 3.1

1.2 45.9 12.7 1.2 3.7

1.8 42.3 11.8 1.7 4.5

1.1 39.7 15.8 2.0 5.9

1.6 41.5 15.8 5.2 7.4

2.1 43.0 17.8 8.1 7.0

2.5 44.4 19.6 9.1 8.0

Note: Last update: 30 October 2000. Source: National Telecommunication Commission.

TABLE 6.4 Structure of Philippine Telecommunications Industry, 1997–2000 (Number of service providers)

Local exchange carrier service Cellular mobile phone service Paging service Public trunk repeater service International gateway facility Satellite service International record carrier Domestic record carrier Very small aperture terminal Public coastal station Radiotelephone Value-added service

1997

1998

1999

2000

76 5 15 10 11 3 5 6 4 12 5 47

76 5 15 10 11 3 5 6 4 12 5 70

76 5 15 10 11 3 5 6 4 12 5 106

77 5 15 10 11 3 5 6 4 12 5 156

Source: Consumer Information, National Telecommunications Commission. .

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The Philippines also has five providers of mobile cellular service. The number of subscribers exploded from 56,000 in 1992, when cellular mobile telephone service was first offered by public carriers, to over 6 million in 2000 (Table 6.5). According to data from the International Telecommunication Union (ITU), in 1998 the Philippines was well behind its ASEAN neighbours in the penetration of mobile phones, with only 38 subscribers per 1,000 people compared with Malaysia’s 137 subscribers per 1,000 (Table 6.6). But the gap is closing. With the doubling of mobile service subscribers from 1999 to 2000, the Philippines now has about 78 subscribers per 1,000 population.12 In August 1997 the Philippines opened its first satellite communications link connecting Manila with all regions of the country. Three companies now provide satellite service. The domestic satellite system has eleven earth stations, and there is access to three Intelsat stations for international communications.13 Three new backbone networks are being built to improve telecommunications service, including a Domestic Fibre Optic Network that will provide nationwide digital coverage (ITECC 2000, p. 2). The most dynamic part of the telecommunications sector recently has been value-added services (VAS). The number of VAS providers increased from 47 in 1997 to 156 in 2000 (Table 6.4). Rather than build their own networks, VAS providers use the established networks of the public carriers to offer enhanced services not ordinarily provided by the public carriers,

TABLE 6.5 Mobile Cellular Service Subscribers, 1992–2000

1992 1993 1994 1995 1996 1997 1998 1999 2000, May

Number

% growth

56,044 102,400 171,903 493,862 959,024 1,343,620 1,733,652 2,849,880 4,298,000

– 83 68 187 94 40 29 64 51

Source: Department of Transportation and Communication.

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27

29 203 39 86 27

576 438 482 – 86

2

11 137 38 38 4

636 500 419 – 34

Mobile Telephones per 1,000 people 1999

Source: ITU cited in World Bank, World Development Indicators 2001, Tables 5.9, 5.10.

India

Indonesia Malaysia Philippines Thailand Vietnam South Asia

Newly Industrialised Economies Hong Kong Korea Singapore Taiwan China Southeast Asia

Telephone Main Lines per 1,000 people 1999

TABLE 6.6 Information and Telecommunications Infrastructure of Asian Economies

3.3

9.1 68.7 16.9 22.7 8.9

297.6 181.8 436.6 – 12.2

Personal Computers per 1,000 people 1999

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including Internet service, voice-mail, e-mail, text messaging on cell phones, and content such as text logos for cell phones. Value-added services are deregulated telecommunications services, and one reason for the growth of this sector is that providers do not need a franchise from Congress in order to operate. The growth of VAS providers can probably also be attributed to growth in mobile phone and Internet usage and access as well as to the reduced amount of red tape involved in setting them up. Despite the advances during the 1990s, the Philippines lags behind not only the Asian NIEs but also its ASEAN neighbours in most areas of telecommunications infrastructure (Table 6.6). Many lay the blame on defects in the liberalisation of the telecommunications sector. Interconnection problems persist, they argue for example, because PLDT was left in a dominant position. Moreover, legal constraints (such as the constitutional ban on tri-media ownership by foreigners discussed below) hinder the flow of foreign investment in telecommunications infrastructure. Still, technology may provide the Philippines with a way to overcome its lack of infrastructure. The private sector has been investing heavily in mobile telecommunications service, and this technology is in ascendance. At first, though, the benefit will be limited primarily to urban areas; universal access for all Filipinos remains a long way off. Internet Infrastructure

MosCom Internet offered the first commercial Internet service in the Philippines in 1994 (www.mozcom.com). In early 1997 there were an estimated twenty-five Internet service providers (ISPs) with a primary connection to the global Internet. Although it is difficult to get a precise count, we estimate that today there are more than fifty ISPs, and one source projects the number will reach 1,000 in 2005.14 In the past three years the three main cable companies, Destiny Cable, Home Cable, and Sky Internet, introduced cable Internet service along with regular cable TV programming. The number of Internet hosts in the Philippines more than doubled, from 9,204 in January 1999 to 19,448 in January 2001, according to the Internet Domain Survey sponsored by the Internet Software Consortium.15 This figure only counts hosts that use the “.ph” domain. Some hosts in the Philippines use the “.com” and other domain names. Nevertheless, the Philippines has only one-fourth the number of Internet hosts per 10,000 inhabitants as Thailand has and it has many fewer Internet hosts than Malaysia or the Asian NIEs (Table 6.7).

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TABLE 6.7 Key Internet Statistics for Selected Asian Economies Hosts per 10,000 people July 2000

Users ('000) 1999

Subscribers ('000) 1998

0.69 182.92 0.32 1.15 269.25 100.65 27.55 2.21 385.73 – 8.84

8,900 2,430 2,800 900 27,060 10,860 1,500 500 950 – 800

320 400 100 30 5,100 200 60 150 100 800 100

China Hong Kong India Indonesia Japan South Korea Malaysia Philippines Singapore Taiwan Thailand

Source: Hosts from ISC; users from ITU, cited in World Bank, World Development Indicators 2001. Subscribers from Connally 1999.

Internet Access and Use

In many economies the PC is the primary means to access to the Internet, but in the Philippines the penetration of computers is still quite low, about 17 computers per 1,000 people compared with 510 per 1,000 people in the United States (World Bank 2001). PhilWeb.Com, a 2000 ISP entrant, estimates that in addition to the 600 to 700 thousand Internet subscribers in the Philippines with their own PCs there are 1.5 million occasional users with access through Internet cafes and other means.16 Indeed, the Internet cafes play an important role in Internet access in the Philippines.17 According to Digitalfilipino the Philippines had 1,500 Internet cafes at the end of December 2000. Including all those with access to the Internet through a home, office, or school computer, or an Internet cafe, Digital Filipino estimated 2 million Internet users in the Philippines at the end of December 2000.18 According to a 1999 survey by Philippine Communications Satellite Corporation (Philcomsat) Filipinos use the Internet most often for electronic mail (88 percent).19 Web surfing is second (60 percent), followed by Internet chatting (29 percent), and newsgroups (17 percent). Internet use may be hampered by poor telecommunications infrastructure. The Philcomsat survey found

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that most Internet subscribers were unhappy with their service due to frequent disconnection, access difficulty (busy signals), and slow downloading times. Service quality should improve with the increasing availability of satellite, cable, and fibre optic communications networks. Payments Systems

The payments system is a critical part of the infrastructure for online transactions, and credit cards have been the main payments mechanism for e-commerce. In the United States, concern over sending credit card information through the Internet seems to be an initial hindrance to online purchases. In the Philippines the problem is more fundamental — the low penetration of credit cards limits the number of potential online buyers. In 1997, thirteen credit card issuers in the Philippines reported a total active cardholder base of two million, or slightly under 3 percent of the population (Lamberte 2001). Executives of iAyala, the IT business development and incubation arm of Philippine conglomerate Ayala Corporation, complained that credit card penetration is too low to support a significant business-toconsumer (B2C) market. The low rate of credit card use has prompted Filipino firms to develop other forms of payment. One is a pre-paid card system by which customers pay into an account in advance, and the firm deducts the cost of goods or services from this account as the customer consumes them. Pre-paid cards caught on in a large way with cellular phone users and they have started to proliferate for Internet access and even among landline telephone subscribers. PhilWeb.Com, a new provider of dial-up and broadband satellite Internet service focused its strategy on pre-paid cards. Customers purchase its Zoom Internet Card to use at one of its chain of CyberWorld cafes or Cyberstations, single PCs installed in hotels and other establishments around the country.20 Electric Power

Electric power generation is an important part of the info-structure, since computers, network servers, and fax machines all require a reliable supply of electrical power. The total system capacity in the Philippines almost doubled from 6,683 megawatts in 1992 to 12,050 megawatts in 1999.21 Despite improvements during the 1990s, the World Bank estimates that 16 percent of electrical power output in the Philippines was lost in transmission and distribution in 1998. This was almost double the 9 percent rate in

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Thailand and more than double Malaysia’s 7 percent (World Bank 2001, Table 5.9). The prospects for electric power generation in the Philippines improved greatly with the passage of the Power Reform Bill in June 2001. This legislation provides the legal framework for restructuring the electric power industry and for privatising and opening parts of the industry to competition. Passage of the bill will also release almost US$1 billion in loans from the Asian Development Bank and the Japanese Ex-Im Bank.22 This step towards deregulation of the wholesale and retail sides is expected to allow for better service and lower prices. Interestingly, the application of IT will play a large part in achieving these improvements. IT will be needed to organise and manage the power pools and bidding exchanges that will raise efficiency and drive electricity rates down. Legal and Business Infrastructure

Passage of the E-commerce Act in June 2000 gave the Philippines the beginning of a legal framework suitable for the Internet age. To be able to transact business smoothly over the Internet, the legal force traditionally accorded to paper documents must extend to the electronic arena. This landmark legislation recognised the authenticity of electronic documents and gave them the same “legal effect, validity or enforceability as any other document or legal writing”. The E-commerce Act also affirmed the full force of the 1992 Consumer Act of the Philippines (RA 7394) with respect to transactions involving electronic data messages or electronic documents and provided for penalties against computer crimes (Section 33).23 Other provisions and objectives of the Act included: • Section 29, which put electronic commerce under the Department of Trade and Industry, and • Sections 31 and 32, which safeguarded access and confidentiality of computer files and accounts. Nevertheless, the E-commerce Act is only a start to building a legal infrastructure to support the development of e-commerce and Internetrelated business in the Philippines. It does not address other legal issues related to e-commerce such as taxation, for example. Moreover, certain existing laws pose a significant obstacle to the emerging trend of convergence in the information and telecommunications industry. For one thing, the Telecommunications Act prohibits a single

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company from engaging in both telecommunications and broadcasting (whether through airwaves or cable) under a single franchise. For another, the Philippine Constitution constrains the development of information technology, while at the same time enshrining the importance of communication. On one hand, Article XVI, Section 10 of the Constitution states: The State shall provide the policy environment for the full development of Filipino capability and the emergence of communication structures suitable to the needs and aspirations of the nation and the balanced flow of information into, out of, and across the country, in accordance with a policy that respects the freedom of speech and of the press.

On the other hand, however, Section 11 of the same article prohibits foreign ownership of public utilities (which include telecommunications) and mass media: The ownership and management of mass media shall be limited to citizens of the Philippines, or to corporations, cooperatives or associations, wholly-owned and managed by such citizens. The Congress shall regulate or prohibit monopolies in commercial mass media when the public interest so requires. No combinations in restraint of trade or unfair competition therein shall be allowed. The advertising industry is impressed with public interest, and shall be regulated by law for the protection of consumers and the promotion of the general welfare. Only Filipino citizens or corporations or associations at least seventy per centum of the capital of which is owned by such citizens shall be allowed to engage in the advertising industry. The participation of foreign investors in the governing body of entities in such industry shall be limited to their proportionate share in the capital thereof, and all the executive and managing officers of such entities must be citizens of the Philippines.

These prohibitions discourage foreign investment in the telecommunications sector. Technology is developing rapidly and the future trend is for telecommunications, broadcasting, and other media to be delivered through the same channel, most likely the Internet. Restricting firms from simultaneously engaging in these activities imposes the unnecessary cost of doing them separately and prevents firms from exploiting their synergies. The existing legal restrictions may make Filipino companies less efficient,

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handicap them in competing with counterparts in other countries, and exclude them from full participation in e-commerce business. Accounting systems are also a part of the legal and business infrastructure. Because of the Philippines’ history of business connections with the United States in particular, the accounting practices of Filipino firms are readily adaptable to support the transaction of business on the Internet. These systems meet international standards of consistency and transparency and they are compatible with the practices of multinational corporations. Government Programs and Policies to Support IT-related Business

Since the mid-1990s the Philippine government has adopted many policies to encourage the diffusion of information technology and to support the development of IT-related and Internet-based business. Deregulation of Telecommunications

President Ramos initiated liberalisation of the telecommunications industry in 1993. Executive Order (EO) 59 mandated compulsory interconnection of all carriers and EO 109 required holders of Cellular Mobile Telephone Service (CMTS) and International Gateway Facility (IGF) licences to install 400,000 and 300,000 landlines respectively within a specified time frame. EO 109 also implemented the Service Area Scheme (SAS), which divided the country into eleven service areas with designated service providers. Until that time the Philippine Long Distance Telephone Company had provided as much as 95 percent of all telephone service. The Public Telecommunications Policy Act of 1995 (RA 7925) reiterated the importance of telecommunications and the obligation of the government to develop the industry. It also set out the responsibilities of the National Telecommunications Commission (NTC) and the Department of Transportation and Communications and mandated the NTC to establish rates and tariffs. Deregulation led to the significant improvement of the telecom infrastructure during the 1990s. National IT Plan: IT21

In July 1994 President Ramos approved the National Information Technology Plan and created the National Information Technology Council (NITC) to oversee its implementation. The Plan was subsequently renamed

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the IT Action Agenda for the 21st Century, or IT21. IT21 was approved on 28 October 1997 as the country’s guide for IT development. The IT Action Agenda called for: • developing the information infrastructure to link the country, • turning the Philippines into a regional hub for software development and training, • adopting IT to carry out government tasks, • developing and adopting IT in educational and training institutions to create a critical mass of IT professionals and an IT-literate workforce, and • upgrading IT resources in the local R&D sector. E-government

In 1996, House Resolution 890 proposed linking all government departments, agencies, bureaus, and local government offices together through the Internet. This so-called RPWeb Strategy would improve the efficiency, effectiveness, and transparency of the bureaucracy and would also serve as the nucleus of an information superhighway, or Philippine Information Infrastructure.24 President Ramos approved the RPWeb strategy in 1997 under Administrative Order 332, with implementation to begin that year, starting with cabinet members down to the assistant secretary level.25 The 2000 E-Commerce Act reiterated this directive, requiring all government offices to accept and issue electronic documents within two years (Section 27) and directing the government to install an online network connecting government offices (Section 28). The Government Information Systems Plan (GISP) approved in July 2000 is an integrated IT plan that provides a vision for e-government in the Philippines, including the services and common applications to be adopted over the next four to five years. Investment Incentives

The Special Economic Zone Act of 1995 established the Philippine Economic Zone Authority (PEZA) as a government corporation mandated to create employment opportunities and spur the growth and diversification of exports by attracting foreign investors to economic zones. Economic zones accredited as Information Technology Parks, or so-called Cyberparks provide the infrastructure, support facilities, and amenities to attract firms in the IT industry in order to promote the development and export of

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Bonifacio Information Special Technology Zone RCBC Plaza IT Park

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RCBC Realty Corporation

Bases Conversion & Development Authority

Fort Bonifacio Development Corporation Filinvest Alabang, Inc.

Fort Bonifacio Silicon Valley IT Park

Northgate Cyber Zone

Megaworld Properties and Holdings, Inc.

Eastwood City Cyberpark

Developer Bagumbayan, Quezon City, Metro Manila Fort Bonifacio Global City, Taguig, Metro Manila Alabang, Muntinlupa City Metro Manila Fort Bonifacio, Taguig, Metro Manila Ayala Avenue corner Sen. Gil J. Puyat Avenue, Makati City

Location

floor area: 15.04 hectares

25 hectares

18.7 hectares

24.4 hectares

13.3 hectares

Area

TABLE 6.8 Status of PEZA-accredited Cyberparks in 2001

• • • • • • • • • • • • • • •

continued on next page

53,000 installed lines 277,777 available phone lines leased lines, ISDN, fibre optic 187,414 installed lines 53,882 available phone lines leased lines, ISDN, fibre optic 38,886 installed lines 142,543 available phone lines leased lines, ISDN, fibre optic 187,414 installed lines 53,882 available phone lines leased lines, ISDN, fibre optic 421,942 installed lines 239,606 available phone lines leased lines, ISDN, fibre optic

Telecom Facilities

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Filinvest Asia Corporation

Cebu Property Ventures & Development Corporation First Centro, Inc.

*PBCom Tower

CCTC IT Park

Aseana Business Park, Boulevard 2000, Parañaque City, Metro Manila Ayala Avenue corner Herrera Street, Makati City, Metro Manila Barangay Lahug and Apas, Cebu City Lapu-Lapu City, Mactan, Cebu

Location

Note: * denotes IT Parks with applications pending PEZA Board consideration.

Cebu Cybertown IT Park

Aseana IT Plaza Consortium

Developer

*ASEANA Intelligent Technologies Plaz

TABLE 6.8 – cont’d

11.5 hectares

23.7 hectares

floor area: 11,748 hectares

12.3 hectares

Area

• • • • • •

30,967 installed lines 119,777 available phone lines leased lines, ISDN, fibre optic 16,950 installed lines 22,512 available phone lines leased lines, ISDN, fibre optic

• 421,942 installed lines • 239,606 available phone lines • leased lines, ISDN, fibre optic

• 43,216 installed lines • 142,029 available phone lines • leased lines, ISDN, fibre optic

Telecom Facilities

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software products and services and other IT-related activities.26 To date, PEZA has accredited or is processing applications for 200 hectares of such IT-targeted economic zones (Table 6.8). Incentives for IT projects that locate in these Cyberparks include: • exemption from import duties on imported machinery, equipment, and raw materials; • tax deductions on training expenses; • local sales tax allowances; • permanent residence status for foreign investors; and • permission to employ non-resident aliens. Among the IT-related business activities that can avail of these benefits are: • • • • • •

software development and application; IT-enabled services such as call centres; content development for multi-media or Internet purposes; knowledge-based and computer-enabled support services; business process outsourcing using e-commerce; and IT research and development.

In addition, the Board of Investment’s Investment Priorities Plan (IPP) for 2000 included IT and telecommunications areas among the activities eligible for special investment incentives. For the first time, qualifying projects in IT-enabled services, support and knowledge-based services, business process outsourcing and software development, and projects to establish and operate telecommunications systems could take advantage of various tax holidays, tax deductions, and tax and duty waivers.27 Intellectual Property Protection

The Intellectual Property Code adopted on 1 January 1998 imposes penalties and fines for the manufacture, distribution, and use of unlicensed software. Its significant features are that it: • protects inventions for a period of twenty years from filing; • protects industrial designs for a period of five years with five-year renewals; and • grants protection to the first to file, rather than the first to invent. At the same time, an Intellectual Property Office was organised to replace the Bureau of Patents, Trademarks, and Technology Transfer. Among

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other functions, the office examines applications for patents and registration of marks. PROSPECTS FOR E-COMMERCE IN THE PHILIPPINES

IT has made its mark in the Philippines as it has elsewhere in Asia and in the rest of the world. So far, though, IT-related business in the Philippines has mainly been connected with foreign firms — as users of electronics and computer components, as outsourcers of computer programs or back office services. Now, the task facing the Philippines is to transform the domestic economy — from the Old Economy to the New Economy, from the industrial age to the information age, and from supplier-driven industry to customer-driven industry. In 1997, Filipinos bought US$1.6 million worth of goods and services over the Internet.28 Industry experts estimate that by 2005, the total value of e-commerce transactions in the Philippines could reach US$7 billion. This is a substantial amount of online trade, particularly since the projected volume of e-commerce is US$11 billion in Singapore, Thailand, and Indonesia and US$10 billion in Malaysia, and most of these economies have at least twice the per capita income of the Philippines.29 The future lies in Filipino firms that exploit the potential of the Internet and e-commerce and that pursue B2C and especially B2B business. Developing e-commerce in the Philippines requires firms in the private sector ready to seize the opening opportunities and productive collaboration by government to overcome the threats. Private Sector Opportunities and Threats

The Philippines will continue to provide back office services to foreign firms that have realised the benefits of outsourcing skill-intensive differentiated services to developing countries (World Bank 2000a). But also, the same Filipino labour force that attracts these IT-related businesses from abroad provides a strong foundation for the development of domestic e-commerce and Internet-based businesses. Filipino workers’ English fluency and technical savvy are aptly suited to support a shift by local firms to web-based systems. An early Philippine B2B entry called ZipClaims, for example, will provide third-party administration of insurance claim settlements over the Internet, initially targeting domestic insurers, but later expanding its service into the Asia-Pacific region. The Philippines’ long-standing trading relationship and cultural familiarity with the United States have been a considerable advantage in

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forming cross-border networks with American firms. U.S. firms are the dominant foreign firms active in hardware manufacturing as well as in outsourcing back office and IT-enabled services. Links with U.S. firms expanded from physical production networks to digital ones with the development of IT and the Internet. For U.S. firms, even traditional brick and mortar ones, outsourcing the routine processing of information and transactions to Philippine firms offers the possibility of huge cost savings. There is great scope for Philippine firms to provide such services as firms try to cut costs. For example, capturing, storing, and processing information such as records, physicians’ notes, test results, and insurance claims costs U.S. hospitals P300 billion a year, or one-third of the total cost of health care (Evans and Wurster 1997). The onset of recession in the United States in March 2001 heightened the pressure to reduce costs and may force many more U.S. companies to outsource non-core business tasks. There is also wide scope for networking domestic producers and suppliers and for creating supply networks within the East Asia region. HatchAsia Inc. will build an incubating facility in Fort Bonifacio City in Metro Manila to house B2B start-ups. Its owners believe that successful B2B ventures offer services that improve the bottom lines for their clients, and it will target the Asia-Pacific region as its market. In 2000 six Philippine conglomerates together set up Bayantrade, an online exchange for the purchase of direct inputs. When it fully harnesses their supplier relationships and distribution networks, this B2B enterprise will generate huge savings for the partners. One challenge to building B2B businesses in Asia, according to Dhawan et al., is to find ways to induce manufacturers to procure direct inputs online.30 Experience in the United States suggests that firms are less likely to use the Internet to purchase direct goods than to purchase indirect goods, and in Asia direct goods comprise 80 percent of manufacturers’ purchases compared to only 60 percent in the United States.31 To overcome this challenge, Dhawan suggests that B2B businesses in Asia may need to train buyers to go online. On the other hand, Philippine B2B exchanges may not find it that difficult to build up buyers’ confidence, since they are simply linking buyers and sellers that have long-standing relationships. For e-commerce to flourish in the Philippines, as well as in other developing economies of the Asia-Pacific region, the inadequacies in the info-structure need to be addressed. Deficiencies particularly damaging to e-commerce include the relatively low level of Internet penetration, low use of credit cards, the lack of a reliable, secure online payment mechanism, and the dearth of third-party logistics providers. In some parts of the

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Philippines, for example, less than one-quarter of cities and municipalities are served by local telephone exchange carriers.32 While inadequate telecommunication, distribution, and payments infrastructure may slow the development of e-commerce, such deficiencies also provide business opportunities and stimulate business innovation. For example, low credit-card usage, low Internet access, and poor distribution and transportation systems could lead to the development of a hybrid model for B2C e-commerce in the Philippines. One such model would combine the U.S. practice of customers placing online orders at an Internet cafe with the system developed by Japan’s 7-Eleven convenience store chain in which consumers receive, inspect, and pay for their purchases at a neighbourhood store.33 In addition, gaps in infrastructure represent business opportunities for entrepreneurs who develop ways to fill them (Dhawan et al. 2000). On one hand, the higher distribution and logistics costs and greater number of intermediaries involved in the supply chains in Asia are signs of inefficiency, but on the other hand they represent opportunities for new firms that target these areas (Dhawan et al. 2000). Role of Government

Filling the gaps in the info-structure is also a job for the government. For this, the government needs to co-operate with the private sector. A welcome development is the formation of the Information Technology and Electronic Commerce Council (ITECC) in the second quarter of 2001. This is a joint public-private sector initiative that intends to formulate public policies and action plans that will support the private sector’s efforts to develop the information technology sector. For example, ITECC-sponsored privatepublic dialogues have generated specific suggestions on how the government may foster the development of the telecommunications infrastructure needed for IT and e-commerce. Whether the government translates these suggestions into concrete programs remains to be seen. The Philippine government demonstrated its commitment to developing e-commerce with the passage of the E-commerce Act, although much work remains to ensure that this law is effectively implemented. For example, the implementing rules and regulations (IRR) that accompany this Act refer mainly to the Bureau of Internal Revenue. Other government agencies have yet to craft their respective IRRs on e-commerce. Various government agencies have also taken steps to support new IT-related business. In the fourth quarter of 2000, the Department of Trade and Industry (DTI) introduced a set of investment incentives for IT and

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e-commerce ventures that locate in cyber-enabled buildings and meet certain requirements. These incentives match those offered by the Philippine Economic Zone Authority to firms locating in its accredited IT parks. Also, the Bases Conversion Development Authority in conjunction with the Fort Bonifacio Development Corporation is expected to establish the Fort Bonifacio IT Park by 2002 using a low-interest long-term loan from Japan. The 2000 Investment Priority Plan provides incentives not only for IT ventures that produce export goods and services, but also for IT-related ventures so long as they sell 70 percent of their output to local IT firms. By helping to broaden the base of IT support firms in the Philippines, these incentives will foster the development of a vibrant cluster of IT firms servicing international and domestic markets. Moreover by offering incentives to IT-related firms serving domestic markets, the 2000 Investment Priority Plan will stimulate the development of local businesses that are essential to support domestic e-commerce, including such low-tech but labour-intensive services as call support, parcel delivery, and warehousing. In summary, the opportunities for Filipino firms lie in capturing AsiaPacific markets for back office services as well as in leveraging the cost savings from switching to B2B transactions. The public sector will serve the emerging e-commerce economy by improving the efficiency and effectiveness of delivering services online. The greatest threats to the future of e-commerce in the Philippines emanate from delayed improvement in the telecommunication infrastructure due to failure of co-ordination between the private and public sectors. How well the Philippines performs in the New Economy depends on how quickly these two sectors respond to the challenges. Notes 1 2

3

. The Philippine software industry attracted worldwide attention in 2000 when a local programmer was identified as the source of the “Love Bug” virus. Less well known was the pivotal role Filipino programmers played in developing the antidote for this virus. Dennis Arroyo, “Believe it or not, RP is an emerging hi-tech power”, Philippine Daily Inquirer, 22 November 2000. Economic Indicators Online, National Economic Development Agency. . M.A. Hamlin argues that official figures understate the value of software exports to the extent that software developed in the Philippines is transmitted over the Internet or through

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4

5

6

7

8 9

10

11

12

13

14

15 16 17

18

19 20 21

22

electronic data interchange (EDI). “Measuring the New Economy”, . “White Collar Gold Mine: AOL, other giants ship jobs to Asia”, Far Eastern Economic Review, 2 September 1999. “At Your Service”, Far Eastern Economic Review, 2 September 1999. . Far Eastern Economic Review, 28 June 2001. . Based on Philippine Statistical Yearbook, National Statistical Coordination Board (1997), Chapter 10. “At Your Service”, Far Eastern Economic Review, 2 September 1999. Country Brief — Philippines/Economy, Financial Times Survey, 28 September 1999. . D. Sheehan, “Advantage in Jeopardy”, Far Eastern Economic Review, 10 October 2000. . Consumer Information, Local Exchange Carrier Service (1992–2000). . Calculation based on NTC figure of 6,454,359 cellular subscribers in 2000 and population of 76.5 million. Global New E-Economy Index, 2000 PDF file downloaded from MetricNet. . International Data Corporation cited in Economic Indicators Online, National Economic and Development Authority. . . . The lower cost of Internet cafes in the provinces than in Manila has helped to bridge the internal digital divide, making users in outlying areas tech-savvy and reducing the income gap. J. Toral, “DigitalFilipino Philippine Internet Demographics”, 3 December 2000. . J. Toral, “DigitalFilipino Philippine Internet Demographics”, 3 December 2000. . Survey cited in Connally 1999. . National Power Corporation cited in Economic Indicators Online, National Economic Development Authority. . Press Release US-ASEAN Business Council, 5 June 2001. .

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24 25 26 27 28

29 30

31

32

33

177

Ironically, a “cyber crime” may have hastened the passing of the E-Commerce Act. While Philippine authorities apprehended the computer student who unleashed the Love Bug virus rather quickly, they were at a loss as to what crime to charge him with because existing laws did not provide for computer crimes. The best they could do was to charge him under a law covering credit card fraud, but the connection was tenuous and they eventually had to release the culprit. This incident underscored the need for a bill under which to punish computer-related crimes such as hacking and fraud. . . . . “RP Internet Users: 217,000 and Rising”, Computerworld-Philippines, 15 October 1998, p. 1. Far Eastern Economic Review, 24 August 2000. Dhawan et al. (2000) identified four characteristics of the business environment in Asia that present particular challenges and opportunities for building B2B in the region. Direct goods, which are used directly in a manufactured product, typically have to be suited to a certain production process, and manufacturers are interested particular specifications. Generic descriptions are likely to suffice for procurement of indirect goods, such as paper clips or travel that do not end up in the final product. National Telecommunication Commission from Economic Indicators Online, . See DeVera (2000) for a more detailed discussion.

References

Arroyo, Dennis M. 2000. “Believe it or not, RP is an emerging hi-tech power”. Philippine Daily Inquirer, 22 November. Asian Development Bank. 2000. “IT and Development: Prospects and Policies”. Asian Development Outlook 2000 Update. September, pp. 57–69. Asian Development Bank. . Connally, Bree. 1999. “Information Technology in the Philippines”. Kogod School of Business, American University, Washington, D.C. .

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DeVera, Roberto. 2000. “Fulfilling E-wishes”. Regional Markets Adviser (March), pp. 1–2. Manila: University of Asia and the Pacific. Dhawan, Rajat K., Ramesh Mangaleswaran, Asutosh Padhi, Shirish Sankhe, Karsten Schween, and Paresh Vaish. 2000. “The Asian Difference in B2B”. The McKinsey Quarterly 1: 38–47. Domingo, Rico V. 2000. “Internet Regulation: The Philippine Experience”. Paper presented to the Trade Policy Forum Meeting sponsored by the Pacific Economic Cooperation Council, Bandar Seri Begawan, Brunei Darussalam, 28–29 May. Evans, Philip B., and Thomas S. Wurster. 1997. “Strategy and the New Economics of Information”. Harvard Business Review 75(5): 70–82. Information Technology and Electronic Commerce Council (ITECC). 2000. Philippine Government Online; Government Information Systems Plan. Manila: Republic of Philippines. . Lamberte, Mario. 2001. “The Philippine Payment System: Efficiency and Implications for the Conduct of Monetary Policy”. Working Paper, Philippine Institute for Development Studies, 19 October. Panagariya, Arvind. 2000. “E-Commerce, WTO and Developing Countries”. Paper presented to the Trade Policy Forum Meeting sponsored by the Pacific Economic Cooperation Council, Bandar Seri Begawan, Brunei Darussalam, 28–29 May. World Bank. 1997. “Philippines — Managing Global Integration”. Vol. II Sector Report 17024. Washington, D.C.: World Bank. . ———. 2000a. “Electronic Commerce and Developing Countries”. In Global Economic Prospects and the Developing Countries: 2001. . ———. 2000b. “Philippines — Growth with Equity: The Remaining Agenda”. Sector Report 20066. Washington, D.C.: World Bank. . ———. 2001. World Development Indicators 2001. Washington, D.C.: World Bank.

© 2003 Institute of Southeast Asian Studies, Singapore

Reproduced from Towards a Knowledge-based Economy: East Asia’s Changing Industrial Geography, edited by Seiichi Masuyama and Donna Vandenbrink (Singapore: Institute of Southeast Asian Studies, 2003). This version was obtained electronically direct from the publisher on condition that copyright is not infringed. No part of this publication may be reproduced without the prior permission of the Institute of Southeast Asian Studies. Individual articles are available from < http://bookshop.iseas.edu.sg >

INDONESIA: TELECOMMUNICATIONS AND IT DEVELOPMENT 179

7 Telecommunications and Information Technology Development in Indonesia Hamonangan Hutabarat Like most developing countries, Indonesia is striving to reach the level of information technology attained in the advanced economies. Telecommunications and other information technology infrastructure are the prerequisites to connect to the global information economy. Until 1997 the telecommunications sector in Indonesia grew rapidly, on a par with the rate in neighbouring countries. The economic crisis triggered by the currency crisis in 1997 had a severe impact on Indonesia’s telecommunications sector. Political instability and changes in the government created uncertainties in the business climate. The fear that Indonesia will fall into the regional digital divide in the near future could be realised. This chapter first describes Indonesia’s telecommunications infrastructure including government policies towards the sector, its recent growth and performance, and the impact of the economic crisis up to mid-2000. The second part of the chapter gives an overview of the information technology industry, infrastructure, and access in Indonesia. The third part discusses the role of information and communications technology in the integration of the Asian market and describes Indonesia’s position with respect to the digital divide. The chapter concludes with a summary and suggestions for how the government can improve Indonesia’s access to the global information society. THE TELECOMMUNICATIONS SECTOR: GOVERNMENT POLICY AND INDUSTRY PERFORMANCE

Indonesia covers the 17,500 islands of the Nusantara archipelago, which spans 5,100 kilometres (almost the distance between Los Angeles and

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New York or between London and Moscow). Indonesia’s rulers have been obsessed with uniting the archipelago since Gajah Mada reigned over the Majapahit Kingdom in the thirteenth century. The desire to unite the country re-emerged under Dutch colonial occupation in the Indonesian Youngmen’s Vows of 28 October 1928. The Vows stated the wish of delegates to the Youth Congress, representing various Indonesian tribes and regions, to create one mother land, the Indonesian land, one nation, the Indonesian nation, and one language, the Indonesian language. The realisation of this goal began on 17 August 1945 with Indonesia’s proclamation of independence. The Juanda Declaration of 13 December 1957 extended the Nusantara Region (Wawasan Nusantara) 12 miles from the shoreline, and the new extended territory became the basis for long-term national defence planning for Indonesia’s communications system. Believing telecommunications to be critical to Indonesia’s development, the government gave telecommunication infrastructure top priority during the early period of national economic development. The post-war history of the telecommunications sector in Indonesia can be described in three phases: government monopoly, participation of the private sector, and globalisation. Government Monopoly Phase: Up to 1989

From independence in 1945 to the end of the 1980s, Indonesia’s telecommunications sector was a government monopoly completely closed to private business, domestic as well as foreign. After rebuilding the telephone communications infrastructure ruined during the Second World War, the government started to build automatic telephone networks in provincial capitals all over Indonesia and it continued this work into the early 1960s. In 1961 the government transferred the provision of most telecommunications services to a newly established state-owned company, the precursor to today’s PT Telkommunikasi Indonesia (PT Telkom, or Telkom). Indonesia entered the satellite era at the beginning of the New Order Regime, with the promulgation of the Foreign Investment Law in 1967. On 9 June 1967, the Republic of Indonesia signed an agreement with ITT (International Telephone and Telecommunications) of the United States to build a satellite station in Jatiluhur and to establish PT Indosat as a subsidiary of ITT. On 27 September 1969, the station was inaugurated under the commercial operation of Indosat. The availability of smooth international connections via satellite contributed significantly to the

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INDONESIA: TELECOMMUNICATIONS AND IT DEVELOPMENT 181

expansion of foreign direct investment in Indonesia after 1970. In 1980 the government bought all the shares of Indosat, changed it to a state-owned company, and made it the sole provider of international telecommunications in Indonesia. Indosat operates four international gateways: Surabaya, Jakarta, Medan, and Batam, and maintains communications with more than 240 countries around the world. Thus, the telecommunications sector came under the control of Telkom, which had the monopoly over the domestic telephone and telecommunication system, and Indosat (PT Indonesian Satellite Corporation), which monopolised telecommunications with foreign countries through satellites and undersea cables. During this phase, through the two state companies, the government focused on developing three systems — microwave, satellite, and undersea cable and fibre-optic systems — as components of an integrated transmission infrastructure to provide efficient telecommunications for Indonesia. Microwave Systems

Indonesia developed a microwave system called Nusantara Microwave Networks to enable “direct interlocal”, or long-distance direct-access, calls. There are four microwave networks: Trans-Sumatra, Java-Bali, Surabaya-Banjarmasin, and Eastern Indonesia. The microwave network development project began in 1969 and the Java-Bali network was completed in 1973. The Trans-Sumatra network was completed in 1975, and the Eastern Indonesia network was inaugurated in June 1978. The Surabaya-Banjarmasin “Troposcatter” was built to link the islands of Java and Kalimantan. This system transmits microwaves into the troposphere, after which they are further scattered in such a way as to be able to be received at a distance of over 1,000 kilometres. Satellite System

In 1970 Indonesia began to pursue the idea of building a domestic satellite communications system to augment the microwave network. The decision to use satellites for domestic telecommunications was a brave one and a leap into the future in the telecommunication business. At the time, only two advanced countries (the United States and Canada) used satellites for domestic telecommunications. The idea was realised with the launching of the Palapa satellite on 8 July 1976 from Kennedy Space Centre in the United States. The Palapa

© 2003 Institute of Southeast Asian Studies, Singapore

182 HAMONANGAN HUTABARAT

satellite covers all of Indonesia and the ASEAN countries. It has the capacity to carry 6,000 telephone lines and 12 television channels. With its broad coverage the satellite is relatively cheaper than other transmission systems. It also provides a higher quality and a more sophisticated level of communication. The development of the satellite system induced the domestic manufacture of small earth stations, TV broadcasting stations with medium power, and related equipment. Undersea Cable and Fibre-Optic Systems

Indonesia developed undersea cable and fibre-optic systems for both domestic and international telecommunications. To enhance domestic telecommunications, an undersea cable was laid to connect Surabaya and Banjarmasin on Kalimantan, and fibre-optic cable was used for the North path and the South path of the main-line transmission network on the island of Java. For international telecommunications, the government developed an undersea fibre-optic cable to connect Indonesia with France through the Southeast Asia-Middle East-West Europe II (SEA-ME-WEII) and one between Jakarta, Surabaya, and Australia (JA-SUR-AUS). Private-Sector Participation Phase: 1989–1999

The second phase in the development of Indonesia’s telecommunications sector started with the enactment of Law No. 3 of 1989 and the implementing regulation, Government Regulation No. 8, issued on 16 February 1993. The 1989 Telecommunications Law began the deregulation of the sector and opened the door for private investment, with certain restrictions. This law distinguished basic telecommunication services, which involve the simple delivery of information, from non-basic or value-added services, and defined the role of the private sector in Article 12 Section IV: • The operation of telecommunications service is conducted by the government, where further operations of telecommunication services can be delegated to the Badan Penyelenggara, or Executing Body. The Executing Body consists of the two state telecommunications companies, PT Telkom and PT Indosat. • Other bodies beside the Executing Body can operate basic telecommunication services in co-operation with the Executing Body, while they can operate non-basic telecommunication services without the co-operation of the Executing Body.

© 2003 Institute of Southeast Asian Studies, Singapore

INDONESIA: TELECOMMUNICATIONS AND IT DEVELOPMENT 183

• Special-purpose telecommunications services can be operated by the government institutions concerned, by an individual or legal body beside the Executing Body, and by other institutions as stated above. In other words, licensed private companies were permitted to provide nonbasic telecommunications independently, but in order to operate in the field of basic telecommunications private investors had to co-operate with Telkom for domestic services or with Indosat for international services. Although implementation did not begin until 1993, the 1989 Telecommunications Law eventually stimulated many new activities in Indonesia’s telecommunications sector including joint ventures, joint operations, communication satellite management companies, independent private companies, and the Nusantara-21 Project. Joint Ventures between State Companies and Private Companies

Numerous foreign and domestic private businesses formed joint ventures with the two state telecommunications companies to offer basic telecommunication services. Telkom for example, became affiliated with twenty-one joint venture companies (Table 7.1). Six of these joint ventures provide mobile cellular telecommunications service: PT Satelit Palapa Indonesia (Satelindo); PT Radio Telepon Indonesia (Ratelindo); PT Komunikasi Selular Indonesia (Komselindo) PT Telekomindo Primabhakti; PT Telekomunikasi Selular (Telkomsel); and PT Metro Selular Nusantara (Metrosel). Their formation led to the explosive growth in mobile phone usage since 1993. Joint Operation Companies

In the mid-1990s, Indonesia had only 1.4 phones per 100 inhabitants, a very low rate compared to its neighbours, and the government intended to increase the capacity of local telephone centres by at least 5 million lines during the Sixth Five-year Plan (1994–99), adding 1 million new lines per year. In order to achieve this goal, it opened the opportunity for the private sector, including foreign investors, to co-operate with Telkom through a joint operation scheme. First, Telkom reorganised its twelve regional operating divisions into seven regional divisions and one network division. Each regional division was responsible for providing telecommunication service in its region, while the network division was responsible for long-distance service through

© 2003 Institute of Southeast Asian Studies, Singapore

1988

–

PT Telkom Personal

PT Aplikanusa Lintasarta (Lintasarta)

–

PT Menara Jakarta

Established

Telecommunication service (direct data line), package data communication line, micro earth station communication system, and network application service for industry, finance and banking and other industries, electronic information system, and IDOLA

Regional PHS service

Tower management

Activity Areas

PT Telkom PT Indosat Staff institutions from several banks Employee co-operatives of Department of Telecommunication

PT Telkom PT Indosat PT INTI YKEP Yayasan 64

PT Telkom PT Indosat TVRI Indocitra

Ownership

TABLE 7.1 Companies Affiliated with PT Telkom

© 2003 Institute of Southeast Asian Studies, Singapore

3.74

45.00

25.00 18.80

64.00 4.00 12.00 10.00 10.00

20.00 20.00 9.00 51.00

% Share

continued on next page

VSAT, Cyber Optik

PHS

–

Applied Technology

184 HAMONANGAN HUTABARAT

1989

1990

1991

PT Citra Sari Makmur (CSM)

PT Telekomindo Primabhakti

PT Pasifik Satelit Nusantara (PSN)

Established

TABLE 7.1 – cont’d

© 2003 Institute of Southeast Asian Studies, Singapore

Satellite telecommunication service

Construction and STBSAMPS and STBS-GSM telecommunications services

VSAT satellite communication, network data package, E-mail

Activity Areas

PT Telkom PT Elektrindo Nusantara Quoin Financial Corporation PT Primaupaya Lintaswara PT Skaisnetindo Teknotama Hughes Space & Communications Int’l. Telesat Canada PT Mutuprima Abadi

PT Telkom PT Rajawali Corporation Yayasan Dana Pensiun Pegawai Telkom Yayasan Kartika Eka Paksi Yayasan Tridaya Kejaksaan Agung RI KOPEGTEL

PT Telkom Bell Atlantic Indonesia, Inc PT Tigatra Media

Ownership

8.85 8.85 1.77

25.85 19.33 16.21 9.70 9.38

2.00 0.40

10.00 10.00

10.00 54.00

25.00 36.71 38.29

% Share

continued on next page

Palapa Nusantara satellite (eks B1), transponder Palapa C Extended C-Band, ACeS, PLMNs (public land mobile networks), PSTNs (public switched telephone networks)

AMPS dan GSM

VSAT, Demand Assign Multiple Access (DAMA)

Applied Technology

INDONESIA: TELECOMMUNICATIONS AND IT DEVELOPMENT 185

1993

1993

1993

PT Satelit Palapa Indonesia (Satelindo)

PT Radio Telepon Indonesia (Ratelindo)

PT Bangtelindo

Established

TABLE 7.1 – cont’d

Planning and control management of means of telecommunication development services

Radio phone line telecommunication service

Satellite telecommunication service, digital cellular phone GSM, and SLI (international direct line)

Activity Areas

PT Telkom PT Indosat PT INTI KOPTEL Koperasi Bina Sejahtera PT INTI Koperasi Pegawai Indosat Koperasi Pegawai Kantor Pusat Deppar-postel Dana Pensiun PT Telkom

PT Telkom PT Bakrie Electronics Company

PT Telkom PT Indosat PT Bimagraha Telekomindo De Te Mobile

Ownership

© 2003 Institute of Southeast Asian Studies, Singapore

1.22 73.14

2.44 2.44

4.85 3.66 6.10 6.10

55.00

45.00

22.50 7.50 45.00 25.00

% Share

continued on next page

–

CDPD (cellular digital packet data), E-TDMA

GSM, Palapa satellite C1, C2, dan B4, Intelsat satellite, MCS (master control stations), BCS (base control stations), BTS (base transceiver stations), SKKL (Marine Cable System)

Applied Technology

186 HAMONANGAN HUTABARAT

1995

1995

1995

1995

PT Komunikasi Selular Indonesia (Komselindo )

PT Telekomunikasi Selular (Telkomsel)

PT Infomedia Nusantara

PT Metro Selular Nusantara (Metrosel)

Established

TABLE 7.1 – cont’d

© 2003 Institute of Southeast Asian Studies, Singapore

STBS-AMPS service

Telephone directory publication service, telex, and facsimile

STBS-GSM telecommunication service

STBS-AMPS telecommunication service

Activity Areas

PT Telkom YDPP PT CPS-C PUSKOP ABRI PT Djati Yuda Komunikautama Asialink

PT Telkom Elnusa Dana Pensiun Elnusa

PT Telkom PT Indosat PTT Telecom Netherland PT Setdco Megacell Asia

PT Telkom PT Elektrindo Nusantara

Ownership

4.00 20.00

20.17 3.83 51.20 0.80

15.00 70.00 15.00

42.74 35.00 17.28 5.00

35.00 65.00

% Share

continued on next page

AMPS

Local Area Network (LAN)

GSM, Compact Mobile Base Station (Combat)

AMPS

Applied Technology

INDONESIA: TELECOMMUNICATIONS AND IT DEVELOPMENT 187

1995

1996

1996

1997

1997

PT Patra Telekomindo (Patrakom)

PT Batam Bintan

PT Mobile Selular Indonesia (Mobisel)

PT Indonusa Telemedia

PT Multimedia Nusantara

Established

TABLE 7.1 – cont’d

© 2003 Institute of Southeast Asian Studies, Singapore

Pay TV and multimedia, excluding telephone service

Interactive multimedia telecommunication service (non-telephony)

NMT-450 cellular telecommunication service

Permanent network telecommunication service in Batam

Satellite communication service for oil and gas industry

Activity Areas

5.00

25.00 70.00

95.00

5.00

30.00 10.00 40.00 20.00

% Share

PT Telkom Indocitra Grahabawana Yayasan TVRI PT Indosat Megamedia

31.00 49.00 5.00 15.00

PT Telkom 35.00 PT Telekomindo Primabhakti 20.00 RCTI 20.00 Datakom 25.00

PT Telkom PT Rajasa Hazanah Perkasa Dana Pensiun Pegawai Telkom

PT Telkom Batamindo Industrial Corporation

PT Telkom PT Indosat Elnusa Tanjung Mustika

Ownership

–

–

continued on next page

TV cable, Internet, HFC

Nordic Mobile Telephone 450I (NMT)

VSAT, Internet, Modem Satelit

Applied Technology

188 HAMONANGAN HUTABARAT

© 2003 Institute of Southeast Asian Studies, Singapore

1997

1998

PT Indomedia Telephone Cellular Nasional (Indophone)

PT Tangara Mitrakom (Tangarakom)

Micro earth station communication system service

National telecommunication service PCN/DCS-1800

PCS/PCN/DSN-1800 Telecommunication Service

Activity Areas

Ownership

PT Telkom Koperasi Swadharma PTC

PT Telkom PT Nusamba

PT Telkom Cellnet

Source: Prospektus PT Telkom, October 1995 and Annual Reports of PT Telkom.

1997

PT Selnet Nasional Indonesia (Selnet)

Established

TABLE 7.1 – cont’d

25.00 10.00 65.00

35.00 65.00

10.00 90.00

% Share

Transmission of TDM/TDMA, SCPC DAMA (Single-channel per carrier demand assign multiple access)

PCN/DCS-1800

PCS,PCN,DSN-1800

Applied Technology

INDONESIA: TELECOMMUNICATIONS AND IT DEVELOPMENT 189

190 HAMONANGAN HUTABARAT

Telkom’s national main-line transmission networks. Management of the regional divisions was decentralised so that each division was expected to act as an investment and profit centre. In conjunction with the reorganisation, the government granted Telkom exclusive right to supply local fixed telephone and fixed wireless telecommunications service for a period of at least fifteen years from 1 January 1996 and to provide domestic longdistance direct-dial service for at least ten years. Then, Telkom signed Joint Operation Agreements with five consortia of private investors for five of the new regional divisions — in October 1995 for Divisions I, III, IV, and VII and in May 1996 for Division VI.1 Each consortium consisted of domestic companies and at least one well-known international telecommunications company. Telkom was to transfer operation of all its facilities to the Joint Operation Scheme (JOS) consortium in each Division. For their part, the five consortia, or “JOS partners” of Telkom agreed to develop and operate facilities and provide basic telecommunication service in the Division on behalf of Telkom (Table 7.2). Every JOS partner was expected to build at least 2 million new telephone lines within the first five years, in line with PT Telkom’s fiveyear national plan. The foreign participants in the consortia were expected to contribute investment capital and managerial capability to speed development. The JOS Agreements also stipulated the amount of online capacity that Telkom was to construct by 31 December 1998 and transfer to each JOS partner on completion. The JOS partners agreed to compensate PT Telkom for specified construction costs. PT Telkom was guaranteed a minimum 30 percent share of total annual operating revenue if its actual construction cost exceeded the agreed amount. Communications Satellite Management Companies

Expansion of communication networks and of the role of private investment in the telecommunications business opened new opportunities for private domestic companies in the management of satellite communications. Indonesia now has five companies that operate satellite telecommunication services; two of these are state-owned and three are public-private joint ventures. • PT Telkom manages the B2R, B4, and TELKOM-1 satellites, which serve domestic telecommunications. Each satellite has 24 transponders with C-band frequency. The satellites cover Indonesia, Singapore, Malaysia, Thailand, Vietnam, Cambodia, Philippines, Hong Kong, Papua New Guinea, and Australia.

© 2003 Institute of Southeast Asian Studies, Singapore

Aria West International

West Java Division III Mitra Global Telekomunikasi Indonesia

Central Java Division IV

• US West • Telstra Global International BV Ltd. (20%) (35%) • Nippon Telegraph and Telephone Corp. (15%) Indonesian: • PT Astratel • PT Artimas • PT Indosat (30%) Nusantara (59.5%) Kencana (52.5%) • PT Widya Duta • Other (5.5%) • Asian Infopmindo (15%) Infrastructure • PT Krida Salindo Fund (12.5%) Sentosa (10%) • Other Indonesian Partners (10%)

Consortium members Foreign: • France Cable et Radio SA (35%)

JOS partner with PT Telkom Pramindo Ikat Nusantara

Sumatra Division I

• Singapore Telecommunication International Pte. Ltd (45%)

Bukaka SingTel

Archipelago Division VII

NA

NA

All Divisions

• PT Intidaya • PT Bukaka NA Sistelindomitra Telekomindo (29.03%) International • PT Alatief (55%) Nusakarya Corp. (24.19%) • TM Communications (HK) Ltd. (9.68%) • American International Assurance Co., Ltd. (9.68%) • Other (2.42%) continued on next page

• Cable and Wireless PLC (25%)

Daya Mitra Malindo

Kalimantan Division VI

TABLE 7.2 Details of PT Telkom’s Joint Operating Scheme

INDONESIA: TELECOMMUNICATIONS AND IT DEVELOPMENT 191

© 2003 Institute of Southeast Asian Studies, Singapore

10.0 823.7 30

1,075.1 30

372,267 441,583 400,000

Central Java Division IV

30.0

377,426 529,860 500,000

West Java Division III

435.2 30

20.0

149,881 230,403 237,000

Kalimantan Division VI

566.1 35e

10.0

410,401 497,688 403,000

Archipelago Division VII

4,254.7 NA

105.0

2,028,754 2,506,710 2,056,487

All Divisions

Notes: aOnline capacity to be constructed by Telkom and transferred to JOS unit when completed. b Minimum new lines to be constructed by each JOS unit during initial five years. c The JOS Partners pay compensation to Telkom in accordance with the total facilities available during the JOS construction period. The figures above are converted at Rp2,246 = US$1.00 at Bank of Indonesia on 30 June 1995. d Net Present Value of minimum revenues for Telkom in 15 years, using a discount factor of 18 percent. e Telkom’s revenue share will be adjusted (with a minimum 30%) if the actual cost of investment exceeds the approved amount. Source: PT Telkom Prospectus, Jakarta, 1995.

PT Telkom lines under constructiona Dec 31, 1995 718,779 Dec 31, 1998 807,176 516,487 New linesb Compensation costc US $ million 35.0 PT Telkom revenues US$ milliond 1,354.6 % share 30

Sumatra Division I

TABLE 7.2 – cont’d

192 HAMONANGAN HUTABARAT

© 2003 Institute of Southeast Asian Studies, Singapore

INDONESIA: TELECOMMUNICATIONS AND IT DEVELOPMENT 193

• PT Indosat manages Intelsat and Inmarsat satellites, which are owned by an international consortium to which Indonesia belongs. • PT Satelindo manages the Palapa C1 and C2 satellites and provides international telecommunication service together with Indosat under Government Regulation No. 8 of 1993. Each satellite has 34 transponders of C-band and Ku-band frequencies. The two satellites cover the Asia region, Australia, and New Zealand. • PT Pacifik Satellite Nusantara started in business by managing a used Palapa B satellite under the new name of Palapa Pacific. Through its sister company, PT AceS, it launched the first Asia Cellular satellites, Garuda 1 and Garuda 2, in 1996. • PT Datakom Asia manages a television broadcasting satellite named Cakrawala. The satellite also has five transponders with S-band frequency for digital-TV. Private Companies in Non-basic Telecommunication Services

Ever since the 1989 Telecommunications Law permitted private companies to operate non-basic telecommunications service, this business has grown rapidly. Many new companies were established offering services based on information technology such as Internet and intranet provider services, data communication services, video-conferencing, video entertainment, and telephone and Internet cafes and kiosks. The Nusantara-21 Project

The government took the lead in multimedia communications in Indonesia with the launching of Nusantara-21 in 1996. This project envisioned the development of a multimedia infrastructure network together with content and facilities that would be the starting point in Indonesia’s transition to the global information society. Nusantara-21 differs from Malaysia’s Multimedia Super Corridor (MSC), which concentrated on development of physical infrastructure in a 15-by50 square kilometre area. It also differs from Singapore’s IT2000 (announced in 1992), which followed on Singapore’s physical integration as an Island Intelligent through the “Singapore ONE” (One Network for Everyone) Project. The core of Nusantara-21 is a main-line information transmission network connecting Indonesia’s twenty-seven provincial capitals and creating a single, heterogeneous Nusantara Region (Figure 7.1).2 The Nusantara-21 Project also envisioned the gradual development

© 2003 Institute of Southeast Asian Studies, Singapore

194 HAMONANGAN HUTABARAT

FIGURE 7.1 Vision of Nusantara-21 Backbone Infrastructure

Palapa B5

Palapa B4

Palapa B6

Palapa C1

Palapa C2

Palapa D

LEO/MEO

Sub-Marine F0, 2x5G bps. to Singapore & Malaysia

Bengkulu

Samarinda

Medan Pontianak

Pekanbaru

Sumatera Ring

Aceh

Lampung

Padang

Palu

Kalimantan Ring

Manado

Maluku

Sulawesi Ring

Palangkaraya

Kepulauan Ring

Banjarmasin Ujung Pandang Jambi

Planned (1996) Sub-marine F0. 2x5G bps to Hongkong, Malaysia, Bombay

Palembang

Sub-Marine F0, 2x560M bps & 2x5G bps. to Singapore

Bandung

Ring of Rings

Surabaya

Jakarta

Java Ring

Bali, Tim-Tim. & Nusa Tenggara Ring

Sub-Marine F0, 2x560Mbps. to Colonto Sub-Marine F0, 2x5G bps. to Australia

Irian Jaya Kerdar

Kupang

Mataram

Earth Station with Gateway

Semarang Yogyakarta

LEGENDS

Denpasar

Dili

Gateway in Province Capital

Satellite STM-1 (156M bps) STM-16 (2.5 G bps)

Source: Zuraida Boerhanoeddin, E-commerce in Indonesia, .

of eleven Multimedia Cities (including Jakarta, Surabaya, Medan, and Batam) which would be centres of information-based economic and social activities such as telecommuting, electronic trading, and electronic banking. A third aspect of Nusantara-21 is the development of Multimedia Community Access Centres to give local residents access to informationbased services. The Nusantara-21 vision sees Indonesia joining the global IT community in the twenty-first century, starting with information and institutional infrastructure and led by the public sector to be followed by the private sector. Progress towards realising the vision began when Nusantara-21 was included in the 1996 Outline of State Policy (Garis Besar Haluan Negara, GBHN) and in the Five-Year Plan for 1998–2003 (Repelita VII). In a 1997 decree, the government appointed a National Telematica Coordination Team, headed by the Co-ordinating Minister of Economics, Finance, and Industry. This team announced that: • All major government offices should have a website, and offices up to the second echelon level should have e-mail addresses. • The year 2001 would be National Telematica Year. © 2003 Institute of Southeast Asian Studies, Singapore

INDONESIA: TELECOMMUNICATIONS AND IT DEVELOPMENT 195

Impact of Private Sector Entry

Opening the telecommunications sector to private-sector participation had uneven success in raising the level of Indonesia’s telecommunications infrastructure. Mobile cellular telephone service spread rapidly with the entry of Satelindo and other Telkom joint ventures. Starting from 32,000 in 1993, the number of mobile phones increased over 200 percent in each of the next two years (Table 7.3). The rapid growth in part resulted from the fierce competition among the six public-private firms in the cellular phone business. This contrasted with the situation with fixed-line telephone service, where, rather than competing with other providers, each JOS partner enjoyed exclusive rights to provide service in its District. The total number of fixed telephone lines did increase six-fold from 1.04 million lines in 1990 to 6.08 million lines in 1999 (Table 7.3). Entry of private investors did not accelerate the development of fixed telephone lines, however. In fact, from over 30 percent in 1994 and 1995, the growth rate of phone lines TABLE 7.3 Mobile Cellular Subscribers and Fixed Telephone Lines, 1990–2000 Mobile Cellular Subscribers

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 Q3 CAGR 1993–97 1993–99 1990–99

Fixed Telephone Lines

Number ('000)

% change

Number ('000)

% change

– – – 32.8 62.4 193.4 593.6 1,061.1 1,065.8 2,221.0 3,198.6

– – – – 90.2 210.1 206.9 78.8 0.4 108.4 –

1,043.7 1,276.6 1,542.0 1,848.7 2,439.7 3,290.9 4,186.0 4,982.5 5,571.6 6,080.2 6,535.8

– 22.3 20.8 19.9 32.0 34.9 27.2 19.0 11.8 9.1 –

138.5% 101.9% 21.6%

Source: CIC No. 219, 11 February 1999; dalam Usahawan, No. 5, May 1999; PT. Data Consult Inc., No. 291, 9 May 2000; and .

© 2003 Institute of Southeast Asian Studies, Singapore

196 HAMONANGAN HUTABARAT

has fallen every year since the reorganisation of Telkom and the introduction of the JOS. Impact of the Currency, Economic, and Financial Crises

The currency crisis that started in 1997 and developed into economic and political crises had a severe impact on Indonesia’s telecommunications sector. The sharp drop in the value of the rupiah had a drastic effect on the capital-intensive, import-dependent sector. The operating companies had great difficulty meeting their foreign commitments as the external value of their rupiah revenues was depreciating precipitously. All the stakeholders in the telecommunications sector (from the government, as policymaker and regulator, to business owners) were forced to focus on meeting shortterm interest payments rather than on pursuing long-term investment and business development. Activity in the sector declined for three years after 1997. Many projects were cancelled for lack of investment funding. For example, the government’s plan to add 1 million new telephone lines every year has fallen by the wayside. PT Telkom had difficulty constructing the lines it was to transfer to the JOS partners by the end of 1998, and likewise the JOS partners had trouble meeting their commitments to add new lines by the agreement deadline. These problems created further misunderstandings that became public as some parties to the Joint Operation Agreement attacked other parties. The worst situation was the termination of the Agreement for Division III with Aria West International in July 2001.3 Mobile cellular service providers were also hurt by the currency crisis and the ensuing drop in domestic demand. Their most difficult year was 1998. The value of the currency fell from Rp2,500 to Rp15,000 per U.S. dollar, and the number of new mobile subscribers increased only 0.4 percent (Table 7.3). The economic crisis also made it difficult for mobile phone companies to implement their plans for 1999. For example, Telkomsel, Indonesia’s largest GSM operator, was unable to obtain financing to carry out its medium-term plans to increase from 1.1 million to 1.5 million subscribers. In 1999, unable to expand capacity to handle the intensity of call traffic more efficiently, it had to relocate three existing BTSs (base transceiver systems) to relieve the pressure in the large cities. Although the crises hurt all mobile phone companies, GSM operators came through the difficulties in better condition than analog services. Financing difficulties put the brakes on the plans of PT Satelindo, another GSM provider, to expand its network on Java and outside of Java. But

© 2003 Institute of Southeast Asian Studies, Singapore

INDONESIA: TELECOMMUNICATIONS AND IT DEVELOPMENT 197

Satelindo’s market position benefited from the company’s co-operation with Siemens in the application of WAP (wireless application protocol, a technology that facilitates Internet access from mobile cellular phones). In 2000 Indonesia’s third GSM operator, PT Excelcomindo, added two Mobile Switching Centres (MSCs), one in Jakarta (where 70 percent of its customers are located) and the other in Surabaya. With the US$10 million investment in the Jakarta MSC, the company can expand capacity from 170,000 to 320,000 lines.4 In contrast, the market share of analog (AMPS/NMT) operator Komselindo declined continuously as a result of the aggressive expansion by the operators of the more popular GSM service, plunging from 48.4 percent in 1995 to only 4.4 percent in 1999. With a large foreign loan that must be repaid soon, the company is struggling to find foreign investors. In mid-1999, Komselindo which is based in Jakarta and West Java merged with Metrosel, the other AMPS operator, which is based in Central and East Java, to form a joint operation and service company. As a result of the co-operation, Metrosel’s customers can connect with Komselindo’s customers without going through the Telkom network, and vice versa. This new system can reduce calling charges by 40 percent. Another victim of the economic and financial crises was the Nusantara21 Project. Plans for the multimedia infrastructure project lost momentum in the economic debacle and in the political turmoil that followed the stepping down of President Suharto and the short term of his successor, Habibie. One positive trend in the telecommunications sector since the outbreak of the crises has been the rapid increase in the number of telephone kiosks and Internet cafes. These small, private companies operating between the telecommunications and Internet industries have played a strategic role in spreading Internet technology throughout Indonesia because they are located in end-user areas. Globalisation Phase: 1999 to Present

Indonesia’s telecommunications sector entered the globalisation phase with the promulgation of Law No. 36 in 1999 (1999 Telecommunications Law). This law, which became effective on 8 September 2000, will soon transform the structure of the telecommunications industry. The spirit behind the 1999 Telecommunications Law was the need for business liberalisation as a result of technological change and changes in the global business environment. The new law moves in the direction of opening the

© 2003 Institute of Southeast Asian Studies, Singapore

198 HAMONANGAN HUTABARAT

entire industry to private sector participation. It abolished the role of the Executing Body and the requirement for the state companies to participate in the ownership of any telecommunications company providing basic service. The earlier telecommunications law (Law No. 3 of 1989) had segmented the industry into a monopoly for basic domestic local and long-distance fixed services, a duopoly for basic domestic wireless and international direct-dial services, and an oligopoly for non-basic mobile cellular telecommunication services and radio communication for the general public (Table 7.4). The new 1999 law divided the telecommunications sector into three fields: network providers, service providers, and special-purpose telecommunications operators, and it opened the network-provider and service-provider fields to private business. In addition, it stated that the term of the exclusive rights granted to Telkom and to Indosat could be shortened by mutual agreement between the government and the Executing Body. Accordingly, the two parties moved the expiration of Telkom’s monopoly up to 2002 from the termination dates established in 1996, which were 2005 for domestic long-distance and 2010 for local telephone services. They also agreed to terminate Indosat’s exclusive right to manage international direct-dial service at the end of 2003, rather than in 2004 as previously established.5 The 1999 Telecommunications Law opened the horizons of the telecommunications business in Indonesia, and the business sector positively and vigorously accepted the new policy. Unfortunately, though, because of the lingering economic crisis, the instability of the political situation, and the government’s budget crisis no private parties were ready to make large investment in the sector, and the main impact of the new law so far has been on the state companies. By opening monopolised areas to new entrants, including other state companies, the Telecommunications Law of 1999 put Telkom and Indosat in competition with each other. Now, Telkom is preparing to enter the international telecommunication business and Indosat is preparing to offer domestic long-distance and local telephone connections. Furthermore, these two companies are preparing to unwind their cross-shareholdings in affiliates and in the joint operation companies. Telkom plans to buy all of Indosat’s shares in Telkomsel for US$945 million, while Indosat will buy Telkom’s shares in Satelindo for US$186 million, in PT Aplikanusa Lintas Arta for US$38 million, and in PT Mitra Global Terlekomunikasi Indonesia for US$375 million. These crossshareholdings in affiliated companies generated problems for PT Telkom within the Joint Operation Scheme. For example, in Division IV (Central

© 2003 Institute of Southeast Asian Studies, Singapore

© 2003 Institute of Southeast Asian Studies, Singapore

Source: Compiled by author from various official government documents.

Regulator

Licensing

Form of Co-operation

Organiser

Implementation

Organising body (Telkom and Indosat) and other institutions in co-operation with an organising body Joint venture, Joint operation, Management contract Based on evaluation First-come, first-served Non-transparent Government

Monopoly Exclusive Monopoly Duopoly Closed Oligopoly • Basic service: network and telephone service • Non-basic service: value-added service Basic service must be operated jointly with an Executing Body

Spirit

Structure

Act No. 3 of 1989 Government Regulation No. 8 of 1993 Minister of Telecommunications Decree No. 39

Set of Regulations

Act No. 3 of 1989

Opportunities published by government Selection and evaluation Transparent, fair, and simple Independent regulatory institution

• Network services: Fixed, mobile, and leased-circuit • Basic services: Telephone, value-added telephone, and multimedia • Special purpose telecommunications State companies, private companies, and co-operatives having equal status Submitted to the Organiser.

Multi-operator Open

Act No. 36 of 1999 Government Regulation No. 52 of 2000 Government Regulation No. 53 of 2000 Decree of the Minister Competition

Act No. 36 of 1999

TABLE 7.4 Comparison of Telecommunications Acts of 1989 and 1999

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686.54 56.91 251.71 39.54 132.97 19.96 1,187.63

Source: Central Bureau of Statistics, Annual Reports.

Printed circuit boards CPUs and computers Telephones and facsimile machines Printers Integrated circuits Semiconductors Total

1998 884.26 218.36 158.08 81.66 67.41 18.98 1,428.75

1999

Exports

28.8 283.7 –37.2 106.5 –49.3 –4.9 20.3

1998–99 % growth 24.08 116.44 291.64 9.02 13.08 1.44 455.69

1998 26.99 94.67 76.41 14.66 7.09 2.01 221.83

1999

Imports

12.1 –18.7 –73.8 62.6 –45.8 40.3 –51.3

1998–99 % growth

662.46 –59.53 –39.93 30.52 119.89 18.52 731.93

1998

857.27 123.69 81.67 66.99 60.32 16.97 1,206.91

1999

Balance of Trade

TABLE 7.5 Trade in Information Technology and Telecommunications Products, 1998 and 1999 (US$ millions)

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Java), the company’s trade union showed its objection to them by raising protests and striking. The major reason for the union’s stance was that Indosat had no experience in long-distance service.6 INFORMATION TECHNOLOGY INDUSTRY, INFRASTRUCTURE, AND ACCESS

Telecommunications is only one part of the infrastructure that Indonesia needs to connect with the global information economy. Production and Trade in IT Products

On balance, Indonesia is a net exporter of IT products (Table 7.5). Indonesia’s IT manufacturing industry consists of printed circuit boards (PCBs), computer central processing units (CPUs), telephone and fax machines, computer printers, integrated circuits (ICs), and semiconductors. Between 1998 and 1999 exports of IT products rose 20 percent from US$1.19 billion to US$1.43 billion, although they still comprised under 3 percent of total exports. Export of CPUs increased the most, at a rate of 284 percent, followed by printers with a 106 percent increase, and PCBs exports, which increased 29 percent. In fact, export of other IT products (except PCBs, CPUs, and printers) declined. The main export destinations were Singapore (35.9 percent), Japan (22.8 percent), United States (14.9 percent), Malaysia (9.1 percent), and Germany (3.9 percent). Indonesia’s imports of IT products fell 51 percent from US$456 million in 1998 to US$222 million in 1999 as a consequence of the economic crisis. Despite the lingering economic crises investment in the IT manufacturing industry is still growing. From 1999 to the first quarter of 2000, foreign direct investment in Indonesia’s IT sector totalled US$525.7 million. Epson of Japan made the largest investment, in the amount of US$155.4 million, followed by Advanced Microtronics from the United States with US$151.2 million, Wearness Technology of Singapore with US$74.0 million, Japan’s NEC with US$65.0 million, and Seagate Technology of Singapore with US$65.1 million. Diffusion of Personal Computers

The availability of PCs in Indonesia increased significantly during the 1990s. Starting from 84,700 in 1991 domestic sales of PCs jumped to 430,000 in 1997, a compound growth rate of 31 percent per year (Table

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TABLE 7.6 Sales of Personal Computers, 1991–2000

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 Q1 CAGR 1991–97 1991–99

Number of Units

% change

84,734 105,802 171,075 251,831 316,058 400,054 430,000 92,380 281,000 99,000

– 24.9 61.7 47.2 25.5 26.6 7.5 –78.5 204.2 –

31.1% 16.7%

Source: CIC No. 239, 1999 and Bisnis Indonesia, 6 March 2000.

7.6). Although sales of PCs fell almost 80 percent in 1998, in the aftermath of the financial and economic crises, they started to recover in 1999. Nevertheless, the number of units sold in 1999 was only two-thirds the number sold in 1997. Despite the upward sales trend, PCs are still rare. According to the International Telecommunication Union, in 1998 Indonesia had only 8.2 PCs per 1,000 inhabitants (World Bank 2001, Table 19). Another source estimates that only 6 percent of Indonesian households owned PCs as of the first quarter of 2000 (See Table 7.13). Internet Access

According to the Indonesian Internet Service Provider Association (APJII), the number of Internet subscribers multiplied from 31,000 in 1996 to 384,000 at the end of 2000 (Table 7.7). The Association estimates the total number of Internet users in 2000 at 1.45 million, up from just 110,000 in 1996. It is difficult to judge the number of Internet users accurately, but it is certain that it exceeds the number of subscribers, by a factor of almost four according to the APJII.

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TABLE 7.7 Internet Users and Subscribers, 1996–2000 Users

1996 1997 1998 1999 2000 CAGR 1996-00

Subscribers

Number ('000)

% change

Number ('000)

% change

Ratio of users to subscribers

110 384 512 1,000e 1,450e

– 249.1 33.3 95.3 45.0

31 75 134 256e 384e

– 141.9 78.7 91.0 50.0

3.5 5.1 3.8 3.9 3.8

90.5%

87.6%

Note: e designates estimate. Source: Asosiasi Penyelenggara Jasa Internet Indonesia (Indonesian Internet Service Provider Association), .

Indonesia has many more Internet users than subscribers because most people log on from public access points. A survey conducted by A.C. Nielson in mid-2000 found that Indonesians accessed the Internet most frequently from offices (45 percent of responses), followed by Internet cafes (18 percent), educational institutions (14 percent), and relatives’ or neighbours’ homes (12 percent). With small percentages of Indonesian households having telephone service or owning personal computers, cyber cafes and telephone kiosks have become a popular means to access the Internet. The number of “Warnets”, or cafes offering Internet service, increased 30 percent during the year 2000, to 2,500, and they can be found in every major city. In fact, Indonesia has the most Internet kiosks among countries in the Asia-Pacific region. The Nielson survey also found that 55 percent of Indonesian Internet users are employees, 30 percent are students, and 15 percent are high-school graduates. Indonesia has three local domain registration institutions. IDNIC (www.idnic.net.id) was the first and uses the country’s top-level domain, ‘id’. MedanNIC (www.medannic.com) is affiliated with the international organisation, ICANN (Internet Corporation for Assigned Names and Numbers) and Namadomain is a newly established institution affiliated with InterNic. These three institutions are now competing for market share of domain names for Indonesia. Out of the total of 7,435 registered domain names as of July 2000, IDNIC had 2,187 and MedanNIC had 543 (Table

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TABLE 7.8 Registered Domain Names, 1995–2000

1995 1996 1997 1998 1999 2000, July CAGR 1995–99

Number

% change

87 723 1,487 2,170 4,707 7,435

– 731.0 105.7 45.9 116.9 –

143.4%

Source: IDNIC, Bisnis Indonesia, 13 March 2000, Gatra, 1 July 2000, IDNIC, MedanNIC, and Bisnis Indonesia, 20 July 2000.

7.8). From 1995 to 1999 the number of registered domain names grew at a compound annual rate of 143 percent, although new registrations increased by only 46 percent in 1998 in yet another consequence of the economic crises. Most of the registered domain names are in the business (.co) and organisation (.or) categories of the international domain classification system (Table 7.9). The Post and Telecommunications Ministry has issued more than 150 licences for Internet service providers, but only about 40 licensees are TABLE 7.9 Local Domain Names by Type (Q1 2000)

ac.id co.id or.id net.id mil.id web.id sch.id Total

Type

Number

Share of Domain Names (%)

Education Business Organization Internet Military Website

405 4,733 1,251 309 6 540 191 7,435

5.45 63.66 16.83 4.16 0.08 7.26 2.57 100.0

Source: IDNIC and Bisnis Indonesia, 13 March 2000.

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operating ISPs, mostly located in Jakarta. WasantaraNet (www. wasantara.net.id), which was developed and operated by the post office, has the widest coverage with 116 nodes reaching most provinces.7 E-Commerce

Although e-commerce had become widespread in developed economies by 1996, it has attracted serious attention in Indonesia only since 1999. The Indonesian government could not act as technological leader in this application of IT because of its crisis-created fiscal problems and because deregulation had diminished its direct role in the telecommunications sector. Moreover, until early 1999, the private business community was also focused on overcoming the economic crises. Indeed, most large domestic corporations were connected to the banking crisis and were kept busy by the government investigation into the misuse of loans from the central bank. In mid-1999, however, companies that had been less severely affected started to pay attention to e-commerce, and new Internet-based companies started to appear almost every week. The initial players were in businessto-consumer (B2C) e-commerce and later business-to-business (B2B) firms appeared. IDC projected e-commerce transactions would reach $250 million for year-end 2000 and $3.2 billion by 2003.8 Several banks including Bank Bukopin, Lippo Bank, and Bank Niara have started to offer online services such as funds transfer and bill payment. Now, B2B in Indonesia is expected to grow rapidly, while B2C will grow more slowly. The Garnter Group ranks Indonesia among the top nations in Asia for eprocurement services, with direct services expected to grow 195 percent and indirect procurement projected to increase 215 percent. In a survey of 1,100 Indonesian Internet users conducted in early 2000 only 9.9 percent of the respondents had ever made a transaction through the Internet. Respondents gave the following reasons for not making Internet transactions: Have no credit card (19.2 percent); do not trust ecommerce (15.1 percent); high risk (13.6 percent); no need yet (13.1 percent); not interested (11.2 percent); more expensive (7.1 percent); quality of the goods is not guaranteed (6.3 percent); do not know how (5.5 percent); do not have enough money (4.0 percent); and prefer traditional shops (3.3 percent). Some of the consumers’ reluctance to make Internet transactions appears to be due to short-term factors and will likely melt away with improvement in the economy and decline in unemployment. But this survey also uncovers some inherent problems with B2C e-commerce that need to be overcome © 2003 Institute of Southeast Asian Studies, Singapore

206 HAMONANGAN HUTABARAT

TABLE 7.10 Credit Card Use, 1991–2000 Cards

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

Transaction Value

Number ('000)

% change

Cards per 1,000 inhabitants

435.0 680.0 830.4 1,072.0 1,345.0 1,887.4 2,678.8 2,671.2 2,720.5 2,705.0

– 56.3 22.1 29.1 25.5 40.3 41.9 –0.3 1.9 –

2.4 3.7 4.4 5.6 6.9 9.5 13.3 13.1 13.2 12.6

% US$ million change 620 880 1,225 1,868 2,410 2,766 2,958 787 843 153

– 41.9 39.2 52.5 29.0 14.8 6.9 –73.4 7.1 –

US$ per card 1,425.3 1,294.1 1,475.2 1,742.5 1,791.8 1,465.5 1,104.2 294.6 309.9 56.5

Notes: Values for 2000 from October. Transaction value = Rp1.3 trillion converted at Rp8,500 per US dollar. Source: CIC No. 238, 1999 and Central Bank of Indonesia.

before Indonesian consumers will see it as a viable alternative to traditional shopping. At the top of the list are the payments system and the security and trustworthiness of e-commerce. Use of credit cards as a means of payment has increased significantly, especially in the last ten years, as the number of middle- and high-income Indonesians expanded. The number of credit cards jumped from only 435,000 in 1991 to 2.72 million in 1999, but there are still only twelve cards in use for every 1,000 Indonesians (Table 7.10).9 Moreover, Indonesia provides only weak legal protection of consumers’ rights in e-commerce. Law No. 8 of 1999 about Consumer Protection, which became effective from April 2000, stipulated prohibitions on producers, but they will be very difficult to apply to e-commerce. INFORMATION AND COMMUNICATIONS TECHNOLOGY AND INDONESIA’S INTEGRATION INTO THE GLOBAL AND REGIONAL MARKET

Information and communications technology (ICT) is becoming increasingly important to every economy’s prospects because it supports and facilitates connections with global and regional markets. As economic

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integration and globalisation proceed, economies without adequate ICT infrastructure will fall further and further behind while ICT-ready economies gain efficiency and international competitiveness. In the East Asia region a gap is emerging between economies with access to information and communications technologies (including telephones, computers, and the Internet) and those without. This so-called digital divide and the debut of the ASEAN Free Trade Area (AFTA) in 2003 will shape the future course of the economies in the region. In order to prepare for the challenge of more open economic boundaries, ASEAN as a region and individual members such as Indonesia need to narrow the gap in ICT infrastructure. Indonesia and the Digital Divide in Asia

Despite significant recent improvements, Indonesia currently ranks below most of its neighbours on almost all measures of physical infrastructure and Internet access. This gap will make it difficult for Indonesia to capture TABLE 7.11 Fixed Phone Lines and Density in Selected Asian Economies (1999 year-end estimate) Fixed Phone Lines

Singapore Hong Kong Taiwan Japan Korea Malaysia China Thailand Philippines Indonesia Vietnam India Cambodia

Number ('000)

per 100 inhabitants

1,860.6 3,838.7 12,043.8 66,000.0 21,250.3 4,433.0 108,807.0 5,037.5 2,700.0 6,080.2 2,000.0 21,593.7 27.7

57.70 55.77 54.42 52.17 45.72 20.31 8.59 8.35 3.70 2.91 2.58 2.20 0.25

Source: Telkom on Kompas, 28 June 2000.

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the benefits of the region-wide market and to integrate with the global information economy. Telephone Penetration

Indonesia has among the lowest telephone densities among Asian economies. Its 6 million fixed telephone lines is many more than in Singapore, Hong Kong, Malaysia, Thailand, or the Philippines. But, given Indonesia’s large population, this works out to only 2.9 lines for every 100 people, just slightly above the rate in Vietnam and India (Table 7.11). Indonesia also ranks near the bottom among East Asian economies in the number of mobile subscribers per capita, and it is at the bottom in the proportion of households with mobile cellular service (Table 7.12). TABLE 7.12 Mobile Phone Density and Penetration in Selected Asian Economies (1999 year-end estimate)

Singapore Malaysia Korea Thailand Philippines China Indonesia

Density

Penetration

Subscribers per 100 inhabitants

% of households

20.88 9.83 8.45 4.80 1.21 0.54 0.40

Hong Kong Japan Korea Singapore Taiwan China Indonesia

54.10 47.20 46.40 45.70 39.40 3.40 2.56

Note: Penetration rate for Indonesia is Q3 2000. Source: Density: CIC No. 226, 1999. Penetration: Nomura Research Institute, PT Data Consult Inc. No. 291, 9 May 2000, and PT Telkom.

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Personal Computer and Internet Usage

With only 6 percent of households having personal computers, Indonesia ranks lowest in PC penetration among Asian economies except Thailand (3 percent) and China (1 percent) (Table 7.13). In contrast, almost threequarters of households in the leader, South Korea, have computers. Indonesia ranks well below most other East Asian economies on most all measures of Internet use and penetration as well. Internet usage in Indonesia, at 0.4 percent of the population, is only slightly higher than in China (0.3 percent) and well below Singapore’s 17.9 percent and Hong Kong’s 14.6 percent (Table 7.14). Even after robust growth in 2000, Internet penetration in Indonesia (3 percent of households) is less than half that in Malaysia and the Philippines (8 percent) and less than one-tenth the rate in Singapore (32 percent). Finally, Indonesia ranked lowest among seven Asian economies in the number of Internet domain servers. It had only 6,500 compared to 70,000 in China and 2.6 million in Japan (Table 7.15).

TABLE 7.13 PC Penetration in Selected Asian Economies (1999 year-end estimate) Percent of households with PCs Korea Singapore Taiwan Japan Hong Kong Malaysia Philippines Indonesia Thailand China

74.1 58.9 32.3 29.5 27.5 17.0 11.0 6.0 3.0 1.0

Note: Data for Malaysia, Philippines, Indonesia, and Thailand are Q1 2000. Source: Bisnis Indonesia, 26 June 2000, NRI, IDC, and Eksekutif, April 2000.

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TABLE 7.14 Internet Penetration in Selected Asian Economies, 1999 and 2000 % of population

Singapore Hong Kong Malaysia Philippines Thailand Indonesia China

1999

Q1 2000

17.9 14.6 5.6 3.0 2.0 0.4 0.3

32.0 – 8.0 8.0 2.4 3.0 –

Source: Business News No. 6471, 29 May 2000 and Bisnis Indonesia, 26 June 2000.

TABLE 7.15 Internet Domain Servers in Selected Asian Economies (end-January 2000) Number of servers ('000) Japan Taiwan Korea Singapore Hong Kong China Indonesia

2,630 850 280 150 110 70 6.5

Note: Indonesia is Q2 2000. Source: Nomura Research Institute and Bisnis Indonesia, 13 March 2000.

ICT Facilitates Indonesia’s Business Ties to Asian Markets

ICT has already played a role in the integration of Indonesian businesses with the regional economy. Since mid-1985 several Indonesian

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conglomerates have utilised online computer systems for communication among their operations sites in major cities in Indonesia, and later advances in satellite telecommunications enabled them to extend the reach of these online systems to include ASEAN countries and beyond. At the same time, multinational companies operating in Indonesia have been using online systems to exchange management, accounting, and supply information with their offices abroad. Domestic companies, especially export-oriented ones that had established good relationships with partners in East Asia, started to develop and utilise regional ICT networks for business transactions. Such networks proved to be a significant asset during the economic crises because these companies were wholly dependent on foreign loans for imported raw materials, intermediate goods, and working capital and they depended on foreign partners as transportation and marketing channels. The riots in and after 1998, especially the one directed against Chinese-owned businesses, tested the system. The networks enabled business owners who left Indonesia to continue to run their operations from abroad (from Singapore, Hong Kong, or Australia, for example). Moreover, the slow pace of the domestic economy since 1997 has led Indonesian businesses to increase their activities in the region. These businesses are developing and strengthening their linkages with operations in other East Asian economies and with Australia. e-ASEAN

In anticipation of AFTA, ASEAN members have jointly been taking steps since 1998 to accelerate the development of ICT infrastructure. They have moved from agreeing to include an “ASEAN Information Infrastructure” in the Hanoi Plan of Action, to recommending the launching of a regional technology network called the “e-ASEAN Initiative”, and finally to signing the e-ASEAN Framework Agreement in Singapore in November 2000. The objectives of the e-ASEAN Agreement are:10 • To promote co-operation to develop, strengthen, and enhance the competitiveness of the ICT sector in ASEAN; • To promote co-operation to reduce the digital divide within and among ASEAN member states; • To promote co-operation between the public and private sectors in realising e-ASEAN; and • To promote the liberalisation of trade in ICT products, ICT services, and investments to support the e-ASEAN initiative.

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Most member states will eliminate duties and non-tariff barriers on intraASEAN ICT products in three tranches: on 1 January 2003, 1 January 2004, and 1 January 2005. Cambodia, Lao PDR, Myanmar, and Vietnam will follow five years later. Members that are ready may accelerate the implementation of the Agreement to 2002. To facilitate establishment of the ASEAN Information Infrastructure member states agreed to: • Enhance the design and standards of their national information infrastructure to facilitate interconnectivity and ensure technical interoperability. • Work towards establishing high-speed direct connection between their national information infrastructures with a view to evolving this interconnection into an ASEAN Information Infrastructure backbone. • Work towards developing ASEAN content relating, but not limited, to co-operation in digital libraries and tourism portals. • Work towards facilitating the setting-up of national and regional Internet exchanges and Internet gateways including regional caching and mirroring. To promote the growth of electronic commerce, ASEAN members agreed to adopt regulatory and legislative frameworks for e-commerce that enhance consumer trust and confidence and facilitate the transformation of business towards the development of e-ASEAN. Specifically they agreed to: • Put in place national laws and policies relating to electronic commerce transactions based on international norms; • Facilitate the establishment of mutual recognition of digital signature frameworks; • Facilitate secure regional electronic transactions, payments, and settlements, through mechanisms such as electronic payments gateways; • Adopt measures to protect intellectual property rights arising from ecommerce; • Consider adopting the World Intellectual Property Organisation (WIPO) treaties, namely the 1996 Copyright Treaty and the 1996 Performances and Phonograms Treaty; • Take measures to promote personal data protection and consumer privacy; and • Encourage the use of alternative dispute resolution (ADR) mechanisms for online transactions.

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Thus, the e-ASEAN Framework Agreement is really a comprehensive action plan for regional co-operation to accelerate the application of information technology in government institutions as well as private businesses in member economies. SUMMARY AND CONCLUSIONS

Indonesia’s telecommunications sector changed substantially over the past decade. Before 1990, the sector was a pure government monopoly. The government realised its obsession to integrate the large archipelago with a single telecommunications system through microwave networks and satellite communications operated by two state companies, Telkom and Indosat. The sector was partially opened to the private sector with the Telecommunications Law of 1989. Private investors entered the field of non-basic telecommunications as joint venture companies with the state companies. During the 1990s reorganisation of Telkom also opened opportunities for private partners (domestic and foreign) to operate five regional divisions jointly with the state company. The government set down a vision for the future development of information and communications infrastructure in Indonesia in the Nusantara-21 Project. This momentum that the partial opening of the sector had begun to build slowed abruptly as the 1997 economic crisis weakened both private and state telecommunications companies. Beginning in September 2000, the telecommunications sector was subjected to another shock, as every field of service was opened to all players, public and private, domestic and foreign. This globalisation of Indonesia’s telecommunications sector has failed as yet to attract the desired surge of new investment because investors are wary of Indonesia’s lingering economic crisis, political instability, and government budget crisis. At present Indonesia lags in telecommunications and information technology development and infrastructure. Indonesia needs to un-jam the telephone industry and increase the availability of other digital technologies. Although the number of fixed telephone lines and sales of personal computers grew rapidly over the past ten years, diffusion of these technologies is still low, especially compared to developed economies, and access is confined to a narrow group of higher income Indonesians. The Internet is just taking hold as parts of the economy begin to recover from the economic crises of 1997–98.

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Increasing access to all types of ICT and improving the ICT infrastructure are necessary for Indonesia to join in the global information economy and benefit from the ongoing integration of the Asian market, but this will be difficult to accomplish quickly with the current slow rate of economic growth. Moreover, demand for new infrastructure and even newer technologies will continue to rise. At the end of 2000 the government updated the Strategic Development Plan and Nusantara-21 and revised its projections of demand for information infrastructure and services. For 2004 the government now foresees: • the need to add 9–10 million regular telephone lines and around 1.7 million high-speed information connections for data communication and video; • 10–15 million cellular telephone customers; and • the need for accessible multimedia facilities in at least eleven large cities to support the digital economies in Indonesia’s business centres. Thus, Indonesia seems assured of looking across a wide digital divide for the immediate future, and without significant investment in information and telecommunications infrastructure by 2004 it will remain poorly positioned in global telecommunications for the coming five to ten years. Suggestions for Government Policy

With the added political autonomy given to local governments since 1999, Indonesians can no longer expect the central government to take the lead in ICT infrastructure investment. Significant investments must come largely from private investors, domestic or foreign. To attract such investment, the government has promoted competition through liberalisation and privatisation. Within its proscribed capacity, the government should actively foster an environment conducive to the IT industry and to establish the necessary physical and institutional infrastructure, at least within the framework of the e-ASEAN Agreement. The government of Indonesia should: • revive the Vision of Nusantara-21 by getting the private sector more involved in investment in physical infrastructure; • activate e-government in central offices as well as in new district offices. Standardisation of forms and computer programs for district offices will save money and design time and it will allow greater focus on training operations staff and helping clients;

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• further liberalise or privatise the fixed-cable telephone sector to create the type of competition that stimulated the growth of mobile cellular capacity; and • put in place institutional infrastructure related to electronic transactions and payments, statutory protection of personal information, and the enforcement of existing laws. Notes 1

2

3 4

5

6 7

8

9

10

The other two, Division II (Jakarta and vicinity) and Division V (East Java), remained under the direct management of Telkom. The backbone infrastructure consists of satellite, digital microwave radio, optical fibre, and undersea cable in a “ring of rings” structure to take advantage of Indonesia’s existing telecommunications network and to take into account geographic conditions. . Komselindo, a foreign direct investment company started in October 1996, moved quickly to expand its BTSs and has now started to develop microwave and underground fibre-optic networks. The exclusive rights of both state companies were terminated on 31 May 2001 with Law No. 21 of 2001. . B. Rahardjo, “Indonesian Internet Statistics”, October 2001, downloaded from . “ExportIT Asia: Preliminary Report”, U.S. Department of Commerce, Office of Information Technologies, December 2000. . The number of credit cards actually declined in 1998 in the aftermath of the crises. The e-ASEAN Framework Agreement adopted the following definitions: “Information and Communication Technology” (ICT) is the infrastructure, hardware, and software systems needed to capture, process, and disseminate information to generate information-based products and services. “ICT products” include the products in the WTO Information Technology Agreement (ITA1) and related products which Member States may agree to add later; “ICT Services” are the Information and Communications-related services listed in the Central Product Classification (CPC) and any additional related services which Member States may agree to add later. “Investment(s)” means direct investment(s)

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related to the production of ICT products and the provision of ICT services. References

Asmoro, Pudji. 2000. “Merekat Loyalitas Pelanggan Telkom Dengan Budaya Customer First”. Business News. 6 November. Association of South East Asian Nations (ASEAN). 2000. E-ASEAN Framework Agreement. ASEAN Secretariat. November. Capricorn Indonesia Consult, Inc. (CIC). 1999. “Bisnis Telepon Seluler Semakin Inovatif”. CIC No. 219, 11, Jakarta: PT Capricorn Indonesia Consult. Data Consult. 2000. “Mobile Phone Market Growth Impeded By Limited Capacity of Network”. DC Indonesian Commercial Newsletter, 9 May. Economist. 1 April 2000. “Internet Economics: A Thinker’s Guide”. Kompas. 17 November 2000. “Terbongkar Sindikat Kejahatan Lewat Internet”. Mark Plus and Co. 2000. “The Internet Branding Survey-2000”. SWA. National Telecommunications and Information Administration. 1999. Falling through the Net: Defining the Digital Divide. Washington, D.C.: U.S. Department of Commerce. July. Parapak, Jonathan Ir. 2000. “Maraknya E-Commerce”. Kompas. 25 June. Setiawan, Ir Suryatin. 2000. “Telekomunikasi Indonesia, Sebuah Ironi Yang Indah”. Kompas. 28 June. Suara Pembaruan. 4 June 2000. “Business Melalui E-Commerce Rawan Penipuan”. Telkom dan IKAL. 1997. Telekomunikasi Indonesia. Jakarta: PT Telkom dan IKAL. World Bank. 2001. World Development Report 2000/01. Oxford: Oxford University Press.

© 2003 Institute of Southeast Asian Studies, Singapore

Reproduced from Towards a Knowledge-based Economy: East Asia’s Changing Industrial Geography, edited by Seiichi Masuyama and Donna Vandenbrink (Singapore: Institute of Southeast Asian Studies, 2003). This version was obtained electronically direct from the publisher on condition that copyright is not infringed. No part of this publication may be reproduced without the prior permission of the Institute of Southeast Asian Studies. Individual articles are available from < http://bookshop.iseas.edu.sg >

INEQUALITY, DIGITAL DIVIDE, AND INTERNATIONAL COLLABORATION 217

8 Inequality, the Digital Divide, and International Collaboration in East Asia Wan Latifah and Zainal Aznam Yusof INTRODUCTION

Technology has always played an important part in economic growth. In the framework of endogenous growth theory, technology and the ideas or knowledge embodied in technology occupy a special place in explaining the growth of economies. In particular, attention has focused on the contribution of information and communications technology (ICT) to economic growth and to the transformation of the economy, especially in linking economic and business organisations, developing e-commerce, and influencing manufacturing processes and even investment decisions in the supply chain. With growth the pre-eminent focus, the implications of ICT for inequality have not been given sufficient attention. Concern with the emergence of the “digital divide” is a recent phenomenon. There is a presumption that ICT worsens the digital divide and in turn benefits only, or mainly, higher income individuals and households. On the other hand, it has been argued that if the poor have access to ICT, or if ICT is applied to enhance the economic activities on which they depend, it could reduce poverty and, in turn, improve the overall level of inequality. Unfortunately, the evidence is too scarce to enable us to be more certain about the impact of ICT on overall inequality. The presumption, however, is still pessimistic, i.e., that ICT exacerbates the differences between the poor and rich within a country and by extrapolation between countries. The purpose of this brief chapter is to raise issues related to the digital divide emerging with the growth and diffusion of ICT throughout the Asian economies.

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POVERTY AND INEQUALITY: SIZEABLE AND WIDENING

According to the World Bank, almost one-quarter (24 percent) of the population of the developing world, 1.2 billion people, lives on less than US$1 a day. Other dimensions of development highlight the extent of poverty and inequality in the world today. In rich countries fewer than ten children in 1,000 fail to reach their fifth birthday, while in the poorest countries as many as one-fifth of all children do not live to age five. Furthermore, in poor countries as many as one-half of children under five years of age are malnourished, while in rich countries less than 5 percent are. While economic growth can reduce the level of poverty, how much poverty falls with a given rate of economic growth differs across countries and over time. It has been argued that the extent of the reduction in poverty depends on how the distribution of income changes with growth and on the initial disparity in income, assets, and access to opportunities to share in the benefits of growth. In countries where the distribution of income becomes more equal with growth, poverty can be expected to fall faster compared to countries where the distribution of income widens. Overall, the evidence does not suggest a systematic relationship across countries between growth and income inequality. Differences in the regional and sectoral composition of growth can result in different changes in the overall distribution of income. If, for example, growth is concentrated in sectors from which the poor derive most of their income, such as agriculture, then growth will be linked with a fall in income inequality. Before the financial crisis of 1997, East Asia had made much progress in reducing the absolute level of poverty (Table 8.1). Over the period 1975 to 1995, poverty in East Asia fell by two-thirds (based on a headcount index using US$1 per day purchasing power parity, PPP, as the poverty line). Asia’s low level of income inequality at the outset has often been cited as one reason for the region’s rapid growth. In more recent years, the evidence suggests, income inequality has been rising, and this tends to reduce the contribution of growth to poverty reduction (Table 8.2). Global economic integration has been accelerating. The continuing integration of the world’s economies including those in East Asia is being pushed by the growth of technology flows, especially of ICT, and the emergence of a more networked economy. While the East Asian economies are expanding their telecommunication infrastructures and encouraging the growth of ICT-related industries, the pace and extent of increases vary from one country to another. Some economies have made more progress

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TABLE 8.1 Poverty in Asia (Percent) Poverty Line at: US$1 PPP per day Share of population in poverty China Indonesia Malaysia Philippines Thailand

1995 1996 1995 1994 1992

22.2 7.7 4.3 26.9

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9 The New Role of Hong Kong as a Regional Hub in an Emerging E-economy Edward K.Y. Chen and Raymond Ng

I.

INTRODUCTION

The recent revolution in information and communication technologies (ICTs), as marked particularly by the rapid expansion and improved functionality of the Internet, has generated extensive and far-reaching economic impacts around the world. Most importantly, it has created a global digital network, a mass communication and data transmission facility that is independent of time and space. This network provides an effective means of information flows and greatly enhances the capacity for accessing, storing, analysing, and exchanging information. The ICT revolution has also created a global cyber-marketplace that facilitates borderless electronic trading and the growth of the information industry. The emergence of a globally networked economy provides unprecedented opportunities (but also challenges) for both advanced and developing countries to achieve industrial upgrading and boost long-term economic growth. Advances in ICTs have, among other things, created a new global trading network that streamlines the traditional trading and distribution system. This should promote further integration (and competition) in the global goods and capital markets. Reductions in communication, information, and transaction costs encourage businesses to adopt more globalised production, sourcing, and marketing strategies. To maintain their competitive edge, firms should take steps to further enhance their production and operation efficiency and diversify into producing differentiated or customised products. In addition, the advance in ICTs is

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a crucial driver of economic growth and development. Among other things, it provides an effective channel that greatly accelerates the spillover of knowledge, boosting the external and social returns to investment in knowledge- and technology-creation. It is a key source of growth as stressed by the new growth theory, for instance. ICTs also facilitate the development of information-intensive industry that is high in knowledgecontent and hence in added value. Importantly, the emerging network economy, combined with the globalisation of goods and services markets, offers unparalleled opportunities for developing countries to catch up on industrialisation and development. Given the improved access to a global information base and the opportunity to join in the global supply chain, developing countries are now better able to leapfrog stages of industrialisation to develop technology and information-intensive industries. To gain fully from the emerging economic networking, developing countries should take active steps to implement various reform measures and policy initiatives to boost their ICT infrastructure and develop the human and technology resources required for promoting the New Economy. In particular, less developed countries with low levels of ICTs are likely to suffer from insufficient access to the global trading system and might be forced into ICT-related poverty (i.e., the digital divide). Equally important, economies should examine how to utilise ICTs fully to enhance overall efficiency and to re-energise existing strengths of the “old” economy. This has important policy implications for Hong Kong, which is a small, outwardlooking and service-oriented economy as well as a latecomer in the IT industry. In the past few years Hong Kong has experienced rapid growth in Internet business and has made remarkable progress in the adoption of ICTs. The traditional business sector has also undergone marked restructuring. These changes should be attributed, at least in part, to the government’s efforts to promote the New Economy. Among other objectives, the government has committed to developing Hong Kong into a leading digital city and an Internet hub in the Asia-Pacific region for both Internet traffic and content development. In achieving this, the government has implemented various reform and policy initiatives to provide infrastructure and institutional support and to create an environment conducive to developing the IT industry. This chapter examines the strategy (and potential) for Hong Kong to further strengthen its competitive edge and to reposition itself for longterm growth in a global network economy. It pays particular attention to Hong Kong’s potential as a regional IT hub and to the transformation of traditional industry based on ICTs. The rest of this chapter is organised as

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follows. Section II examines the latest developments in Hong Kong’s New Economy. Section III discusses the evolving role of the government in the New Economy and examines the associated policy measures adopted in Hong Kong. Section IV explores Hong Kong’s potential to develop as a regional IT hub. Section V examines the development of a logistics distribution centre, and Section VI looks at the growth of the e-finance industry in Hong Kong. Section VII briefly discusses the implications of the network economy for regional co-operation and Section VIII provides a conclusion. II.

CURRENT DEVELOPMENTS OF THE NEW ECONOMY IN HONG KONG

A well-built telecommunication infrastructure is a key element of the New Economy, and Hong Kong has developed an advanced telecommunications network. It has operated a fully digitised network since 1995 and has achieved full broadband coverage for all commercial buildings and over 90 percent of domestic units. There are on average 58 exchange lines per 100 inhabitants, 105 residential lines per 100 households, and 23 facsimile lines per 100 business lines. With regard to external connectivity, Hong Kong has a total of 31 external facility operators licensed (or about to be licensed) to operate satellite and cable facilities and 165 external telecommunication services operators. Hong Kong’s mobile phone market is also developing rapidly. Currently, there are eleven mobile phone networks and four digital standards. Mobile phones have reached 71 percent of the population, which is one of the highest penetration rates in the world. The government finalised the licensing procedure for third-generation mobile telecom services and invited applications in 2001. This will provide a platform for commercial applications of mobile phones. Hong Kong’s Internet industry has grown rapidly over the past few years. According to the Hong Kong Trade Development Council (HKTDC), as of September 2000, there were a total of 218 Internet services providers (ISPs) providing access to the Internet. Five of these offered broadband services. Most ISPs also served as Internet content providers (ICPs), offering users a wide range of information, including entertainment, shopping, fashion, sports, travel, and news. Hong Kong had numerous ICPs (or websites), the majority of which depended on online advertising as a major source of revenue and some of which were involved in electronic commerce. Application services providers (ASPs) in general provided

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technical support and IT management and application services through the Internet or a proprietary network. They included, for instance, integrated solutions for electronic commerce and supply chain management. Hong Kong has achieved rapid growth in the use of the Internet and in the adoption of online transactions by both business and household sectors over the past few years. According to an official survey on the adoption of IT in early 2000, the computer had reached 50 percent of all Hong Kong households and 73 percent of households with computers were connected to the Internet. In the business sector, about half of all establishments had computers, among which 37 percent had Internet connections. The computer and Internet penetration rates reached 92 percent and 78 percent of large firms respectively, much higher than the penetration rates for mediumsized firms (78 and 63 percent) and for small firms (48 and 34 percent). In addition, about 7 percent of firms had their own websites. The use of the World Wide Web was more prevalent among large companies (about 43.2 percent of firms) than among medium-sized and small firms (18 and 5 percent of firms, respectively). These web pages mainly provided information on the companies and their products or services (Hong Kong Census and Statistics Department 2000). The low computer and Internet penetration rates of small firms (which account for a significant share of the Hong Kong economy) are somewhat worrying. Such slow take-up rates could delay the upgrading of their business based on advances in ICTs. Electronic commerce in Hong Kong was still at the early stage. Only about 5 percent of firms reported that they had ordered or purchased goods, services, or information online during the survey period, among which 35 percent reported having received orders online. Business receipts generated from online sales of goods and services in 1999 amounted to HK$4.6 billion, representing only 0.11 percent of total receipts. Nevertheless, online sales had grown by 57 percent compared to 1998 (Hong Kong Census and Statistics Department 2000). In addition, according to a survey by AC Nielsen’s NetRatings, among the eighteen countries claiming to represent more than 80 percent of the global Internet audience, Hong Kong ranked first in terms of Internet usage for October 2000, followed by the United States. Internet usage time in Hong Kong averaged 10 hours and 13 minutes per capita, above the 10 hours and 4 minutes in the United States. Hong Kong also was first in the average time spent per visit and in the number of websites visited (Ming Pao 2000). Hong Kong has experienced a drastic transformation of business based on the advance in ICTs over the past few years. In addition to the rapid

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growth of telecommunications, Internet, and related industries, many conventional service industries have already taken steps to offer their services online, including, for instance the media, banking, finance, and travel and estate agents. Most notably, major real property developers have diversified their business onto the Internet or into related commercial applications. As of April 2000, over 230 of the companies listed on the main board of the Hong Kong Stock Exchange (about 30 percent of the total) had announced plans to invest in the Internet or related technology projects over the previous eleven months (Kwong 2000). In addition, a total of fifty-six technology companies have been listed on the Growth Enterprise Market (GEM, Hong Kong’s version of a venture board of the stock exchange) since its November 1999 launch, and a total of HK$15.3 billion had been raised by the end of 2000. A significant proportion of these listed companies is involved in IT or Internet industries. III. EVOLVING ROLE OF GOVERNMENT IN THE NEW ECONOMY

Policymakers are prompted to reconsider the government’s evolving role in adopting various technology, human resource, and other policies required for the growth of the New Economy. The government should, among other things, adopt an active technology policy, increase its own investment in R&D, and encourage private sector R&D initiatives. Investment in R&D and knowledge-creation is widely seen as a key source of technological advancement and economic growth. Importantly, such investment will generate substantial positive external benefits, giving rise to increasing returns. This creates a market failure, and without public support R&D is not likely to receive the socially optimal level of investment. This helps to justify the government’s active R&D support. To an extent, public investment (expenditure) in R&D will both temporarily boost the level of aggregate spending (and hence the rate of output growth) and drive economic growth in the long run. Attention should also be given to the need to raise and channel financial resources to fuel the growth of the New Economy. Because technology firms (particularly small firms) in general lack fixed assets and involve high risk, they have extreme difficulty obtaining funding through conventional channels, that is, bank loans. The government should increase steps to address this difficulty, for example, by providing public funding to encourage start-ups and expansion of technology-intensive industry and by developing a venture capital market. In addition, the New Economy calls for an active human resources strategy to meet fast-changing skill

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requirements. Such strategy should be aimed to produce a technologically sophisticated, creative, and flexible workforce with diverse talents. Among other things, steps should be taken to reform the education and training system to promote whole-person development and a culture of lifelong and life-wide education or training. Advances in ICTs help to lower information and transaction costs. This encourages businesses to restructure their operations and adopt more globalised production, sourcing, and marketing strategies. Small firms are able to develop an edge and produce customised products for multiple markets or directly for the global supply chain. This poses a major challenge to the traditional views of economies of scale, economies based on standardisation and mass production. Competition will increasingly become scale-neutral. In addition, the sharp reduction in the cost of inter-firm transactions brought about by ICTs (relative to that of intra-firm transactions) is expected to drive firms to outsource business functions in order to continuously enhance efficiency and competitiveness. On the other hand, business re-engineering or transformation (e.g., through merger, acquisition, de-merger, and various types of strategic alliance and joint venture) will increase as firms try to upgrade to or focus on core (technology) businesses. In light of these developments, the government should promptly review its industry and competition policies to encourage the growth of SMEs and, at the same time, to prevent large firms from limiting competition and earning monopolistic profits. Equally important, rapid business restructuring and re-engineering are expected to have a significant impact on the labour market, which in turn will have crucial implications on labour and social policy. Specifically, the rapid growth of the New Economy (combined with the ICT-based restructuring of businesses) will likely give rise to serious destruction of jobs and mismatch of skills, causing an excess supply of simple-skilled labour, the widening of income inequality, and a rise in structural unemployment. It seems necessary therefore for the government to revise labour and social policy to provide appropriate unemployment assistance and adequate retraining or other vocational support. In promoting Hong Kong’s New Economy, the government has taken several policy and programme initiatives to boost Hong Kong’s R&D capabilities (and resource base) and to encourage the growth of IT and other technology industries. Specifically, it is building a Science Park to provide land and premises especially for technology firms and activities, and an Applied Science and Technology Research Institute (ASTRI) located at the Science Park to provide technological infrastructure for midstream

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R&D. In November 1999 the government also set up an Innovation and Technology Fund (ITF) of HK$5 billion to support private-sector R&D and innovative initiatives and to operate incubation programmes to promote technology industry, especially among small firms. In addition, in March 1999 with the co-operation of a private company the government launched a Cyberport (business park) project, which will promote the IT industry by providing the physical infrastructure it requires. The government has also taken steps to address the funding requirements of the New Economy. For instance, the ITF operates a Small Entrepreneur Research Assistance Programme to help small entrepreneurs undertake commercial R&D at the pre-market launch stage. It also operates an Applied Research Fund Scheme to provide equity capital to promising local technology ventures. The Growth Enterprise Market at the Hong Kong Stock Exchange also provides a channel for emerging technology companies to raise equity capital. Hong Kong’s venture capital market has grown rapidly over the past few years and it is now the second largest venture capital base in Asia, after Japan. Total venture funds under management grew by 50.1 percent to reach US$14.5 billion in 1998. New funds raised in 1998 amounted to US$3.1 billion, a considerable jump from US$1.9 billion in 1997. Hong Kong ranked first in Asia in these two areas (total venture funds managed and new funds raised). However, the venture capital market in Hong Kong mainly serves as an administrative hub for the region, with over 90 percent of funds coming from and then going to overseas ventures. Nonetheless, a developed venture capital market provides a crucial source of financial support for Hong Kong’s emerging IT industry. Hong Kong’s aspiration to develop as a knowledge-based economy demands reshaping its human resources and, more specifically, expanding the number of scientists, engineers, and IT professionals. The government has taken steps to reform its education and training systems to promote lifelong and life-wide education. The government has proposed improving the curricula and assessment systems at the primary and secondary levels and developing a system of transferable credits and encouraging crossdisciplinary learning at the tertiary level. In addition, the ITF runs a Teaching Company Scheme to encourage companies to take on graduate research students for specific R&D projects. The government has also made efforts to attract Mainland talents to work in Hong Kong by relaxing the immigration restrictions on scientists. It has recently proposed to enlarge the scientist importation scheme by entirely removing these immigration restrictions. The government has also commissioned a

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consultancy study to examine the manpower and training needs of the IT industry and to recommend a strategy to address Hong Kong’s shortage of IT manpower. Indeed, the government’s recent R&D initiatives (Cyberport in particular) combined with the emerging R&D career opportunity, culture, and entrepreneurial dynamism, should be incentives for overseas R&D professionals to work in Hong Kong. Nonetheless, as a long-term policy objective, the government should take drastic steps to train indigenous scientists and researchers. The government could boost postgraduate science and engineering research programs by increasing (research) funding to universities or offering more scholarships for postgraduate studies at home or abroad. Specifically, to accelerate the growth of the ICT industry, the government has been proactive in creating an environment conducive to investment in ICT infrastructure and in promoting the exploitation of ICTs in the community. Among other things, it has further liberalised Hong Kong’s telecommunications industry and put in place a regulatory framework that promotes competition and convergence of ICTs in the telecommunications sector. With the entire telecommunications market (local and external and service- and facilities-based) further open to competition, the prices of mobile phone and IDD services have fallen dramatically and service quality has improved markedly. The local fixed network market now has ten licensed operators, all providing broadband networks and services. Among the six new licences issued in 2000, five were to operate wireless networks and one was awarded to the existing cable television operator to provide services over its cable network. Since publishing its Digital 21 Information Technology Strategy in November 1998 the government has implemented various policy measures and initiatives to promote wider use (and other commercial applications) of the Internet and to stimulate the growth of the IT industry. It has taken steps to develop a legal framework to support the use of electronic transactions. The Electronic Transactions Ordinance enacted in January 2000, among other things, gives electronic records and digital signatures the same legal status as their paper-based counterparts and ensures that they can be used in contract formation and are admissible as evidence in court. In order to enhance public confidence in electronic transactions, the government has taken the lead in accepting electronic submissions and it has addressed the related security issue. The Electronic Transactions Ordinance establishes a voluntary recognition scheme for the operation of certification authorities in Hong Kong. The Hongkong Post Certification Authority was set up in early 2000 to operate a local Public Key

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Infrastructure to provide certification services and issue digital certificates for businesses and individuals. To facilitate cross-border electronic transactions, the Authority is exploring a cross-recognition facility and it signed a memorandum of understanding on cross-recognition arrangements with ViaCode of United Kingdom, I.D.Safe of Singapore, and DigiCert of Malaysia in September 2000. In addition, two private certification authorities currently operate in Hong Kong. Tradelink Electronic Commerce Limited (a joint venture of the government and several private-sector shareholders) provides digital certificates for local trading companies to submit traderelated documents to the government online. JETCO (an electronic service company formed by a group of major banks) provides the certification facility to support the group’s Internet banking activities. The government has taken the lead in the adoption of electronic transactions, by gradually switching to paperless transactions internally and by providing its services online. Since the early 1990s the Hong Kong government has encouraged online trade-related transactions (e.g., customs administration and certificates of origin) exclusively through a proprietary electronic data interchange (EDI) facility operated by the Tradelink. Tradelink has now served over 53,000 companies, with 100-percent trade declarations submitted through electronic means. It has upgraded its EDI system to an Internet-based platform and started to provide a number of value-added services. In April 2000 the government launched an Electronic Tendering System, which allows online notification, submission, and awarding of tenders. Most notably, in October 2000, the government launched an Electronic Service Delivery (ESD) scheme, giving the public an electronic channel through which to access various public services on a 24-hour-a-day basis, including submission of tax returns, renewal of driving and vehicle licences, voter registration, and payment of government bills. When the conversion of common forms into XML format is completed, the government will be able to automate the processing of all electronic records and transactions within the government. The government’s switching from paper-based to online transactions not only reduces costs and increases efficiency, but it also enhances the transparency and quality of public services. Moreover such e-government initiatives also jump-start the wider use of online transactions in the private sector and disseminate to the business community relevant ICT applications. They also set a common standard and expectation for online information exchange and transactions. The Hong Kong government has undertaken to build a common interface for electronic transactions based on international standards for the use of Chinese language in online

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communication. This among other things helps to promote common technical standards in the Internet, a prerequisite for efficient data transmission and document exchange among different IT systems. It also participates in the development of the International Organisation for Standardisation’s (ISO) 10646 Standard for the coding of ideographs, and in May 2000 it set up a mechanism to manage Hong Kong’s Supplementary Character Set under this Standard. IV.

HONG KONG’S POTENTIAL AS A REGIONAL IT HUB

As noted earlier, the government aspires to develop Hong Kong as a leading digital city and an IT hub in the Asia-Pacific region for both Internet traffic and content development. This strategy indeed suits Hong Kong’s developed telecommunication infrastructure, its geographical location at the centre of the region and, of course, its established role as a regional trading, financial, and business hub. It seeks to overcome Hong Kong’s high operating and rental costs by developing new commercial opportunities that offer high added value and are land-efficient. To enhance its locational advantages for these kinds of activities, Hong Kong needs to generate new (or diverted) Internet traffic and to become the crossroads of electronic communications and transactions in the region. Currently, Hong Kong’s technology stock and R&D capabilities are rather limited, its human resources are skewed towards the service industry, and it lacks the scientists, engineers, or other professionals required to support the growth of the IT industry. Therefore to reshape its resource base and competitive advantage Hong Kong must not only improve the local information infrastructure but also put in place soft infrastructures such as a regulatory framework, R&D and innovative capability, human capital, and IT entrepreneurship. Connectivity (local and external) is perhaps the most crucial prerequisite for an IT hub. Hong Kong must build a high-capacity, high-speed telecommunications network to accommodate the volume of Internet traffic expected for a digital hub. It should also allow electronic transactions to be performed efficiently and provide quality, open access at competitive prices. Hong Kong is already one of the most wired cities in the region, and its capacity in terms of submarine and satellite communication links is among the largest in the region. Hong Kong has IDD telecom services connections to 230 countries and to over 2,200 cities in the Chinese Mainland. International telephone traffic grew by an average of 15 percent per year from 1989 to 1999 and reached 4.3 billion minutes in 1999. Hong

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Kong is also a leading teleport for the region, supplying telecommunication broadcasting services through thirty-six satellite earth antennas. It provides MNEs, international press agencies, and TV channels with dedicated relay services enabling them to link their satellite signals across the region. To further raise Hong Kong’s international telecommunication capability, the government has issued several licences or letters of intent to operators of satellite-based and both above-ground and submarine cable-based external facilities. The advances in and convergence of telecommunications technologies have had revolutionary impacts on broadcasting. Digitalisation combined with wider bandwidth and improved compression techniques has made it feasible to transmit disparate forms of data by a single means. In light of the increasing convergence of telecommunications, broadcasting, and IT markets at both the technological and service levels, in February 2000 the government adopted a technology-neutral regulatory framework under the Broadcasting Ordinance. This framework aims to create an open regulatory environment to promote investment, technology application, and innovation in the broadcasting industry. In July 2000, the government issued five new pay-TV licences. It also issued a local satellite operator a licence to introduce broadcasting-satellite services (BSS) in Hong Kong. Following the success of the 1999 technical trials of digital audio broadcasting and digital terrestrial television, the government is formulating a policy to regulate provision of broadcasting services in the digital environment. The Cyberport project aims to promote the strategic IT industry by providing high-quality working and living environments and the IT facilities to attract a cluster of IT firms specialising in IT applications, services, and multimedia content development. This infrastructure project should help to attract foreign technology firms to invest in Hong Kong, to expand the pool of talent and expertise, and to facilitate technology transfer. It should also facilitate the creation of international linkages and stimulate the growth of local IT businesses. Cyberport has drawn the attention of many global and local technology firms with over 160 IT and multimedia firms indicating interest in becoming tenants. Hong Kong’s established role as a trading, business, and financial hub for the East Asia region contributes to its development as a regional IT hub. Hong Kong is a regional trading centre, and its trade with the AsiaPacific region accounted for 16.5 percent of intra-regional trade in 1997. Hong Kong is also a major source of foreign direct investment (FDI) in the region, ranking as the second largest source of outward FDI in Asia in 1998. Hong Kong was the largest investor in China and a leading investor

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in such ASEAN countries as Indonesia, Thailand, Vietnam, and the Philippines. Hong Kong is also a prominent destination for inward FDI, with the majority of incoming capital investment going to the services industry including real estate, business services, trading, banking, and finance. Hong Kong is also a leading banking and financial centre for the region, particularly for foreign exchange trading and for arranging syndicated loans. The Hong Kong stock market ranked second in Asia in terms of capitalisation (end of July 2000). Further, many MNEs use Hong Kong as a regional base to manage their businesses in Asia, particularly in Mainland China. According to an official survey, 3,001 overseas companies had established regional operations in Hong Kong as of June 2000, 20.5 percent more than in 1999. Of these companies, 855 were regional headquarters and 2,146 served as regional offices. Most of the regional headquarters firms came from the United States, Japan, or the United Kingdom and they were mainly involved in the wholesale and retail, import/export, and business services industries (Hong Kong Census and Statistics Department 2000). A free economy, a competitive market, low taxes, rule of law, excellent regulatory framework, efficient and cheap telecommunication, geographical proximity to China, physical infrastructure, educated workforce, managerial expertise, banking and financial facilities, and free press, speech, and flows of information are widely touted as factors in Hong Kong’s position as a regional base. Respondents to an official survey reported that access to information, in particular, was the most important factor in their choosing Hong Kong as a base for regional operations. In a world of fast-changing technologies and market conditions, access to information is crucial for business decision-making of all kinds. Free flows of information and freedom of press and speech are also key elements of an Internet hub. Hong Kong ranked ninth among the sixty countries in the Businessreadiness Ranking 2000 prepared by the Economist Intelligence Unit, and it placed second to Singapore among countries in Asia.1 Hong Kong serves a regional role both as a place where business activities take place and as a focal point (or crossroads) for flows of all kinds of business, market, and financial information, as well as for communications and document exchanges. This greatly enhances its positioning to become a regional hub for electronic commerce and transactions. Hong Kong’s geographic proximity to and its extensive business affiliations and connections with China add to its potential as the gateway for electronic commerce with the Mainland. In addition, Hong Kong’s extensive trading and business connections around the world could form a huge database

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and platform to serve global suppliers and buyers (large and small) and provide a strong foundation for all kinds of cross-border business-tobusiness (B2B) or business-to-consumer (B2C) e–commerce. Hong Kong’s dynamic business community, swift management style, and entrepreneurial flair are also an advantage. Hong Kong businessmen are well known for their responsiveness to market changes and for their ability to take advantage of emerging opportunities. The speedy move by property developers to diversify into the IT industry is one example. In addition, Hong Kong’s bilingual capability also strengthens its potential in the development of an IT hub. Hong Kong can serve as a regional gateway routing Internet flows and electronic commerce for both Chinese- and English-speaking countries. The development and hosting of dual-language, Chinese-English, portals in Hong Kong will help transform it into a hub for e-commerce and other Internet applications in the region. A key element of Internet routing is the domain name system, which serves as the root of addresses for Internet hosts. The government needs to increase efforts to set up a mechanism to develop a domain name system for Hong Kong. It has already reviewed the administration, arrangement, and assignment of Internet domain names with the aim of establishing a new body to facilitate the overall administration of Internet domain names in Hong Kong. Hong Kong has great potential to develop content for the Internet. Despite being a latecomer in software development, Hong Kong has many industries (in particular, banking, finance, shipping, trading, and container management) that have adapted quickly to advances in ICT. Other industries are expected to adopt the new technology soon. This will create a huge demand for Internet application software, which should boost the local IT industry. Hong Kong could start out by developing, modifying, and adapting commercial applications software for local industries. As it acquires expertise, technology, and human resources in business software development Hong Kong could gradually become a base for outsourcing to other emerging economies in the region. Hong Kong’s accumulation of knowledge and expertise in banking, finance, marketing, advertising, and management could form a crucial asset for content development. Such knowledge can be packaged for sale online as training or education software or information products. In addition, Hong Kong is a regional centre for major international newspaper, magazine, and book publishers. It has 46 newspapers, 717 registered periodicals, and offices for some 130 international media organisations. Hong Kong is a regional base for the Far Eastern Economic Review, Asiaweek, and Readers’ Digest. Online publishing is growing in popularity in Hong Kong with an increasing

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number of major newspapers and regional magazines issuing Internet editions. Hong Kong has also developed one of the largest and most dynamic film industries in the world. It is a leading film exporter, especially to Southeast Asia, Taiwan, and South Korea. Hong Kong is also a leading exporter of television programmes, mainly to Chinese-speaking overseas markets. The popularity of Hong Kong’s films, directors, actors, and popstars in the regional (as well as international) market enhances Hong Kong’s position to become a regional multimedia and broadcasting hub. V.

DEVELOPMENT OF HONG KONG AS A LOGISTICS AND DISTRIBUTION CENTRE

With its transportation and communication infrastructure, port facilities, efficient banking system, geographical location, and history as a trade and transport hub and gateway to Mainland China, Hong Kong is well endowed to serve as a logistics and distribution hub for the Asia-Pacific region. The government has taken an interest in supporting Hong Kong as a regional transportation and logistics hub and it has commissioned a strategic study on development of logistics services. In addition, it has chosen a site near the airport on which to develop a logistics management centre, for which tender documents were issued in July 2000. Development of such a centre would not only support Hong Kong’s position as a logistics and distribution hub but also modernise its third-party logistics (3PL) industry and enhance the competitiveness and facilitate the upgrading of its manufacturing industry. The transport, storage, and communication industry currently accounts for more than 9 percent of Hong Kong’s GDP. Logistics support, specifically, air/sea transportation, freight forwarding, and warehousing, has become crucial to Hong Kong’s manufacturing industry over the past two decades as local firms have relocated labour-intensive production to Mainland China where operating costs are lower. Outward processing trade with China reached HK$1,293 billion in 1999, about 47.2 percent of Hong Kong’s total trade volume, and local firms have taken the role of coordinators of this geographically fragmented process. Nonetheless, Hong Kong’s logistics industry is rather underdeveloped and is mainly dominated by air and sea transportation and traditional freight forwarding. Many of Hong Kong’s warehouses are conventional multi-storied, low-ceilinged buildings, instead of the single-storied, high-ceilinged cargo-handling and storage facilities that providers of comprehensive integrated logistics services require. With advances in ICTs and online commerce, warehouses

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have become not simply storage facilities but distribution and product transformation centres. Warehouse logistics providers are now responsible for moving inventory rapidly and efficiently throughout the supply chain and performing value-added services including light manufacturing, barcoding and labelling, final configuration and assembly, repackaging of customised products, and order packing and delivery. Indeed, today logistics includes not only physical systems to store and transport goods but also communications and information systems to track the movement of the goods and other systems to manage and co-ordinate transactions all along the supply chain. A logistics and distribution centre would provide related marketing and administrative services such as invoicing and customs clearance. Strategically, such a centre should also serve as a centralised point for storing, selecting, packing, and forwarding products directly to the customer’s dock. In addition, it should provide a “one-stop-shop” solution for users by linking all suppliers and buyers along the supply chain with 3PLs and government agencies through advanced EDI or other Internet-based networks. Such a logistics and distribution centre would strengthen Hong Kong’s capacity in 3PL and would give manufacturers access to the cost and efficiency benefits of modern integrated logistics. These firms urgently need to improve competitiveness because of rising costs in Mainland China and increasing competition from other developing countries. Typically, the huge investments in technology and warehouse facilities that integrated logistics systems require are beyond the means of the SMEs that predominate in Hong Kong’s manufacturing sector. By outsourcing to third-party providers these firms can convert fixed logistics and warehousing costs into variable costs and focus resources on improving the core business, for example through product differentiation or innovation. Moreover, through a modern logistics and distribution centre they can reduce time-tomarket through access to sophisticated management and production technologies such as fast-cycle distribution, speed-order fulfilment, and just-in-time production; they can reduce their inventories and related carrying and other logistics costs through electronic supply chain management; they can increase the accuracy of order-taking and improve customer service with real-time tracking of order fulfilment and delivery status through EDI; and they can reduce errors and the need to rework by switching from paper-based to electronic transactions. In all these ways, the upgrading of the 3PL industry allows manufacturers to regain competitiveness by reducing transactions and information costs and time, and increasing efficiency in sourcing, production, and delivery. Adopting

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ICTs also allows manufacturers to link up with the global supply chain, selling directly in the overseas market. ICTs reduce the cost of communication and transactions and enhance the ability to access and process real-time information at negligible cost. They also enable small producers, which dominate Hong Kong’s manufacturing sector, to match customer needs precisely through mass customisation and personalisation of production and to sell products online and deliver them directly to retailers or individual customers abroad. Together, the development of a logistics distribution centre and of 3PL capability in Hong Kong should stimulate domestic exports and attract the return of production activities that had shifted to the Mainland. It may also encourage inward FDI in 3PL in time-sensitive, high-end consumer goods industries. Moreover, the increased economic activity should create employment opportunities for IT and logistics professionals as well as for low-skilled workers for such jobs as picking orders, staging pallets, loading trucks, and repackaging customised products. According to Voon and Ho (2000), the investment in the total specialist logistics industry (amounting to about HK$35 billion on various port terminal, air-cargo handling, fixed equipment, and other business and human resources investments) could generate a total of 74,780 jobs for Hong Kong in the first six years of the project. In addition, it would also create huge spillover effects. The social rate of return is reported to reach 20 percent, much higher than the 6.8 percent private rate of return. The manufacturing, trading, and service industries should benefit from cost reduction and efficiency gain, new job creation, and the inflow of FDI. VI. DEVELOPMENT OF AN E-FINANCE INDUSTRY IN HONG KONG

Advances in ICTs have profound impacts on the banking and finance industry. Even before the emergence of the Internet technology, financial institutions in Hong Kong introduced ICTs to reduce the physical burden and cost of surging paper-based transactions, to streamline operations, and to improve customer service. ATMs, payments by phone or dial-up banking services, and electronic money (multi-purpose storedvalue cards) are widely available and used in Hong Kong. In addition, the financial infrastructure for payment and settlement among financial institutions is built on ICTs. For instance, the Hong Kong Monetary Authority has developed a real-time gross settlement system (RTGS) for inter-bank clearing and settlement. It has also built a Central

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Moneymarket Unit (CMU) facility for seamless trading in commercial and debt papers. Internet Banking

The growth of Internet banking is expected to transform the industry drastically. Internet banking provides a virtual counterpart to physical branches and delivers real-time online functionality including 24-hour account access, cheque and saving account opening, billing and payment services, applications and approvals of loans and credit cards, funds transfer between accounts, brokerage, and a wide range of financial information and bank-specific messages. In addition, Internet banking can provide customised services, such as up-to-the-minute tracking of expenses and transaction details and customised reports that show transactions by type of investment, expense, or income. Internet banking also allows users to manage multiple accounts as well as to handle budget and cash flows. From the banks’ point of view, as well as improving customer service, online banking transactions increase efficiency and save costs by switching away from paper-based transactions such as monthly statements and credit card bills. Fees for online bill payment services may increase banks’ revenues. The Internet also gives banks greater opportunities to cross-sell products such as credit cards, home and car loans, insurance, and stock trading. ICTs greatly enhance banks’ capabilities to process and analyse information about their customers, facilitating “mass customisation” of products. They are now more able to design products precisely to the needs of individual customers. Where a huge branch network was once a strength it has now become a liability to many banks. By enabling banks to consolidate or cut down the number of physical branches, Internet banking yields great savings in rental, staff, and other overhead costs. With these cost savings “branchless” banks should be able to pay higher rates on deposits and to charge lower rates on loans or fees for other bank services than traditional banks. Moreover, greater transparency and public access to market information may force banks to share the benefit of these lower costs with consumers. Internet banking also has the potential to enhance competition in the banking industry. The declining importance of a brick-and-mortar presence puts foreign banks or banks with smaller branch networks in a stronger position to compete with bigger banks. Increased competition will lead to further narrowing of the interest rate spread and put a greater squeeze on

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banks’ profits. It should encourage banks to enhance efficiency, consolidate operations, and diversify into non-interest earning activities and explore other business opportunities perhaps in fast-growing e-commerce areas such as bookkeeping services, issuing invoices and confirmations for online businesses, digital-cash or digital-cheque, letters of credit for etrade, and payment settlement. Internet banking has grown rapidly in Hong Kong over the past few years. Most of Hong Kong’s major commercial banks (HSBC, Hang Seng Bank, Bank of China, Standard Chartered Bank, Bank of East Asia, and Dao Heng Bank) already offer online services. They have all adopted a dual-channel delivery approach (the so-called “click-and-mortar” system), with both traditional branch networks and electronic services. They provide mainly retail banking and brokerage services over the Internet. The rise of Internet banking poses new challenges to regulators to cope with the potential risks, including operation (security) risk, legal risk, and banking (virtual bank runs) risk. The Hong Kong Monetary Authority is currently developing a policy framework for Internet banking. In May 2000 it issued a set of draft guidelines on Internet banking for consultation. E-Brokerage

The advance in ICTs is also transforming the stock market. The growth of online brokerage enhances competition, transparency, and efficiency in the industry. Electronic brokerage service is delivered through an electronic trading system that connects investors directly with the stock exchange. It is an automated trading and order routing system with rules and approval process (for example, verification of authorisations and margin requirements) built-in. Like Internet banking, online brokerage helps to lower processing costs by reducing paper-based trading and human intermediation. Its other advantages include standardisation of trading transactions, ease of use and access, timeliness of transaction execution, up-to-the-minute equity quotes, financial news and information, and customised financial reports. More importantly, improved information on trading (for example, verifiable information provided by e-brokerages and the ability to observe actual flows of orders as well as the time of execution) makes the market or trading process more transparent and exposed. Informed investors are now better able to monitor transactions, obtain the best quotes, and assess brokerage efficiency, performance, and service quality. The industry has become increasingly customer-centred. E-brokerage should pose a major challenge to the traditional brokerage system. Traditional institutional and retail brokerages were able to rely on © 2003 Institute of Southeast Asian Studies, Singapore

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(fixed) commission fees as a main source of profits because customers had limited access to the exchange. E-brokerage provides direct access to the exchange, enabling investors to dis-intermediate traditional brokers or fund managers. Mere matching of buyers and sellers and executing of transactions no longer justify the role of traditional brokers. Increased competition from online brokers forces them to lower their fixed commissions or to charge flexible, negotiable commissions. Traditional brokerages are also forced to become more efficient (say by re-engineering operations) and to reduce operating costs by using the Internet to provide routine services such as information dissemination, statement presentation and placement, and account verification. At the same time, traditional brokers need to redefine the services they provide to investors, emphasising professional research and advice, use of credit for margins, or customised reports, for example. They should perhaps shift from relying solely on trading commissions to relying on management and other professional fees (which may be performance-based). Ebrokerages may also encourage product diversification, e.g., customised investment portfolios with personalised return-risk combinations and riskhedging. Importantly, a transparent and competitive stock market with lower commissions and transactions costs should encourage more active and frequent trading. This should drive up the turnover rates and hence commission-based revenues. In addition, retail investment will gradually become an important source of liquidity in the stock market. The emergence of online brokerage also lowers the physical barriers to local stock market entry and encourages cross-border trading in stocks or other commercial papers, which creates an additional source of competition and facilitates further integration of global financial markets. To provide the financial infrastructure for online brokerage, the Stock Exchange of Hong Kong launched the AMS/3 (Third-generation Automatic Order Matching and Execution System) in October 2000. It has converted all on- and off-floor trading terminals into AMS/3 terminals. When fully implemented, the order routing system will enable investors to place orders directly by telephone or by other electronic channels such as the Internet, mobile phone, or other proprietary network systems. Investors can also check trading status over the Internet and other channels and use other investment services such as IPO subscription. E-brokerages have grown rapidly over the past few years. Many banks with online channels and major brokerages in Hong Kong already provide their services online and offer various inducements such as rebate of commission or other discounts on cross-sale products. The Hong Kong Stock Exchange has agreed to the government’s proposal to remove the © 2003 Institute of Southeast Asian Studies, Singapore

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minimum brokerage commission rule for both stock and futures transactions from April 2002. Quite a few brokerages have launched online trading for foreign stocks, particularly U.S. stocks. Financial Market Integration

Advances in ICTs should promote further global integration of financial markets and cross-border capital mobilisation. ICTs help to create a network of individual financial markets, say, in Asia, giving rise to a truly “regionalised” financial market. The 1997 Asian financial crisis highlighted the flaw with the emerging Asian economies’ reliance on bank lending as a major source of finance and channel for tapping foreign capital. It is therefore important for the Asian region as a whole to develop more balanced financial markets with diversified channels of financial intermediation. Specifically, an active and liquid Asian debt market should more effectively direct long-term savings to long-term investment activities. It would also promote the growth of institutionalised savings and provide various debt instruments for portfolio managers to contain market and maturity risks. ICTs are the foundation of the financial infrastructure that provides secure and efficient clearing, payment, and settlement of financial transactions across borders. Many Asian countries have already upgraded their payment systems to the RTGS standard that provides delivery-versuspayment (DvP) transactions for security trading and payment-versuspayment (PvP) transactions for foreign exchange trading. The formation of a network of payment systems in Asia should greatly encourage crossborder trading in debt securities and other financial assets in the region. In this regard, in 2000 Hong Kong launched an RTGS system for financial transactions denominated in U.S. dollars in addition to the one for Hong Kong dollar-denominated transactions. This should facilitate the crossborder issuing and trading of debt securities in Hong Kong. Hong Kong is already a major banking and financial hub in Asia, with most international bankers, brokers, and institutional investors present there. It should strive as well to become a regional bond centre, a centre for issuing debt and for the trading, holding, and settlement of Asian bonds and other debt securities for participants in Asian time zones at least. This would further enhance Hong Kong’s position as a regional financial hub. In addition to being a fund-raising centre, Hong Kong should reposition itself as a fund management centre for Asia with international investors actively investing or managing funds in Hong Kong.

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VII. IMPLICATIONS FOR REGIONAL CO-OPERATION AND DEVELOPMENT

Advances in ICTs and the global economic and trading network that they support should raise overall efficiency and growth for the global economy. Nonetheless, because access to the global network has been uneven, there is concern about the emergence of a global digital divide. ICTs (and connectivity) now serve as a key to participating in global exchange. Less developed countries with inadequate information infrastructure have tended to have poorer access, and they may be increasingly excluded from this new trading system and forced into ICT-related poverty. The threat that a global digital divide may emerge has drawn the attention of multinational institutions and the international business community towards bridging the digital gap. Indeed, from the perspective of the global economy, it is crucial to achieving ultimate productive and allocative efficiency and improved living standards that all countries, with their diverse comparative advantages and their cultural and resource uniqueness, are included in the new trading network. On the positive side, the network economy has opened up new opportunities for developing countries. Access to the global pool of technologies, market information, and talents allows them to skip old technologies and leapfrog intermediate stages of industrialisation to develop the high technology and knowledge industries of the New Economy. In a network economy with increasingly globalised marketing of finished products and sourcing of supplies, small developing countries that develop their own edges can gain a position as part of the global supply chain. The trend towards customisation and the rapid growth of electronic commerce affords SMEs in developing countries greater opportunities to compete on the world market, producing customised goods or parts in multiple supply chains. For their own part, developing countries should take active steps to build their communication and information infrastructure.2 Indeed, with the enhanced capability and flexibility of the latest information technology and the drastic drop in the prices of related hardware and software, developing countries should be able to afford to build highly efficient information networks. Specifically, they should liberalise the telecommunication industry and create a pro-competitive and technologyneutral regulatory environment to encourage private-sector investment in the IT infrastructure and to promote the deployment of such infrastructure. They should consider seriously (further) opening the industry to foreign

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competition. This will attract inward FDI and bring in needed capital, expertise, and technology. Intensified competition will also help lower prices, increase access to the information network, and promote services and product innovation. Developing economies should also promote digital literacy and IT education, boost R&D and innovation capabilities, and develop a venture capital market. Concerted actions among the Asian economies will foster cross-border electronic commerce in the region. In addition to building a high-capacity regional information infrastructure network, they should work together to enhance confidence (security) in electronic transactions to encourage crossborder commercial exchanges. Given the diversity of technological solutions, multinational efforts will be required to set common security standards and procedures. Many Asian countries have already established domestic digital certification authorities and have started to pursue mutual recognition on a bilateral basis. They should proceed to form a regional mechanism to support cross-recognition of certification, with a consistent set of rules and regulations to govern the responsibilities and liabilities of certification authorities. The Asian economies should also devote effort to establishing coordinated mechanisms to protect consumers. National consumer protection laws and regulations have limited applicability to online transactions, which often involve parties in different jurisdictions. It is therefore necessary to establish a dispute settlement facility for resolving disputes and appropriating responsibility (and compensation) between parties to such transactions. It is also important to establish a common mechanism for making refunds in the case of cancelled orders, defective products, or lost delivery (i.e., standard consumer protection expectations). Asian economies should also consider providing a common (quality) certification facility (such as a labelling system) for online businesses that have achieved certain international standards. Individual countries (and the region as a whole) should intensify efforts to protect intellectual property rights in cyberspace because the digital nature of most information and multimedia products sold online makes them particularly vulnerable to duplication and piracy. Reducing the cost and time required for delivery of goods would encourage cross-border e-business. This includes providing for efficient (and cheap) physical delivery of goods ordered online, as well as timely online delivery of digital goods and services. Inadequate physical infrastructure could seriously delay delivery, particularly of physical goods, and slow the growth of e-commerce. Asian countries should take steps to

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continually upgrade their port and transportation facilities and to promote competition in these industries to lower the cost and to increase the efficiency and speed of physical delivery channels. In addition, they should work to simplify customs clearance procedures, particularly for parcel delivery. Linking national customs administration facilities in a regional network using Internet-based EDI should also enhance overall delivery efficiency by reducing the time and costs associated with customs-related transactions. An efficient payment system is essential for market exchanges. Global economic networking is driving cross-border trading in goods and services as well as securities, and the resulting rapid growth in international payment and settlement traffic calls for upgrading the payment infrastructure of global financial systems. This will increase payment stability and efficiency and reduce risk. Asian countries should seriously explore establishing a regional network of national inter-bank payment and settlement systems. In addition to the previously mentioned RTGS system for domestic interbank payments and settlements, many Asian countries have also adopted modern clearing and settlement systems for the stock, futures, and debt markets. Linking these domestic RTGSs together to make an intra-regional network infrastructure should facilitate seamless trading in financial instruments across borders. This will alleviate the burden of a surging volume of trading and more importantly reduce the risks inherent in the existing payment and settlement system (e.g., systemic risk, liquidity risk, and Herstatt risk). In addition, to facilitate the integration of financial markets in the region, it is crucial for Asian economies to harmonise their regulatory and supervisory standards for the banking industry. They also need to co-ordinate the regulation and supervision of individual stock exchanges including their listing, trading, and settlement rules and other practices such as corporate governance, information disclosure, and investor protection. For the Asian region as a whole to benefit fully from the new network economy will require co-ordinated efforts involving high-level government officials and the business community to implement a wide range of programs, including the harmonisation and simplification of customs rules and procedures, building a regional electronic customs administration network, upgrading port and transport facilities, promoting cross-recognition of digital certification, and enhancing customer and privacy protection. ASEAN’s recent initiative to create an e-ASEAN Framework and its move to extend regional co-operation to ASEAN-Plus-Three have been encouraging signs of such a region-wide approach. The ASEAN schemes

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offer an institutional framework for concerted efforts to address the issue of the digital divide and to promote the growth of the New Economy. VIII. CONCLUSION

New ICTs have dramatically transformed the ways markets operate and the way firms sell their products, source supplies, and organise operations. They enable a dramatic increase in the flow of information and lower the cost for firms to process and utilise such information to re-engineer supply chains and production processes. The emergence of a cyber-marketplace can lower transaction costs and reduce barriers-to-entry and other market imperfections. It should also enable more direct consumer-producer relationships and promote a competitive, consumer-centred market. As a result, markets should become more efficient, raising aggregate supply in the economy and facilitating better allocation of resources. The emerging global trading network and rapid growth of cross-border electronic transactions contribute to globalisation of trade and capital flows. Businesses around the world are increasingly encouraged to adopt more globalised production, sourcing, and marketing strategies, as well as to diversify into producing customised products to match consumer needs. Specifically, the network economy has offered substantial digital opportunities for developing countries to participate (more actively or directly) in the global supply chain. They should focus on developing their own competitive edges and market niches, aiming to produce highly customised products for multiple markets. The implied growth strategy is for a developing economy to continuously upgrade its information infrastructure (and connectivity), to explore new opportunities in the new digital economy, as well as to use ICTs to enhance the competitiveness of, or to revitalise, the conventional industries wherein lie its existing strengths. In addition to investing in the necessary information infrastructure, economies need to establish a market-based, flexible, and forward-looking regulatory framework, and to develop other soft infrastructures such as R&D facilities, human capital, venture capital, and entrepreneurship. Hong Kong’s economy has adapted quickly to the ICT revolution. There has been rapid growth in the use of Internet and ITrelated commercial applications. The government has apparently switched to playing a proactive role in this regard. It has implemented various policies and other initiatives to reshape Hong Kong’s knowledge- and resource-base for the New Economy. Overall, Hong Kong is proceeding

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on the right track for a growth strategy that aims to enhance its existing competitiveness in a global cyber-economy. Notes 1

2

The index compares the preparedness for e-business among sixty countries by weighing the expected attractiveness of their general business environment over the next five years and their degrees of connectivity (EIU Business Readiness Ranking 2000). Of course, they also need to adopt conventional growth policy measures such as well-built physical infrastructure, an efficient financial market, educated workforce, free trade, and a market economy.

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Chen, Edward K.Y., and Raymond Ng. 2000. “Economic Restructuring of Hong Kong on the Basis of Innovation and Technology”. Paper presented at the AT10 Researchers’ Meeting on “Industrial Restructuring in East Asia towards the 21st Century”, Tokyo Club Foundation on Global Studies, Nomura Research Institute, Tokyo, January. Cooke, J.A. 2000. “Re-inventing the Public Warehouse”. Logistic Management and Distribution Report 39(5): 44–50. Davenport, S., and D. Bibby. 1999. “Rethinking a National Innovation System: The Small Country as ‘SME’”. Technology Analysis and Strategic Management 11(3): 431–62. Economist. 2000a. “Internet Economics: A Thinkers’ Guide”. 1 April. ———. 2000b. “The New Economy: Untangling e-Economics”. 23 September. Economist Intelligence Unit (EIU). 2000. Press Release on “Where is the Best Place to E-Business”. 7 June. Fingar, P. 2000. “E-Commerce: Transforming the Supply Chain”. Logistics Management and Distribution Report, Supplement: E-logistics, April, pp. E7–E10. Global Information and Communication Technologies Department, World Bank Group. 2000. “The Networking Revolution: Opportunities and Challenges for Developing Countries”. InfoDev Working Papers Series, June. Granitsas, A. 2000. “Tangled in the Web?”. Far Eastern Economic Review. 4 May, pp. 48–50. Hamlet, C. 2000. “Community Banks Go Online”. ABA Banking Journal 92(3): 61–64. Hong Kong Bond Markets: A Regional Leader in the Making? 2000. Asiamoney 11(9): 22–25. November. Hong Kong Exchanges and Clearing Limited. 2000. Growth Enterprise Market Statistics. . Hong Kong Monetary Authority. 2000. “Guideline on Authorization on Virtual Banks”. HKMA Quarterly Bulletin, No. 23 (May): 46–51. Hong Kong SAR Government. 1998. Digital 21-IT Strategy. ———. 2000a. Policy Address 2000. ———. 2000b. “Regional Operation Pouring into Hong Kong”. Press Release. 12 December. Hong Kong Trade Development Council. 2000a. Economic and Trade Information in Hong Kong. From , December.

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———. 2000b. Profiles of Hong Kong Major Service Industry — Telecommunication, Internet, Information Technology Services, Film, Publishing. December. Keynes, A. J. 1999. “Virtual Banking”. Black Enterprise 30(4): 145–48. Kiesnoski, K. 1999. “Cyberbanks: Carving a Market Niche?”. Bank Systems & Technology 26(5): 30–36. Konana, P., N.M. Menon, and S. Balasubramanian. 2000. “The Implications of Online Investing”. Association for Computing Machinery – Communications of the ACM (New York) 43(1): 34–41. Kwong, K.C. 2000. Opening Remarks at the Second Conference on the Internet and Technology in the Asian Financial Markets, Hong Kong, 13 April. Mingpao, (Chinese newspaper), 29 December 2000. Morgan, C., and S. Perkins. 2000. “Electronic Exchanges Emerge Transforming the Equities Business”. Wall Street and Technology 18(10): 72–74. Nadler, P.S. 2000. “Fact and Fiction in Internet Banking”. The Secure Lender 56(3): 44–48. Organisation for Economic Co-operation and Development (OECD). 1997. “Dismantling the Barriers to Global Electronic Commerce”. Conference Documents. International Conference and Business-Government Forum on Dismantling the Barriers to Global Electronic Commerce, organised by the OECD and Government of Finland, Finland, 19–21 November. ———. 2000. OECD Information Technology Outlook 2000: ICTs, ECommerce and the Information Economy: Highlights. March. Petrazzini, B., and J. Ure. 1997. “Hong Kong’s Communication Infrastructure: The Evolving Role of a Regional Information Hub”. In Information Technology and the Challenge for Hong Kong, edited by J.M. Burn and M.G. Martinsons. Hong Kong: Hong Kong University Press, pp. 61–90. Severino, R.C. 2000. “ASEAN and Hong Kong: Common Interests and New Opportunities in a Changing Region”. Luncheon Talk at the Asia Society Hong Kong Centre, Hong Kong, 5 April. Sims, M. 2000. “Tomorrow’s Warehouse Today”. Global Cosmetic Industry 166(2): 38–42. Tapsell, S. 1998. “Brickless Banking”. Management (Auckland) 45(4): 38–40. Trunk, C. 1998. “Warehouse Management Systems: New Pathways to Justification”. Material Handling Engineering 53(1): 48–55.

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Tse, K.L. 2000. “Growth of Multinational IT Companies in Hong Kong as a Regional Base for the Asia Pacific” (in Chinese). China Review, April, pp. 71–75. Visco, I. 2000. “The New Economy: Fact or Fiction?”. The OECD Observer, Organisation for Economic Cooperation and Development, Issue 221/ 222, pp. 6–10. Voon, T., and L.S. Ho. 2000. Economic Impacts of Logistics Centre Development in Hong Kong. Hong Kong: Centre for Public Policy Studies, Lingnan University. World Bank. 2001. Global Economic Prospects and the Developing Countries 2001. Yam, J. 1988. “The Impact of Technology on Financial Development in East Asia”. Journal of International Affairs 51(2): 539–53.

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Reproduced from Towards a Knowledge-based Economy: East Asia’s Changing Industrial Geography, edited by Seiichi Masuyama and Donna Vandenbrink (Singapore: Institute of Southeast Asian Studies, 2003). This version was obtained electronically direct from the publisher on condition that copyright is not infringed. No part of this publication may be reproduced without the prior permission of the Institute of Southeast Asian Studies. Individual articles are available from < http://bookshop.iseas.edu.sg >

SINGAPORE: A REGIONAL HUB IN ICT 259

10 Singapore: A Regional Hub in ICT Chia Siow Yue and Jamus Jerome Lim INTRODUCTION

Singapore is a unique island city-state in Southeast Asia, with an area of only 650 square kilometres and a population of 4 million. Despite its small size and dearth of natural resources, it became one of East Asia’s miracle economies and emerged relatively unscathed by the Asian financial crisis of 1997–98. The annual GDP growth rate has averaged over 7 percent since political independence in 1965, resulting in a per capita income level that ranks among the highest in the world. Singapore overcomes its size and natural resource constraints by leveraging on the region and the world. It is both a manufacturing base, producing increasingly skill- and technology-intensive goods for the global and regional markets, as well as a services hub, producing largely for the regional market. Singapore’s recently adopted strategy to position itself as a regional information and communications technology (ICT) hub is part of its overall strategy to develop as a knowledge-based economy. Singapore is well placed for this role because of its rapid and advanced development of ICT and because its other hub activities in commerce and transportation complement the activities of an ICT hub. The ICT revolution has created global communications networks. Notwithstanding the trend towards standardisation in the global network, however, regional network nodes exist and thrive because of national and regional differences. The traditional flying geese pattern of East Asian development, characterised by hierarchical and uni-directional diffusion of technology and production from upper-tier to lower-tier countries, is giving way to a complex network relationship driven by ICT. Trade, investment, and technology flows are multi-directional, leading to the emergence of interrelated clusters. Thus, Penang in Malaysia is specialising in supply of

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electronic parts, while the Philippines is leveraging on its educated labour force to be an IT service centre for foreign multinational corporations (MNCs). Singapore is positioning itself as a service centre and headquarters (HQ) logistics base for Southeast Asia. As a city-state with extensive trade, transportation, and telecommunications connections, Singapore is the recognised hub city of the region. It is the regional entrepôt, and intraregional trade in Southeast Asia is largely with and through Singapore. It is the major shipping and air transport node of the region, linked by sea and air to all parts of Southeast Asia and by land to Malaysia. It is the region’s financial centre, providing an ever-broader range of financial services. Flows of goods, services, and people have been reinforced by outward investments to the region. As a regional hub, Singapore is the location for the regional headquarters of many American, European, and Japanese MNCs. Political considerations often complicate and constrain Singapore’s role as a regional hub and its complementarities with neighbouring Indonesia and Malaysia. Singapore aspires to be more than a regional hub city. It is a global city; with its extensive global commercial, financial, transportation, telecommunications, and information links it serves as the conduit between the region and the world beyond. Singapore also plays host to some 6,000 foreign MNCs and international companies from outside of Southeast Asia. This chapter develops a picture of Singapore as an ICT hub: its aspirations, its competitive advantages, and its weaknesses. The next section lays out the conceptual framework to understand the emergence of hubs and clusters. Then the chapter examines the role of Singapore as a regional hub and reviews ICT development and policies in Singapore. CONCEPTUAL FRAMEWORK

The dictionary defines a hub as the central part of a wheel, round which it turns and to which the outside edge or rim is connected by spokes. In economic terms, hubs represent concentrations of certain economic activities, interconnected companies, and institutions in a defined geographical space. Economic hubs and clusters may emerge because of an initial advantage in the availability of specific raw materials (the iron and steel-producing centres in the United States and Europe) or of specific skills (the entertainment industry in Hollywood and the ICT industry in Silicon Valley). Economies of scale and agglomeration lead to the growth

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of hubs and clusters. They include companies in industries with related skills, technologies, or common inputs. They also include government and academic research institutions that provide standards, education and training, research, and technical support. Clusters often extend along the value chain to include suppliers and providers of specialised inputs or infrastructure. Hubs can grow to serve hinterlands within national borders, or even beyond national boundaries, as is the case with London’s financial centre and the Hong Kong and Singapore entrepôts. Hubs and clusters can emerge and decline in response to market forces. This section reviews two theoretical models that analyse the emergence of industrial clusters and hubs. The Fujita, Krugman, and Venables (1999) model is based on increasing returns from positive externalities due to agglomeration in a borderless world with trade costs. Porter’s (1998a, 1998b) model introduces important qualitative variables such as knowledge spillovers and institutional benefits and focuses on competitive advantages in cluster location. Influence of Industry-specific Inputs and Transport Costs on Agglomeration of Industry

In the Fujita, Krugman, and Venables model, forward and backward linkages among firms create centripetal forces that support agglomeration, but trade costs give rise to conflicting centrifugal forces. From an initial “flat-earth” equilibrium in which industry is evenly dispersed, the model examines how industrial clusters eventually develop as a result of slight deviations in the parameters of the model — the size of the manufacturing sector, consumers’ elasticity of substitution, trade costs, and factor inputs specific to an industry. These subsequently impact on the frequency of the fluctuations, and result in a “preferred frequency” which is simply the number of agglomerations or clusters that form in a stable equilibrium. Of key interest for the purposes of policy are the two parameters of industryspecific factors and trade costs. Figure 10.1 illustrates how the existence of industry-specific factors affects the tendency to form industrial clusters. It shows the results of a model simulation with no industry-specific factors and one when they are present. The height of the curves represents the stability of the initial flatearth equilibrium, or, equivalently, the likelihood that industry clusters emerge. Below the horizontal dotted line, the centrifugal forces dominate, the flat-earth equilibrium is stable, and no agglomeration results. Above the dotted line, the centripetal forces are stronger, the initial equilibrium is

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FIGURE 10.1 Effect of Industry-specific Factors on Agglomeration

Stability of flat earth Unstable Industry-specific factors absent 0

Stable

Industry-specific factors present

Frequency of Agglomeration

Source: Adapted from Fujita, Krugman, and Venables 1999.

unstable, and some clusters will develop. The point where the curve attains a peak is the preferred frequency of agglomeration, or the number of clusters in a new equilibrium. In Figure 10.1, the curve for the case with industry-specific inputs lies below the one without such inputs and it covers a narrower range of frequencies. When factor inputs are not industry-specific (the upper curve), an industry can locate in many different places, but when inputs are specific to an industry (the lower curve), industries have greater motivation to pool resources in fewer locations. Therefore, although agglomerations are less likely to occur, if they do, only an intermediate number of clusters will emerge. Figure 10.2 illustrates the effect of transport (trade) costs in this model. The solid line indicates the preferred frequency of agglomeration for the two-industry case when there are industry-specific factors. The dotted lines indicate how the spatial structure (number of agglomerations) evolves as transport costs fall (upper dotted line) or rise (lower dotted line). Most significant is the “punctuated equilibrium” nature of this evolution: the spatial structure remains stable over wide ranges of transport costs and then shifts abruptly. In other words, inertia from the forces that resulted in

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FIGURE 10.2 Effect of Transport Costs on Agglomeration

Frequency of agglomeration Decreasing transport costs

Preferred frequency

Increasing transport costs

Transport costs Source: Adapted from Fujita, Krugman, and Venables 1999.

the existing clusters continues to resist the pressure from changing transport costs until a critical point, and then a new economic geography develops, with more clusters forming or some disappearing. This suggests that there is considerable path-dependence in the spatial structure over time. Moreover, the pathways to the new spatial structure are asymmetric between rising and falling transport costs. This suggests that simply reversing changes in transport costs will not lead the economy to revert to a former spatial structure. Figure 10.3 shows how the spatial distribution of the two industries differs for three levels of trade costs (high, intermediate, and low), with the curves in each panel representing the concentration of industry at each location. As trade costs fall, there is a move towards a lower frequency of agglomeration. In particular, industry 2 (the lower trade cost industry) moves from occupying the core in the middle panel to occupying the periphery in the bottom panel. Likewise, the higher trade cost industry shifts from periphery to core. Intuitively, as trade costs fall across the board, they become low enough that agglomeration forces are no longer as important for industry 2 which relocates to benefit from lower wages at the periphery.

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FIGURE 10.3 Effect of Transport Costs on Location

Transport Costs

Industry 2

Concentration of Industry High

Industry 1 Industry 2

Concentration of Industry

Intermediate

Concentration of Industry

Low

Industry 1 Industry 2

Industry 1 Location

Source: Adapted from Fujita, Krugman, and Venables 1999.

Influence of Location on Competitiveness

Porter used the Diamond Model, shown in Figure 10.4, as the basis of his explanation of the beneficial impact of industrial clusters on productivity and productivity growth. The four points of the diamond represent four categories of influences on a firm’s competitiveness that depend on its location: Factor Input Conditions; Context for Firm Strategy and Rivalry; Demand Conditions; and Related and Supporting Industries. Factor Input Conditions include tangible aspects such as physical infrastructure and intangible ones such as information and the legal framework. The Context for Firm Strategy and Rivalry encompasses the local investment climate as

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FIGURE 10.4 Porter’s Diamond Model of Locational Competitive Advantage

Context for Firm Strategy & Rivalry

■

Local context encourages investment & upgrading

■

Vigorous competition among local rivals

Factor Input Conditions

■

Factor quantity & cost

■

Factor quality

■

Factor specialisation

Related & Supporting Industries

■

Presence of good local suppliers

■

Presence of competitive related industries

Demand Conditions

■

Demanding local consumers

■

Local needs reflect global preferences

■

Local specialised needs can be served globally

Source: Porter 1998a.

well as local policies that affect rivalry. Demand Conditions in the local market influence whether firms can move from imitative, low-quality products and services to competing based on differentiated products. The factors under the Related and Supporting Industries category are the key facet of the diamond that relate to the formation and growth of industry clusters. Porter argues that the quality of the business environment, defined by these four categories, is of paramount importance to an economy’s sophistication and productivity, and hence its competitiveness. Further, he argues that the factors in the Related and Supporting Industries category, or the cluster-specific aspects of the business environment, are the most significant. In particular, clusters influence productivity, innovation (and productivity growth), and new business formation, which in turn supports innovation and subsequently expands the cluster. First, clusters enhance

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productivity through more efficient sourcing of inputs, improved access to skilled human resources, suppliers, and specialised information, and various complementarities within the cluster. Second, clusters influence innovation because they normally contain sophisticated buyers who drive the innovation cycle and because they offer innovators better sourcing options, greater supplier support, and pressure from peers, competitors, and consumers. Third, clusters encourage the emergence of new businesses because the complementarities among inputs, suppliers, and technologies on which new businesses might depend are more visible. New businesses, in turn, pick up the slack in innovation left by larger firms, furthering innovation within the cluster.

FIGURE 10.5 Government Influences in Porter ’s Diamond Model

Context for Firm Strategy & Rivalry

Factor Input Conditions

■

Create specialised education and training

■

Establish university research in clusterrelated technologies

■

Support clusterspecific information gathering

■

Enhance specialised infrastructure

■

Eliminate barriers to local competition

■

Organise government departments in clusters

■

Attract foreign investment to clusters

■

Promote exports around clusters

Related & Supporting Industries

■

Sponsor forums for cluster participants

■

Encourage cluster efforts to attract foreign suppliers

■

Establish clusterorientated free trade zones

Source: Porter 1998b.

© 2003 Institute of Southeast Asian Studies, Singapore

Demand Conditions

■

Create streamlined, proinnovation regulatory standards affecting clusters

■

Sponsor independent quality rating bodies for cluster goods & services

■

Act as sophisticated buyer of cluster goods & services

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Cluster analysis takes a broad, dynamic view of competition that emphasises growth in productivity. As such, it advocates the development of all clusters, not just selected ones. This stance implies that foreign imports and firms are important contributors to agglomeration externalities and therefore that competition and trade are a positive-sum game. From the perspective of Porter’s Diamond Model, government policy to support industrial clusters involves four key aspects: maintaining macroeconomic and political stability; improving micro-economic capacity; establishing micro-economic rules and incentives for competition; and facilitating cluster development and upgrading (Figure 10.5). SINGAPORE AS REGIONAL HUB

Singapore’s status as a regional hub for Southeast Asia and sometimes for the broader East Asia and Pacific region is evident from its role as a regional trading, financial, transport, and telecommunications hub as well as manufacturing base for foreign MNCs (Chia 2000). As a regional hub, Singapore also has extensive commercial, financial, transportation, telecommunications, and information links around the world. It is the conduit for global commercial and financial penetration into Southeast Asia and for Southeast Asian goods entering the world market. Manufactured goods produced in Singapore are destined largely for markets in North America and Western Europe rather than Southeast Asia, although intra-regional trade in intermediate goods is very active. With the growth of ICT in international trade and investment, Singapore has added another dimension to its hub activities and aspirations. Manufacturing-Services Nexus

Singapore grew rapidly as a manufacturing base (Chia 1997). However, by the end of the 1980s, it renewed emphasis on the development of services to provide a broader economic base and in recognition of the manufacturingservices nexus. Policymakers adopted Porter’s cluster model as the basis for developing Singapore’s industrial competitiveness. The Strategic Economic Plan (1991) identified thirteen clusters in manufacturing and services for development. For each cluster, Singapore’s advantages and core capabilities were examined and strategies and initiatives undertaken to close identified gaps. Strategies for manufacturing were grouped under Manufacturing 2000, which stressed the need to retain a manufacturing base in Singapore in view of the manufacturing-services nexus, rather than

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to follow Hong Kong on the path to de-industrialisation. The target was to keep manufacturing at no less than 25 percent of GDP. Strategies for services were grouped under International Business Hub 2000, which aimed at developing Singapore as a global city and a hub for business and finance, logistics and distribution, and communications and information. Industry 21 was launched in 1999 as a ten-year plan to develop Singapore into a vibrant and robust global hub of knowledge industries in manufacturing and traded services, giving new emphasis to knowledgebased activities as the frontier of competitiveness. The new plan continues the cluster strategy. Manufacturing and service clusters identified for development are electronics, logistics, communications and media, chemicals, life sciences, engineering, education and health care, and regional headquarters. Programs are drawn up to promote enterprise and innovation in these clusters. Singapore’s hub strategy is based on the understanding that key economic activities such as finance, shipping, air transport, telecommunications, and information are increasingly concentrated in a few strategic nodes around the world, each one servicing an extended hinterland and linking it with the rest of the world. Singapore seeks to secure the first-mover agglomerative advantage and in so doing hopes to secure its lead on the competition. It does so by planning far ahead, developing a world-class physical infrastructure (airport, seaport, telecommunications network, financial and industrial facilities), investing in human resources (education and training), providing the institutional and incentive frameworks, and building good relations with regional countries through political diplomacy, outward investment, and joint ventures to combine its competitive strengths with regional and international partners. To be accepted as a regional hub, Singapore must provide added value to its economic hinterland through world-class products and services and reputation for quality, reliability, and excellence. Regional Entrepôt

Singapore has served as a regional entrepôt since the early nineteenth century. Its initial advantages were the specific factors of a natural deep harbour and strategic location astride sea lanes for ships plying between East Asia and Europe. In addition, the British colonial administration’s enlightened free-port policy was crucial to Singapore’s early success since many nearby locations were also deep harbour possibilities. The development of transportation, commercial, and financial infrastructure and facilities and the accumulation of expertise in trade and finance © 2003 Institute of Southeast Asian Studies, Singapore

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reinforced the first-mover advantage arising from geographic and policy factors. Singapore’s entrepôt function led to the growth of ancillary storage and warehousing, shipping, and banking services as well as resource processing activities. The entrepôt provided intermediary services for the geographic hinterland — importing Western manufactures for redistribution in the Southeast Asian region and collecting the region’s primary commodities for marketing to the West. Singapore’s intermediation role facilitated the region’s import and export trade and reduced the various transaction costs for buyers and sellers. Neighbouring countries did not always understand the economic function Singapore served, however, creating friction in bilateral relations and a strong desire to bypass Singapore as an intermediary. As neighbouring countries achieved political independence in the early post-World War II period, the national governments developed their own ports, engaged in direct marketing of primary products, and fostered import-substituting industrialisation. These policies dimmed the prospects of Singapore’s entrepôt development and led the city-state to seek the economic alternative of developing export manufacturing spearheaded by foreign MNCs. In actual fact, Singapore’s entrepôt function did not decline as anticipated but followed a different path of development. With the region’s industrialisation since the 1960s and particularly with the shift in emphasis since the early 1980s towards manufacturing for export, Singapore played an increasing role as intermediary for Southeast Asian trade in machinery and equipment and procurement of electronics parts and components (Chia 2001a). Transportation and Logistics Hub

Singapore is one of the world’s busiest seaports handling ships carrying goods and passengers from all over the world. Some 400 shipping lines link Singapore to over 700 ports. In year 2000, 145,383 ships with a gross weight of 910.2 million tonnes and 325.6 million tonnes of cargo called at Singapore. The range and efficiency of its port and port-related services enhance its position as a leading global and regional port. For example, with container throughput of 17.1 million TEU (twenty-foot equivalent units), Singapore is one of the largest container ports in the world. Singapore is a major regional air transport hub recording 86,853 aircraft landings, 28.6 million passengers arriving, departing, or in transit, and 1.7 million tonnes of air cargo loaded and discharged in year 2000. Changi Airport has repeatedly ranked among the world’s top airports in efficiency © 2003 Institute of Southeast Asian Studies, Singapore

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and quality of services. Singapore Airlines and some 70 other carriers provide over 3,300 scheduled flights a week, linking Singapore directly to 133 cities in 54 countries. Singapore has bilateral air service agreements with nearly 100 countries. A planned third terminal at Changi will enable the airport to handle over 60 million passengers a year. ICT has made the global market more competitive and led to radical changes in organisation of production and distribution and the cost and efficiency of managing supply chains. Manufacturers and businesses are looking to third-party logistics (3PL) providers for supply chain management, time-critical deliveries, and innovative fulfilment solutions. Many leading MNCs have already established manufacturing bases in the region to tap its resources and growing markets. Singapore is building up its supply chain capabilities by encouraging 3PL providers, cargo airlines, value-added distributors, and manufacturers to locate their Asian supply chain centres in Singapore. These companies will provide world-class logistics services and be able to configure logistics solutions to enhance manufacturers’ global supply chains. In March 1999 the Economic Development Board (EDB) announced that it would develop thirty integrated 3PLs capable of delivering an integrated chain of services and solutions for manufacturers. To date, Singapore has developed many world-class integrated 3PLs, including Circle International Headquarters, UPS Worldwide Logistics, Accord Reverse Logistics Centre, DHL Express Logistics Centre, BAX Global, and YCH Integrated Logistics Centre. A 26-hectare Airport Logistics Park (ALP) has been established at Changi Airport to promote quick turnaround and value-added logistics activities, including postponement, configuration, subassembly, returns and repairs, and vendor-managed inventory services. Singapore is wooing leading players with strong global networks and capabilities in value-added logistics to co-locate at ALP. In telecommunications, operator-assisted, STD, and IDD telephone services connect Singapore with almost every country in the world. Within Singapore, the emphasis is on communications infrastructure and information technology education. The entire city-state is being networked by fibre-optic cable, which links households, businesses, government agencies, and other institutions into a giant information system. Base for Foreign MNCs and Regional Headquarters

Singapore hosts some 6,000 foreign MNCs and international companies performing manufacturing and service functions and serves many American,

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European, and Japanese MNCs as their regional headquarters (RHQ) for Southeast Asia and also East Asia and the Pacific. MNCs and international companies established RHQs to serve the regional market and co-ordinate their regional subsidiaries and affiliates in East Asia, which experienced extraordinary economic growth for over two decades until the financial crisis in mid-1997. The EDB actively encourages international companies and foreign multinationals to base their RHQ and business headquarters in Singapore. Such hub activity is seen to create high-value jobs and to introduce valuable technology, management, and marketing expertise. Its RHQ projects include chemicals, electronics, engineering, life sciences, logistics, and supply chain management, hospitality, and infocomms and media. RHQs provide a wide range of services to subsidiaries in the region — business planning and co-ordination, treasury and risk management, sourcing of raw materials and components, marketing and sales promotion, personnel management and human resource development, production engineering and product design, technical support, and research and development. Singapore’s locational advantages are geographic, economic, and institutional. These include: a strategic location in the dynamic East Asian region; world-class transport and telecommunications infrastructure, logistics, and financial services; established corporate governance and Western legal and accounting systems; skilled manpower and widespread use of English; political stability, a conducive business environment, and a comfortable living environment; a regulatory framework that is not too intrusive for business; low transaction costs for movement of goods, services, funds, and persons; a financial centre with free movement of capital and foreign exchange; and a favourable tax regime that includes very generous tax incentives (Chia 1997). Regional Financial Centre

Singapore’s financial centre is the third largest in Asia, after Tokyo and Hong Kong. Its primary business is offshore — collecting offshore funds for offshore lending. The business grew rapidly from the start in the late 1960s, when banks were encouraged to set up Asian Currency Units (ACUs) to handle foreign currency deposits and loans. Over the years, the strategy has also been to establish Singapore as a risk management centre with active foreign exchange trading, money market operations, and trading in capital market instruments, equities, and futures.

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A wide variety of foreign financial institutions are located in Singapore, linking it to the international financial network and other global cities. Before the onset of the Asian financial crisis in mid-1997, there were 152 commercial banks (including 140 foreign banks with full, restricted or offshore banking licences), 80 merchant banks, 5 representative offices of banks and merchant banks, and 9 international money brokers. The number of financial institutions has shrunk since the financial crisis in response to global, regional, and domestic consolidation and restructuring. The financial crisis and the slow recovery of regional economies have also led to a sizeable shrinkage in regional lending activities. Foreign financial institutions based in Singapore enjoy the time-zone advantage (straddling Asia and Europe), efficient transport and telecommunications infrastructure, transparent legal framework and financial regulations, ready availability of professional manpower, attractive investment incentives, and political, social, and economic stability. Singapore’s financial system stood the test of the 1997–98 financial crisis, remaining sound while many systems in the region collapsed. Regional Investment Strategy

Singapore’s hub strategy also calls for outward investment and joint ventures to combine the competitive strengths of Singapore with those of the region. Although Singapore has been a net capital exporter since the mid1980s, in 1993 the government began actively encouraging investments in the region due to a number of push and pull factors. On the push side, the maturing economy was facing severe land and labour constraints and rising costs, necessitating outward investment to sustain its growth performance. Outward investment in manufacturing complements domestic industrial upgrading and productivity improvement. In addition, Singaporean subcontractors followed as their foreign MNC clients relocated some production operations to such neighbouring countries as Malaysia and Thailand because of increasing labour shortage and rising wages in Singapore. On the pull side the improving conditions in East Asia in the early 1990s attracted outward investments. The region offered abundant natural resources, low-cost labour, and rapidly expanding markets, providing opportunities for Singapore to invest in manufacturing, services, and infrastructure projects. Choice of investment location depended on market and cost considerations. Proximity to Singapore was a key factor for some, as it facilitated procurement of inputs and shipments of output and provided

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ready access to support staff based in Singapore. Outward finance, commerce, and real estate investments were attracted more by opportunities in the host countries than by the cost-push factor. With limited outward investment experience Singapore’s domestic enterprises preferred investing within the region to investing on a global scale. Geographic proximity and cultural and linguistic familiarity helped to reduce asymmetric information and other transaction costs. Also, for small and medium-sized enterprises with limited managerial resources, nearby investments facilitated management supervision from the home base. Singapore’s regionalisation strategy includes the government and private firms establishing co-operative joint ventures with government agencies and enterprises in host countries. Singapore’s development agencies and state enterprises have entered into partnership with foreign authorities and private enterprises to develop regional infrastructure projects. These include Batam Industrial Park, Bintan Industrial Estate, Bintan Beach International Resort, and Karimun Marine and Petroleum Complexes in the IndonesiaMalaysia-Singapore (IMS) growth triangle, Suzhou Industrial Park in China, the Bangalore Information Technology Park in India, and the Vietnam-Singapore Industrial Park. These industrial parks provide quick and effective start-up platforms for companies, as they are generally selfcontained, with ready-built factories and industrial land located near commercial, medical, educational, residential, recreational, and other facilities. SINGAPORE AS AN ICT HUB

Advances in technology have sharply reduced the cost of information and communication and are driving globalisation. Information and communications technology has reduced the barriers of space and time. It is an enabling technology that improves the productivity of production and distribution; decreases the cost and speed of information gathering, processing, and dissemination; and rapidly changes lifestyles. ICT is also increasingly viewed as a high-growth economic sector to be promoted and nurtured. The differential development and diffusion of ICT across and within countries and societies has given rise to concern about a “digital divide”. According to various indicators, Singapore is among the most advanced economies in East Asia in the development and diffusion of ICT (Table 10.1). The ICT sector cuts across traditional economic sectors. The Department

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441 6 310 450 349 6 89 10 24 136 – 2 2 1

558 86 438 576 482 29 203 39 86 246 3 7 6 27 7 – 2 24 17 – 5 0 1 7 0 0 0 0 449 34 500 636 419 11 137 38 38 205 8 2 – 4 2.3 – 0.8 5.2 7.4 – 0.3 – 0.1 0.5 0 0 0 0

1990 49 0.1 4.8 33.6 72.3 0.2 2.4 0.4 1.6 8 – 0 0 –

1999

Internet Hosts per 1,000 people

0 1 – 1 – 2 5 9 18 52 – – – –

1990 0 – 0 0 0 – – – 7 – – – 2 –

1999

Waiting List for Main Lines per 1,000 people

Source: United Nations Development Program (UNDP), Human Development Report 2001, Table A2.4.

Japan China Korea Hong Kong Singapore Indonesia Malaysia Philippines Thailand Brunei Cambodia Laos Myanmar Vietnam

1999

1990

1990

1999

Cellular Mobile Subscribers per 1,000 people

Telephone Main Lines per 1,000 people

TABLE 10.1 ICT Diffusion in East Asia

0.06 0.06 0.06 0 0.03 0.08 0.06 0 0.23 – 0.15 – – 0.37

1999

91 – 94 – – 44 44 – – – – – – –

1999

Cost of a Threeminute Local Call PPU US$ 1990=100

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of Statistics (DOS) defines the ICT sector as encompassing the entire chain of ICT-related activities, ranging from manufacturing to the wholesale and retail distribution of ICT products, as well as knowledge-based industries such as Internet service providers, computer software development, desktop publishing, and computer schools. The DOS definition is broader than the OECD’s definition of the ICT sector, which excludes activities such as publishing, reproduction of recorded media, broadcasting, library, and archives. The ICT sector is a major contributor to Singapore’s economy with output amounting to S$26 billion in 1996 or 20 percent of GDP (DOS 1998). The main subsector is ICT manufacturing, (12.3 percent), with ICT services (including wholesale and retail trade, telecommunications, business information and technical services and computer-related services) of lesser importance, although the latter has grown rapidly since the data were compiled (Table 10.2). The main ICT-manufacturing industries are computers and electronic office equipment and electronic components. Singapore is an important East Asian production centre for electronics

TABLE 10.2 Value Added of ICT Activities by Sector in Singapore, 1990 and 1996 Value Added (S$ million)

Manufacturing Computers and electronic office equipment Electronic components Other Wholesale and retail trade Telecommunications Computer-related services Business information and technical services Other services Total

Share of GDP (%)

1990

1996

1990

1996

8,256

16,039

12.2

12.3

1,709 1,433 245

7,909 4,910 3,220 4,228 2,745 982

2.5 2.1 0.4

6.0 3.8 2.5 3.2 2.1 0.8

590 240 12,473

1,796 353 26,143

0.9 0.4 18.4

1.4 0.3 20.0

Source: Department of Statistics, The Information and Communication Technology Sector in the Singapore Economy, 1998.

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products, parts, and components. It is also an important marketing and distribution hub for ICT products, particularly office machinery and telecommunications equipment. The number of establishments in the telecommunications subsector grew from three in 1990 to 39 by 1996 and has come to include Internet service providers, mobile cellular and paging services, and satellite-link services. In the business information and technical services subsector, the largest industry is business and management consultancy services, reflecting the growing importance of information and technical services. The major share of the computer-related services subsector is comprised of software development and consultancy, which is a rapid growth industry. The Infocomm Development Authority’s (IDA) Survey on Infocomm Manpower 2000 shows total manpower in the information and communications (infocomm) sector of over 100,000, constituting some 5 percent of the total workforce. The infocomm workforce has the following characteristics: 73 percent have at least a university degree; two-thirds are male; over half are in the 25–34 age group. By occupation, two-thirds are employed in infocomm sales and marketing, technical support and helpdesk, applications development and integration, and management, with sizeable numbers also in systems infrastructure, multimedia development and integration, infocomm education and training, software development and integration, network infrastructure, and Internet infrastructure. ICT Goods Production and Trade

The ICT hardware industry in Singapore, broadly defined to be the electronics goods industry, is a key industrial sector. The industry contributes over half of Singapore’s total manufacturing output (EDB 2000a). Singapore is a major production as well as trading node in the region for electronics products, parts and components, and supporting services. Electronics production is dominated by American, European, and Japanese MNCs with local firms mainly in subcontracting and supporting industries. It is concentrated in the industrial electronics and electronic component subsectors and it is strongly oriented towards exports. The industry is subject to the boom and bust characteristics of the global electronics business cycle as well as to swift restructuring and relocation in response to rapid technological advances and changing competitiveness and comparative advantage. The industry has passed though four phases of development (Chia 1997; Chia and Freeman 2001).

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Phase 1: Late 1960s to Late 1970s

The Singapore industry was established in the late 1960s with the initial influx of electronics assembly plants set up by MNCs from the United States followed by ones from Europe and Japan. These foreign MNCs were pushed into offshore production and outsourcing because of maturing product cycles and rising domestic labour costs. For U.S. firms, the relocation of labour-intensive processes such as semiconductor assembly was also facilitated by the U.S. tariff schedule that imposes tariffs only on the value added of the imports. At that time, Singapore’s locational advantages included ready availability of trainable low-wage labour and stable industrial relations; well-developed industrial, transportation, and telecommunications infrastructure that facilitated early start-ups and justin-time manufacturing; and strong government support and assistance to train the required human resources, develop local supporting industries, and provide attractive investment incentives. In this phase, human skill requirements were low and there was an abundant pool of young and easily trainable female workers. Phase 2: Late 1970s to Late 1980s

The earlier investments in semiconductor assembly plants in which American investors dominated were followed by investments in consumer electronics in which Japanese investors were prominent. The mid-1980s restructuring of the industry saw an influx of American MNCs in industrial electronics, particularly disk drives and other computer peripherals, computer systems and integrated circuits (ICs), reflecting the increasing globalisation of the U.S. electronics industry. Singapore became a major manufacturing site for computers and peripherals. The earlier wage cost advantage had eroded and Singapore’s continuing competitiveness depended increasingly on its skilled workforce and excellent infrastructure. Also, a critical mass of local electronics supporting industries emerged, especially in printed circuit board (PCB) assembly and precision engineering, in part with government support. In 1986, the EDB introduced the Local Industry Upgrading Program (LIUP), which seeks to link specific foreign MNCs with local suppliers to improve the latter’s operational efficiency and technical capabilities. The human skills required in this phase were higher, necessitating significant improvements in technical education and training programmes.

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Phase 3: Late 1980s to Mid-1990s

Rapid technological change and ever-shortening product cycles intensified global and regional competition. This, as well as a growing labour shortage, pressured the Singapore electronics industry into two responses. The first was to upgrade by investing in more technology-intensive operations through automated manufacturing, shifting to higher-end products such as semiconductor wafer fabrication, computer printers, telecommunications equipment, and hard disk drives, as well as product design and R&D. The second response was to relocate labour-intensive operations and mature and lower-priced product lines to neighbouring countries with greater availability of low-wage labour. The local supporting industries gained in strength and took on contract manufacturing or OEM production, as American, European, and Japanese MNCs increasingly engaged in outsourcing. Again, the upgrading of the industrial structure is evident, with the rise in technology-intensive production and the relocation of lower-end products and processes to other economies in the region. Phase 4: Late 1990s and After

Singapore possesses core capabilities in digitisation, wireless technology, miniaturisation, automation, human interface technology, product intelligence, product management and memory wafer fabrication, and application-specific integrated circuit (ASIC) production. The semiconductor industry has been involved in IC design, automated assembly and testing, metal injection moulding and high-density multi-layer PCB manufacture (Low 2000). These diverse production processes and products are characterised by high added value and high precision, with increasing inputs from computer science, engineering, and artificial intelligence research. Singapore’s Industry 21 Masterplan identified electronics as a key cluster for nurturing. The aim is to position Singapore as a world-class electronics hub, by bringing in global leaders with the latest product design, manufacturing, and applications in semiconductors, infocomm products, data storage, and key modules, and management of new products, applications and markets. Current Status

In year 2000 Singapore’s electronic products and components industry had an output value of S$82.3 billion and employed over 100,000 workers

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TABLE 10.3 Electronic Products and Components Manufacturing in Singapore, 1990–2000

Number of establishments Output (S$ million) Computers Disk drives Computer peripherals Communications equipment Printed circuit boards Semiconductors Wafer fabrication and integrated circuits Value added (S$ million) Direct exports (S$ million) Employment

1990

1995

1999

2000

239 27,749 1,058 7,655 3,420 1,354 2,909 3,227

239 57,873 9,477 13,899 101 1,914 2,930 48

205 68,719 10,221 18,924 – 3,640 1,143 9,885

208 82,281 – – – – – –

– 5,922 24,027 122,325

1,153 11,988 45,161 126,891

4,464 15,234 53,125 105,826

– 19,759 – 105,416

Source: Yearbook of Statistics, Singapore; Census of Industrial Production.

(Table 10.3). With the shift towards higher value-added products, employment has shrunk despite the continuing growth in output. Growth was largely driven by the semiconductor and infocomm products subclusters. However, the industry has been undergoing a major cyclical downturn since 2001 and closures and relocation of plants have accelerated in the more labour-intensive and low-value-added segments of the industry. Output of the semiconductor sub-cluster reached S$14 billion in 1999, riding on the buoyant global demand for chips. There are currently forty semiconductor companies in Singapore, involved in wafer fabrication, assembly and test, and IC design activities; and another 160 companies supporting this knowledge-intensive industry. Singapore semiconductor companies are encouraged to team up with key industry innovators to access advanced manufacturing processes and services. However, 2000 and 2001 were not good years for semiconductor producers in Singapore with intense regional competition and the global electronics down-cycle resulting in plummeting prices and severe underutilisation of capacity. The infocomm products sub-cluster includes telecommunications equipment, computers, consumer electronics, office automation, and contract manufacturing. In the telecommunications industry, the need for

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instantaneous information and services continues to drive up demand for bandwidth, infocomm devices, and new applications (via wireless networks) and also in developing technologies such as 3G mobile systems, secured smart-card transactions, and Internet applications and devices. In the computer industry, strong growth in PC output is largely attributed to higher demand for desktops and services in the region, increased emphasis on outsourcing of manufacturing as MNCs focus on core competencies, boosting of supply chain management to better manage inventories and supplies, and direct sales to end-users. Singapore is building up its contract manufacturing base and supply chain management capabilities to be flexible and fast. In the consumer electronics industry, major players have moved significantly from analogue to digital technology, and Singapore’s consumer electronics companies are retraining researchers and engineers to build capability in digital technology. Strong demand in the office automation industry is propelled by global demand for printers and digital imaging products. Outsourcing in this industry is creating more opportunities for contract manufacturers worldwide and in Singapore. The storage sub-cluster of the electronics products and components industry has experienced intense competition and eroding prices. Hard disk drive (HDD) companies in Singapore, especially Seagate and Maxtor, have responded by automating and designing for ease of manufacturing. These firms leverage on Singapore’s world-class engineering, technical, and managerial expertise and experience to restructure and streamline their operations and supply chains. In the key modules sub-cluster, production of passive components and advance interconnects reached high volumes as all major industries adopted more sophisticated electronics (especially such telecommunications devices as mobile phones and pagers) and as the automotive industry increased its use of electronics systems. Passive components and PCB manufacturers performed well. The value chain in Singapore’s electronics industry includes not only manufacturing but also regional co-ordination and procurement activities. With the rapid growth of the electronics industry in the region, Singapore has become an important international trading hub for electronics. A large number of foreign MNCs have established affiliates in Singapore. Some function as international purchasing offices (IPOs) sourcing components and parts from the region for their manufacturing needs around the world and others are RHQs that co-ordinate their various activities in the AsiaPacific region and provide support services (Chia 1997). Singapore is furthering the integration of East Asia through such procurement activities.

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Electronics accounts for a very high share of Singapore’s exports. This reflects not only the large volume of domestic production for export, but also Singapore’s role as an electronics trading hub. Chia’s (1997) study based on 1992 data, revealed three salient features of Singapore’s electronics trade: • First, the largest category of domestically produced exports was disk drives, computers and subassemblies, ICs, TV receivers, and subassemblies. Domestic exports were destined primarily for the U.S. and EC markets (64.1 percent), with Japan accounting for only 5.1 percent. The small Japanese share is noteworthy in view of the large presence of Japanese electronics firms in Singapore. It may be explained by Japan’s high import barriers as well as by the strategy of Japanese electronics firms to use Singapore as an export platform for thirdcountry markets. • Second, entrepôt exports (from other countries’ production) were concentrated in ICs, computers and subassemblies, disk drives, colour TV sets, radios and videocassette recorders, and telecommunications equipment. • Third, East Asian countries, particularly Malaysia, provided large markets for Singapore’s domestic exports of electronic components, indicating the increasingly integrated production pattern in East Asia and Singapore’s role in the value chain. Singapore’s role as a trading hub in electronic products and components is evident from Table 10.4, which shows Singapore’s large electronics trade with East Asia, particularly with ASEAN, in the 1990s. Table 10.5 shows that for year 2000 electronic valves (including ICs, semiconductors, colour TV tubes, CR tubes for computer monitors, TV camera tubes, microwave tubes, and parts for these products) comprised the largest share of imports, domestic exports, and entrepôt exports of machinery and transport equipment. The progressive elimination of import tariffs and non-tariff barriers under the Common Effective Preferential Tariff (CEPT) scheme of the ASEAN Free Trade Area (AFTA) should boost intra-regional trade in electronics. The ASEAN Secretariat (2000) estimated the average tariff rate would fall to 2.7 by 2003. A similar boost is expected to come from the Information Technology Agreement (ITA) under the WTO, which committed countries to eliminate customs duties and other charges on IT products by January 2000. Falling trade barriers with the implementation of AFTA, a general

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TABLE 10.4 Singapore–East Asia Trade in Electronics, 1990–99 (S$ millions)

Trade with: East Asia ASEAN Brunei Indonesia Malaysia Philippines Thailand Cambodia Myanmar Vietnam Japan China Taiwan South Korea Hong Kong

1990

1995

1999

25,772.35 10,319.68 73.70 – 8,402.00 457.86 1,335.19 – 50.93 – 8,975.38 828.62 2,203.57 1,477.69 1,967.41

77,140.38 34,946.30 171.89 – 26,875.62 1,639.03 5,878.49 73.86 93.11 214.32 20,406.18 1,888.53 5,793.37 6,259.60 7,846.40

82,740.15 40,637.77 101.71 – 29,576.95 5,436.42 5,065.29 23.76 72.99 360.65 16,396.76 4,014.74 8,461.27 5,898.46 7,331.16

Source: Singapore Trade Development Board.

decline in transport costs due to advances in transportation technology, and the growth of e-commerce have facilitated the emergence and growth of production networks in IT goods in the East Asian region. This accelerates the trend brought about by changing comparative advantage and costcompetitiveness. Singapore has seen the progressive shift of labour-intensive products and processes to lower-cost destinations in the region, while higher value-added and more technology-intensive products and processes take their place in the Singapore production structure. Prior to the outbreak of the 1997–98 Asian financial crisis demand for ICT goods in East Asia and Singapore grew at a phenomenal rate. This reflected developments on several fronts including increasing range and sophistication of ICT products and their rapidly falling prices as a result of productivity gains; rising affluence and urbanisation of the population; spreading use of ICT by businesses seeking to improve efficiency and productivity; and increasing adoption of ICT by the government sector. Electronics trade and demand in the region were adversely affected by the financial crisis but rebounded significantly in 1999 as a result of the sharp

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96,798 14,743 8,014 15,487 8,454 2,936 3,781 53,415 49,065 8,108 4,328 3,159 4,234 1,774 2,384 23,987

Total trade in machinery and transport equipment Electronic valves Parts for office and data processing machines Data processing machines Communications equipment Electrical machinery Electrical circuit apparatus Subtotal

Imports of machinery and transport equipment Electronic valves Parts for office and data processing machines Data processing machines Communications equipment Electrical machinery Electrical circuit apparatus Subtotal

1990

102,055 30,284 10,535 7,439 8,470 4,272 4,915 65,915

212,062 56,336 23,143 35,114 18,207 7,849 8,387 149,036

1995

Amount (S$ millions)

141,068 52,729 17,030 11,000 8,814 6,468 6,343 102,384

301,470 112,159 36,460 44,527 19,218 12,314 11,972 236,650

2000

TABLE 10.5 Trade in Machinery and Transport Equipment 1990–2000

© 2003 Institute of Southeast Asian Studies, Singapore

100.0 37.4 12.1 7.8 6.2 4.6 4.5 72.6

100.0 37.2 12.1 14.8 6.4 4.1 4.0 78.5

2000

continued on next page

100.0 16.5 8.8 6.4 8.6 3.6 4.9 48.9

100.0 15.2 8.3 16.0 8.7 3.0 3.9 55.2

1990

Composition (%)

SINGAPORE: A REGIONAL HUB IN ICT 283

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32,352 4,844 3,079 10,995 2,985 755 981 23,639 15,381 1,791 607 1,333 1,235 407 416 5,789

Domestic exports of machinery and transport equipment Electronic valves Parts for office and data processing machines Data processing machines Communications equipment Electrical machinery Electrical circuit apparatus Subtotal

Entrepôt exports of machinery and transport equipment Electronic valves Parts for office and data processing machines Data processing machines Communications equipment Electrical machinery Electrical circuit apparatus Subtotal

Source: Yearbook of Statistics, Singapore.

47,733 6,635 3,686 12,328 4,220 1,162 1,397 29,428

1990

Total exports of machinery and transport equipment Electronic valves Parts for office and data processing machines Data processing machines Communications equipment Electrical machinery Electrical circuit apparatus Subtotal

TABLE 10.5 – cont’d

42,256 12,551 2,101 4,865 3,992 1,601 1,294 26,404

67,751 13,501 10,507 22,810 5,745 1,976 2,178 56,717

110,007 26,052 12,608 27,675 9,737 3,577 3,472 83,121

1995

Amount (S$ millions)

74,551 32,897 6,013 8,660 5,061 3,414 2,655 58,700

85,851 26,533 13,417 24,867 5,343 2,432 2,974 75,566

160,402 59,430 19,430 33,527 10,404 5,846 5,629 134,266

2000

100.0 11.6 3.9 8.7 8.0 2.6 2.7 37.6

100.0 15.0 9.5 34.0 9.2 2.3 3.0 73.1

100.0 13.9 7.7 25.8 8.8 2.4 2.9 61.7

1990

100.0 44.1 8.1 11.6 6.8 4.6 3.6 78.7

100.0 30.9 15.6 29.0 6.2 2.8 3.5 88.0

100.0 37.1 12.1 20.9 6.5 3.6 3.5 83.7

2000

Composition (%)

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SINGAPORE: A REGIONAL HUB IN ICT 285

recovery in global electronics demand, thus spearheading a V-shaped recovery for several regional economies in year 2000. The downturn of the global electronics industry in 2001, reflecting the rapid slowdown of the U.S. economy, cast a new pall on economic growth in the region in 2001 and on the first half of 2002 however. ICT Services and Policies

Singapore’s IT “software” industry is much younger than its “hardware” counterpart. Data on Singapore’s trade in ICT services are not readily available. It is increasingly difficult to distinguish ICT services from traditional non-ICT services as ICT penetrates into all economic sectors, including retail trade and transport. The importance of the ICT services industry including software, content, and other ICT services came to be recognised with the rapid computerisation during the 1990s. Government agencies were in the forefront promoting the development and use of ICT services in Singapore. Four phases can be distinguished. Phase 1: 1980–85

The government launched a national information technology drive, embodied in the National Computerisation Plan in 1981 outlining three objectives: computerisation of the civil service, training of software professionals, and building the local IT industry to expand software and services (NCB 1992). The Civil Service Computerisation Programme (CSCP) was launched in 1982 to spearhead the national computerisation effort and set the pace for the application of ICT in the rest of the economy. CSCP applications were designed to improve productivity within the government sector and to link and co-ordinate the various government ministries and agencies. The pool of ICT professionals produced by the CSCP as well as technology transfers by foreign MNCs supported the spread of ICT in the private sector, but domestic R&D in ICT remained weak. Phase 2: 1985–92

In 1985, the National Computer Board (NCB) introduced the National IT Plan (NITP) for Singapore. The plan outlined a seven-pronged ICT strategy — developing IT professionals and experts; improving the ICT infrastructure; promoting the ICT industry; co-ordinating and collaborating

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between various ICT-promoting organisations; establishing a culture that welcomes ICT; encouraging creativity and entrepreneurship; and increasing ICT application in workplaces (Tan et al. 1985). Use and development of ICT accelerated during this period through: • expanded computerisation of the civil service; • diffusion of ICT in key industries; • alliances with international software firms to develop local engineering skills and IT segments; • organised events promoting ICT culture; • installation of fibre optics and integrated services digital network (ISDN) capabilities; • one-stop and non-stop public service facilities; • introduction of a national electronic data interchange (EDI) system; • revamped educational system, with computer awareness programmes and increased emphasis on mathematics and technical competencies in schools and on ICT training in polytechnics and universities; • increased emphasis on R&D, with expenditures rising to S$374.7 million and 0.9 percent of GDP by 1988; and • growth in IT manpower. Phase 3: 1992–2000

In 1992 NCB released the IT2000 Plan outlining a vision of Singapore as an “Intelligent Island”, based on an advanced National Information Infrastructure (NII), which would interconnect computers in virtually every home, school, and workplace. IT2000 aimed at intensified development of ICT-related manpower; improved quality of life; improved personal and community communications; use of the NII to establish a competitive advantage both within and beyond Singapore; and the positioning of Singapore as a regional hub by plugging into international business networks. Figure 10.6 shows the overall organisational framework for the NII. A high-level steering committee co-ordinated policy across government ministries and agencies. Major IT and telecommunications projects were the responsibility of NCB and the Telecommunications Authority of Singapore (TAS) respectively. EDI applications included TradeNet, LawNet, MediNet, and PortNet. Cashless transactions included the GIRO service which provides for automatic transfer of funds from bank accounts to designated merchants or government bodies and the Network for Electronic Transfer System (NETS) which enables electronic fund transfers at point

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FIGURE 10.6 Framework for Singapore’s National Information Infrastructure (NII)

PROJECT SPECIFICATION TEAMS National IT Application Projects

NII GROUP Common Network Services Policy & Legal Framework

GOVERNMENT ICT UTILITIES Telecommunications Networks

Technical Standards

Source: National Computer Board, IT2000 Report.

of sale for credit and debit card transactions. Singapore ONE was launched commercially in June 1999 as an island-wide broadband high-speed infrastructure of high capacity networks and switches for multimedia applications — entertainment, news, education, online shopping and other e-commerce services, video-conferencing, government transactions and fast Internet. Key developments on the ICT policy front during this phase were the liberalisation and consolidation of the telecommunications industry as well as the convergence of information technology, broadcasting, and communications media. As licensing restrictions were lifted and new players entered the market, service operators’ fees collapsed and fees for international calling services, mobile phone use, and Internet access plummeted. NCB was merged with TAS to form the Infocommunications Development Authority (IDA). The National Science and Technology Board (NSTB) was restructured to work on six key thrusts — to promote science and technology to students, professionals, and the public via growing technopreneurial businesses; to develop a conducive environment; to promote finance and investment; to develop manpower for R&D and technopreneurship; to establish international operations; and to strengthen the technology infrastructure.

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Technopreneurship 21 (T21) was launched in 1999 to foster creativity, innovation, and entrepreneurship. It focused on three areas of ICT development: • Revamping the education system (schools, polytechnics, universities) to foster creativity. Polytechnics and universities were restructured to emphasise laboratory work. Public research institutes/centres (RICs) were positioned to bridge basic research by universities and applied research by the private sector. Figure 10.7 shows the RICs and the industry clusters that they support. • Creating a US$1 billion Technopreneurship Investment Fund (TIF) to develop the venture capital industry. In 1998–99, seventy-one start-ups received venture capital funding totalling S$252 million, with the majority of funds going towards ICT-related ventures. NSTB also has a S$150 million Technology Development Fund. • Revamping the legal and regulatory framework to make it more ICTfriendly and bring it in line with international standards and models. A study group convened in February 1997 recommended providing an environment more conducive to e-commerce, including a commercial code, public key infrastructure, and review of existing legislation. FIGURE 10.7 Public Research Institutes and Centres (RICs) Grouped by Industry Focus

Chemicals

GINTIC

IME IHPC

Electronics

ETI

IMRE

IMCB IMA BTC

DSI CSP

CWC

Life Sciences

KRDL CRISP

IT & Telecommunications

Key: BTC Bioprocessing Technology Centre CRISP Centre for Remote Imaging, Sensing & Processing CSP Centre for Signal Processing CWC Centre for Wireless Communication DSI Data Storage Institute ETI Environmental Technology Institute GINTIC Gintic Institute of Manufacturing Technology IMRE Institute of Materials Research & Engineering IME Institute of Microelectronics IMA Institute of Molecular Agrobiology IMCB Institute of Molecular & Cell Biology KRDL Kent Ridge Digital Labs IHPC Institute of High Performance Computing

Source: NSTB 2000.

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By 1999, the infocomm sector (excluding manufacturing) generated revenue of S$20 billion, amounting to 6 percent of Singapore’s GDP. Internet penetration of companies and businesses reached 81 percent; 57 percent of the population had dial-up Internet and 66 percent had mobile phones; and 59 percent of households had PCs and 99 percent were broadband-ready. Phase 4: Infocomm 21 Masterplan

The Infocomm21 Masterplan marks a concerted effort to transform Singapore into a dynamic and vibrant global ICT hub with a competitive e-economy, an infocomm-savvy e-society, excellence in e-government, and e-learning hub. It builds on the earlier foundation of the NII and encompasses ICT goods, services, human resources, and infrastructure. The interactive broadband and multimedia (IBBMM) and mobile wireless network represents the next step in physical infrastructure after the NII, which was the focus of ICT policy during the 1980s and 1990s. The Masterplan aims for a pervasive infocomm network that would support high-speed wireless data access by 2005 (IDA 2000b). This would be realised through xDSL and cable modem technologies, optical fibre installations, fixed wireless technologies, and 3G mobile networks. Development of the broadband infrastructure, broadband industry, and broadband user base progressed steadily in 1999–2000. The wireless broadband market is also expected to grow very rapidly. With developing technological capabilities, industry investments, and falling broadband access costs, more consumers can access the Internet at much higher speeds. With a mobile phone penetration rate of two-thirds of the population, Singapore will be one of the leaders in Asia to embrace mobile Internet. SingTel, Mobile One, and Starhub have launched commercial wireless application protocol (WAP) service. Singapore CableVision currently provides cable broadband in Singapore. Full liberalisation of telecommunications services is expected to expand the choices and competition in this area. The economic recession in 2001 forced postponement of the issuance of 3G licences. A key component of Infocomm 21 is a fully liberalised telecommunications market with competitive pricing and wider choices. The government had already revised and accelerated the schedule for liberalisation of telecommunications and for convergence of information technology, broadcasting, and communications media. By the year 2000, Singapore had issued or expanded more than 150 telecommunications

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licences. Coaxial cable access has been installed in many homes and optical fibre reaches more than 90 percent of homes. A host of leading satellite content providers has set up regional centres in Singapore, including HBO, ESPN, MTV, and Discovery Channel. Another key component of Infocomm 21 is the legal and policy framework for the development of the ICT sector. The existing legal, regulatory, and enforcement framework was revised to conform to international standards and regulatory changes were made to enhance provision of ICT services. The Electronic Transactions Act and amendments to the Computer Misuse Act aimed at promoting and enhancing trust and confidence in e-commerce and ICT services. Manpower strategies for the infocomm sector include enhancing the environment to nurture an Internet-savvy workforce by providing topflight education and training in infocomm skills and establishing standards for infocomm professionals and users; attracting and retaining international infocomm talents; and establishing Singapore as the e-learning hub for the region. Policy increasingly favours the recruitment of ICT service professionals as well as more use of electronic methods for training and education. The goal is to have a body of 250,000 infocomm workers, or 10 percent of the workforce, by 2010 (IDA 2000a). Internet, E-government, and E-commerce

Singapore is an important regional Internet hub, with many companies using Singapore as their key data centre. For example, in 1999, Citibank set up its only Global IT and Data Centre to service fifty-six countries from Singapore. Other notable projects included 1-Net and the ST Telemedia/Sun-Netscape Alliance which announced plans to provide facilities infrastructure and services for web hosting. Several ISP/IX deregulation measures paved the way for more competition and new entrants including DataOne, Cable and Wireless, and UUNet. Netlife AG, one of the top players in Internet application software, established its first R&D centre outside Hamburg and its Asia headquarters in Singapore. Origin BV, a global leader in IT consulting and services, became the first European IT services company to establish a business headquarters in Singapore. It will set up five competency centres including a global enterprise management system and an enterprise resource planning outsourcing centre. In addition, Internet companies such as Lycos, Monster.com, Acer’s 1to80.com, E! Online Asia, and MTV Asia have also based their Asia-Pacific operations in Singapore. Companies that have

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located Asia-Pacific e-commerce hubs in Singapore during the past two years include HP, Compaq, Apple, GES, NatSteel, BeXcom, IBM’s e-procurement, Advanced Manufacturing Online, and Federal Express. The Singapore government was one of the earliest to provide its services online, although it encountered systems development costs and security issues problems along the way. Following the CSCP of the early 1980s, government departments aggressively expanded computer systems in the late 1980s under the National IT Plan (NITP), and computers and computer applications penetrated all areas of government during the 1990s (under IT2000). Under Infocomm 21, an e-Government Action Plan was initiated to succeed the CSCP, with a S$1.5 billion budget to fund programs over a three-year period, paralleling efforts to change the mindset of civil servants to the ways of doing business in the New Economy. Government online services for the public include the electronic filing of income tax forms and the e-citizen website. E-commerce requires a self-sustaining, complete framework with mutually reinforcing components including a telecommunications FIGURE 10.8 Framework for Electronic Commerce in Singapore

Branding Singapore as a Trusted Global ‘DotCom’ Hub and E-Business Thought Leadership Centre

Spurring Consumer Demand

Catalysing the Digital Transformation Fostering

Attracting Top

an E-

Talent

Lifestyle

Sector-Specific Adoption

Broad-Based Adoption

& Bridging the Digital Divide

Laying a Robust Foundation for EBusiness

Source: IDA 2000.

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infrastructure to support the growth of software developers, Internet builders, and application service providers; portals and intermediaries to support e-commerce; and a supporting sound financial system and efficient supply chain management process. Singapore launched an e-commerce master plan in September 1998, marking the start of a campaign to bring e-commerce to mainstream businesses and the public and to attract international e-commerce activities. Singapore also has a vision of becoming a hub for processing e-commerce transactions from the region and the rest of the world. Figure 10.8 summarises the framework of the strategy to develop e-commerce in Singapore. At its foundation are the infrastructure services and setting. The other aspects of e-commerce policy are to spur online consumer spending, to enhance e-business readiness, and to foster digital transformation by encouraging broad-based community use of e-commerce and a more sector-specific cluster policy to encourage adoption of e-commerce. Development of e-ASEAN

The ASEAN region (and the broader East Asia region) has become a major export production platform for ICT goods, but the region has not developed fully the production and use of ICT services (i.e., the production of information and the application of ICT to improve productivity and competitiveness). Apart from Singapore, the other ASEAN countries have fallen behind in the adoption and diffusion of ICT, especially with regard to e-commerce and the Internet. The Third ASEAN Informal Summit of November 1999 established an e-ASEAN Task Force to develop a broad and comprehensive action plan for an ASEAN e-space and to develop competencies within ASEAN to compete in the global information economy. This led to the e-ASEAN Framework Agreement of November 2000. The Agreement’s objectives are to promote co-operation to develop, strengthen, and enhance the competitiveness of the ICT sector in ASEAN; to promote co-operation to reduce the digital divide within individual countries and among ASEAN countries; and to promote the liberalisation of trade in ICT products, services, and investments (Figure 10.9). The e-ASEAN agreement and the liberalisation of trade in ICT products and services will hasten the process of regional integration through declining transaction and trade costs. Intra-regional ICT production and distribution can be expected to change. The business sector as well as policymakers are

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FIGURE 10.9 Conceptual Pillars of e-ASEAN

Connectivity

Etc...

Adoption & Promotion

Environment

Manpower Development

Tech

In

In

Etc...

Flagship Electronic Projects

ASEAN Tourism

Technical Interoperability Standards

Legal, Fiscal & Regulatory Policies

BRANDING

Country NIIs...

Source: Summary Report on the Feasibility of the AII.

poised to pursue the opportunities that e-ASEAN presents to develop Singapore’s role as an ICT hub. CONCLUSION

ICT plays two roles. It is a growth sector in its own right and it enhances competitiveness and efficiency throughout the economy. Increasing returns to scale and spillover externalities of the ICT revolution heralded the New Economy. The ICT revolution is spurring globalisation and changing comparative advantages and economic competitiveness. By lowering transaction costs, including costs of transportation and communication, the ICT revolution has facilitated industrial clustering and the emergence of nodes and hubs. In East Asia, the flying geese pattern of industrial geography with unidirectional flows and hierarchical production networks is transforming into a web of nodes and clusters inter-linked through multi-directional flows of trade, capital, investment, and people reflecting complementarities in demand and supply.

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Singapore is striving to become a knowledge-based economy, as it can no longer compete in traditional activities. It is essential for Singapore to develop ICT as a growth sector as well as to use ICT to raise productivity, enable business, and transform society. Crucial factors in ICT development are a good physical and institutional infrastructure, human resources, science and technology development, and entrepreneurial drive. The public sector has poured tremendous resources into developing an advanced physical infrastructure, supported by necessary changes in co-ordinating and supporting institutions and in the legal and regulatory framework. The science and technology development is being put in place by increasing funds allocated to R&D and greater emphasis on partnerships among research institutions, the business sector, and the government sector. Building a critical mass of human resources and entrepreneurs is a challenging problem, given Singapore’s small population base and riskaverse mindsets. Efforts to expand ICT-related education and training in schools, polytechnics, universities and at the workplace are progressing well, complemented and supplemented by the aggressive recruitment of international talent. In past decades the prevalence of Confucian values, a political culture that emphasised stability and order in society, and an education system geared to examinations contributed to Singapore’s economic success, but these characteristics are now increasingly viewed as stifling creativity and the ability of the economy and society to move forward. The dominance of government and state-owned enterprises (“Singapore, Inc.”), pervasive presence of foreign MNCs, and attractive remuneration and career paths in the bureaucracy and foreign MNCs have stifled the development of domestic entrepreneurship. Changing mindsets is an uphill task, but efforts are being made to revamp the educational system, lighten the heavy hand of government, and create an environment that is more conducive to the emergence of entrepreneurship. With increasing returns, an economy that aspires to take on a hub role benefits from moving first. Growth in the new framework is crucially contingent on having the right initial conditions for the interplay of market forces as well as on policymakers putting in place necessary policy and institutional frameworks. We have seen that Singapore has realised many of the quantitative and qualitative conditions that the Fujita, Krugman, and Venables and Porter models suggest influence the formation and development of industrial clusters and agglomerations. These characteristics will reinforce the city-state’s continuing competitiveness as a regional hub, including its goal of becoming a hub for ICT goods and services. Its

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solid legal framework and supporting ICT infrastructure — in terms of the physical IBBMM network and the science and technology environment — attract ICT players, including both large foreign MNCs and smaller domestic (and possibly regional) technopreneurial start-ups. For Singapore to become an ICT hub for Southeast Asia or the wider East Asia region first its ICT sector must be competitive vis-à-vis other existing and potential hubs in the region and beyond. In addition, though, it must co-operate politically and economically with the region’s economies so that the region as a whole advances. The hub and the hinterland will mutually benefit as all the economies take advantage of the ICT revolution. As the most ICT-ready economy and society in the ASEAN region, Singapore can help its neighbours overcome the digital divide. Singapore’s experience in ICT development can have demonstration effects for what to do and how to do it, and the rest of Southeast Asia can benefit from Singapore’s lead to lower their learning curve and leapfrog. Singapore can provide training for lesser-developed Southeast Asian economies. As a hub, Singapore can link up the economies of Southeast Asia and it can link the Southeast Asian economies to the wider world. Singapore can be a key player in e-ASEAN, to help integrate ASEAN as well as ensure ASEAN’s competitiveness vis-à-vis the rest of the world. As other economies in the region develop their own ICT hubs, the competition and co-operation will result in a more ICT-vibrant Southeast Asia and East Asia. References

Abeysinghe, T. 2000. “Electronics and Growth Cycles in Singapore”. Applied Economics 32: 1657–63. Abeysinghe, T., and P. Wilson. 2001. “Forecasts for the Singapore Economy”. Paper presented at ISEAS Regional Outlook Forum 2001, Singapore, 5 January. ASEAN Secretariat. 2000. Tariff Reduction Programmes under the Common Effective Preferential Tariff (CEPT) Scheme. 7th ed. Jakarta: ASEAN Secretariat. Asian Productivity Organisation. 2000. Information Industry in the AsiaPacific Region. Tokyo: Asian Productivity Organisation. Audretsch, D., and M. Feldman. 1996. Innovative Clusters and the Industry Life Cycle. American Economic Review 86(3): 630–40. Boston Consulting Group. 1999. E-tail of the Tiger: Retail E-Commerce in the Asia Pacific. Boston: Boston Consulting Group. Chia Siow Yue. 1997. “Singapore: Advanced Production Base and Smart

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Hub of the Electronics Industry’. In Multinationals and East Asian Integration, edited by Wendy Dobson and Chia Siow Yue. Canada and Singapore: International Development Research Centre and Institute of Southeast Asian Studies. Chia Siow Yue. 2000. “Singapore: Destination for Multinationals”. In Regions, Globalization and the Knowledge-Based Economy, edited by John Dunning. Oxford: Oxford University Press. ———. 2001a. “Singapore: Global City and Service Hub”. In Globalization and the Sustainability of Cities in the Asia Pacific Region, edited by FuChen Lo and Peter Marcotullio. Tokyo: United Nations University Press. ———. 2001b. “Singapore: Towards a Knowledge-based Economy”. In Industrial Restructuring in East Asia: Towards the 21st Century, edited by S. Masuyama, D. Vandenbrink, and Chia Siow Yue. Tokyo and Singapore: Nomura Research Institute and Institute of Southeast Asian Studies. ———. 2001c. “ASEAN in the Age of Globalization and Information”. In Reinventing ASEAN, edited by Simon Tay, Jesus Estanislao, and Hadi Soesastro. Singapore: Institute of Southeast Asian Studies. Chia Siow Yue and Nick Freeman. 2001. “Growth and Development of the IT Industry: The Case of Singapore”. In Growth and Development of the IT Industry in Bangalore and Singapore: A Comparative Study, edited by Chia Siow Yue, N. Freeman, R. Venkatesan, and S.V. Malvea. Singapore and New Delhi: Institute of Southeast Asian Studies and National Council of Applied Economic Research. Computer Misuse (Amendment) Act (Cap. 50A), 1998. Copyright Act (Cap. 63), with revisions to s. 7(A) & s. 17. Department of Statistics (DOS). 1998. The Information and Communication Technology Sector in the Singapore Economy. Singapore: Department of Statistics. Dixit, A.K., and J.E. Stiglitz. 1977. “Monopolistic Competition and Optimum Product Diversity”. American Economic Review 67(3): 297– 308. Dunning, K.H., B. Kogut, and M. Blomstrom. 1990. Globalisation of Firms and the Competitiveness of Nations. Kent, U.K.: Chartwell-Bratt. Economic Development Board (EDB). 2000a. EDB Yearbook 2000. Singapore: EDB. ———. 2000b. Industry 21 Masterplan. Singapore: EDB. Economist Intelligence Unit (EIU). 2000. Report on E-Business Readiness. London: EIU.

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Electronic Transactions Act (Cap. 88), 1998. Fujita, M., P. Krugman, and A.J. Venables. 1999. The Spatial Economy: Cities, Regions and International Trade. Cambridge, MA: MIT Press. Grossman, S., and E. Helpman. 1991. Innovation and Growth in the World Economy. Cambridge, MA: MIT Press. Infocomm Development Authority of Singapore (IDA). 1999. Infocomm Manpower and Skills Survey 1999 Report. Singapore: IDA. ———. 2000a. Infocomm 21 Strategic Plan. Singapore: IDA. ———. 2000b. “Infocomm Technology Roadmap (Broadband Access and Mobile Wireless)”. July 2000 Release. Singapore: IDA. ———. 2001. Survey on Infocomm Manpower 2000. Singapore: IDA. September. International Trade Centre. 2000. International Trade Statistics Database. Available at . Accessed on 16 January 2001. IT Private Sector Core Group. 1999. “Building the Bridge to the Future”. Recommendations of the IT Private Sector Core Group for AII. Makati City, Philippines: e-ASEAN Task Force Secretariat. Jaffe, A., M. Trajtenberg, and R. Henderson. 1993. “Geographic Location of Knowledge Spillovers as Evidenced by Patent Citations”. Quarterly Journal of Economics 108(3): 577–98. Low, L. 2000. Economics of Information Technology and the Media. Singapore: Singapore University Press. National Computer Board (NCB). 1992. IT2000 Plan. Singapore: NCB. National Science and Technology Board (NSTB). 1991. National Technology Plan. Singapore: NSTB. ———. 1996. National Science and Technology Plan. Singapore: NSTB. Obstfeld, M., and K. Rogoff. 2000. “The Six Major Puzzles in International Macroeconomics: Is There a Common Cause?”. In NBER Macroeconomics Annual, edited by B. Bernanke and K. Rogoff. Cambridge, MA: MIT Press. Porter, M.E. 1990. The Competitive Advantage of Nations. New York: Free Press. ———. 1998a. “Clusters and the New Economics of Competition”. Harvard Business Review, November. ———. 1998b. “Clusters and Competition: New Agendas for Companies, Governments, and Institutions”. In On Competition. Boston, MA: Harvard Business School Press. Rauch, J.E. 1996. ‘“Networks versus Markets in International Trade”. NBER Discussion Paper no. 5617. Tan, C.N., S.K. Goh, S.T. Chua, J. Montiwalla, and S.M. Sung. 1985.

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National IT Plan: A Strategic Framework. Singapore: National IT Plan Working Committee. Teo, T.S.H., and V.K.G. Lim. 1998. “Leveraging Information Technology to Achieve the IT2000 Vision: The Case Study of an Intelligent Island”. Behaviour and Information Technology 17(2): 113–23. Toh Mun Heng. 2000. “Singapore as a Regional Information Technology Hub”. Paper presented at the ASEAN Roundtable 2000, Institute of Southeast Asian Studies, Singapore, 12–13 October. Wong Poh Kam. 2001. “Leveraging Multinational Corporations, Fostering Technopreneurship: The Changing Role of S&T Policy in Singapore”. International Journal of Technology Management. Working Group on AII. 1999. Report on the Feasibility Study of the AII. Makati City, Philippines: e-ASEAN Task Force Secretariat.

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Reproduced from Towards a Knowledge-based Economy: East Asia’s Changing Industrial Geography, edited by Seiichi Masuyama and Donna Vandenbrink (Singapore: Institute of Southeast Asian Studies, 2003). This version was obtained electronically direct from the publisher on condition that copyright is not infringed. No part of this publication may be reproduced without the prior permission of the Institute of Southeast Asian Studies. Individual articles are available from < http://bookshop.iseas.edu.sg >

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11 Impact of B2B E-commerce on Japanese Corporate Networks in East Asia Shoichiro Hara, Seiichi Masuyama, and Hideo Teramura INTRODUCTION

With the rapid development and dissemination of Internet technology, electronic commerce, especially business-to-business (B2B) e-commerce, is spreading in East Asia as it is throughout the world. Typically, when companies move business transactions onto the Internet, they need to significantly open up their internal organisational structure and their relationships with other companies. Japanese corporations operating overseas are criticised for a lack of engagement with the local economy, and host nations complain that Japanese investments do not contribute to the development of local industries. As Japanese firms adopt B2B ecommerce the attendant changes in organisation and relationships with suppliers and other firms could mitigate or even eliminate this problem. This chapter examines this hypothesis. As background to understanding the central question of how B2B e-commerce will develop in East Asia and how it will alter the relationships between Japanese corporations and local firms in the region, we first discuss the generic characteristics of Internetbased transactions between firms and their effect on corporate organisation. We also consider the factors shaping the global strategy of Japanese corporations, since this is the larger context in which their B2B strategy in East Asia is determined. Thus, the chapter begins by discussing the characteristics of B2B e-commerce and then summarising the status, the driving forces, and the players in B2B e-commerce in the East Asia region. The third part describes how Japanese corporations are responding to the

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competitive challenge from foreign corporations that have already adapted to information technology (IT) and globalisation and how this response shapes their implementation of B2B in East Asia. The concluding section lays out an agenda for expanding B2B transactions between Japanese corporations and the rest of East Asia. CHARACTERISTICS OF B2B E-COMMERCE

B2B e-commerce refers to commercial transactions for goods and services between businesses that take place over the Internet.1 The dramatic forecasts that companies throughout the world will rapidly expand their use of the Internet for business transactions are based on the direct gains in efficiency that switching to B2B e-commerce promises. Using the Internet to carry out inter-firm transactions saves on procurement, storage, and transportation costs and speeds up development time by making inter- and intra-company collaboration more efficient. After Cisco Systems, an American communication equipment manufacturer, began applying B2B e-commerce to supply chain management (SCM) in 1996, its average time to procure non-production goods fell from thirteen days to one day and its average per unit processing cost fell to one-sixth.2 Cisco’s move reportedly ushered in the rapid adoption of B2B e-commerce by American corporations as they recognised that Internet-based transactions are essential to make procurement and SCM more efficient. B2B e-commerce is particularly likely to generate supra-normal returns and gains from network externalities.3 Switching to B2B e-commerce may produce even greater improvements in productivity in developing economies, because they are starting from an overall lower level of efficiency. Characteristics of Internet-based Business Transactions

For several decades businesses have been using computers and IT as strategic tools to increase value primarily to their internal value chain, i.e., for procurement, production, sales, delivery, and servicing. Since the 1980s firms have been able to transmit ordering, invoicing, and shipping information electronically within and outside company borders through electronic data interchange (EDI) systems. Advances in IT facilitated the development of information systems for procurement (supply chain management, or SCM), production management (enterprise resource planning, or ERP), and sales, service, and delivery (customer relationship management, or CRM) functions. The spread of the Internet in the 1990s

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multiplied the gains from electronically connecting with many outside business partners as well as the efficiency of internal communications and information systems (Clark 2001, p. 2). Web-based technology helped firms lower the cost and improve the accuracy of routine functions such as accounting, ordering, tracking, and invoicing.4 Moreover, the Internet was a less costly and more flexible way to network inter- and intra-firm functions. Broadly speaking, B2B e-commerce can be divided into two types: closed-end transactions between specific firms that have some prior supply or customer relationship and open market transactions among unspecified, unknown participants through a virtual, or e-marketplace. Firms tend to adopt the Internet first for simple functions and for transactions that generate large economic benefits and later they move more complex transactions and ones with less dramatic economic benefits onto the Internet (Table 11.1). FTIT (2000) identifies the functions that firms can perform through Internet exchanges, in order of increasing complexity, as: • • • • •

sourcing, or identifying new sources of supply; negotiating; transacting and settling; managing supply chains (SCM); and collaborating on design and product development.

Today many firms conduct all their transactions involving sourcing, negotiating, transacting, and SCM functions with specific, known partners through the Internet. On the other hand, open B2B e-commerce transactions in e-marketplaces are confined mainly to the simpler functions. Indeed, over 90 percent of the thousand or more e-marketplaces existing in 2000 are designed only for sourcing and pricing, that is, allowing buyers and TABLE 11.1 Development Path of B2B E-commerce Factor Category Product type Transaction type Exchange function Organising entity

Development Path General and standard products ⇒ Customised products Repetitive transactions ⇒ Unique transactions Sourcing ⇒ Negotiating ⇒ Transaction and payment ⇒ SCM ⇒ Collaborative design and product lifecycle work Single firm or firm group ⇒ Industry-wide

Source: NRI. Development path of exchange function is based on FTIT (2000).

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sellers to exchange information on the goods and services, prices, availability, and terms and conditions. Firms stand to reap major efficiency gains when they begin to use the Internet more widely to collaborate on product design and development. At present, closed B2B e-commerce systems are more widespread and highly developed while e-marketplaces are in an early stage of formation. Many promising B2B e-commerce systems have been initiated by individual buyers as an extension of their EDI systems for managing orders and deliveries. Buyers tend to exert control over procurement markets, and buyers, rather than sellers, tend to gain the most from organising B2B ecommerce systems. In the long run, B2B e-commerce systems dominated by a single-buyer can be expected to merge into exchanges involving many buyers in order to generate greater network externalities. Certain types of products and certain types of transactions are more suited to buying and selling over the Internet (Table 11.1). B2B e-commerce has been more successful with standardised, commodity-type products than with customised products.5 It is also better suited to repetitive transactions than to infrequent or one-time-only transactions. At this stage, most B2B e-commerce transactions involve non-strategic products, and firms keep to traditional channels for strategic items. Moreover, e-commerce is more effective in mediating transactions involving products supplied by a large number of producers or demanded by a large number of buyers. There is not much to be gained from using B2B e-commerce for products with a limited number of suppliers or purchasers. In the electronics industry, for example, where only a few firms produce LCDs, CPUs, and DRAMs, buyers continue to resort to one-on-one negotiation and transactions, and as a result B2B e-commerce has not developed for these components. System Compatibility and Organisational Restructuring

Two factors significantly influence firms’ success with B2B e-commerce: system compatibility and organisational adaptation. Moving to Internet-based procurement requires participants to utilise a common interface, such as the standardised XTML systems. Moreover, to submit and process orders over the Internet, buyers and sellers need to use common forms and descriptions of products. Incompatibility between internal operations and software systems is a major obstacle to building a B2B e-commerce network and also to participating in such a system. Large firms face a decision about dismantling their existing EDI systems, which represent substantial sunk costs, and small and medium-sized

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enterprises (SMEs) face a problem of how to finance additional investments in IT systems. To get the most from investments to support B2B e-commerce, firms must make other changes in their organisation and ways of doing things. The advance of IT has reduced the cost of exchanging information for collaborative activities and thus firms have less need for middle management as well as better opportunities for outsourcing to independent suppliers. For corporations to benefit from Internet-based transactions, they need to de-link the vertically integrated layers of their value chain, concentrate in a particular layer of their core competence, and more extensively network with outside businesses. For example, the IT equipment manufacturing industry is in the vanguard of a movement to de-link design, supply, assembly, distribution, and logistics functions and reconstitute the value chain within and across firm borders to recreate networks of economic relationships in ways that maximise efficiency.6 Thus, a firm’s success or gain from implementing B2B e-commerce transactions depends not only on the technology and information systems it chooses but equally importantly on the extent to which it makes concomitant changes in internal operations and organisation. According to Litan and Rivlin (2001, p. 42): a key to realising the potential productivity gains identified by our authors [of a research project] will be whether the Internet turns out to be as “deep” as they project. That is, will the firms and other actors in each of the sectors actually use the Net more intensely and, in the process, change their ways of doing business — reducing their inventories, cutting their customer service costs, and changing their organisational structures — in the ways and to the extent that have been projected.

Small, young companies that do not have a legacy of old systems and established structures may find it easier to make the organisational adjustments that B2B e-commerce requires. B2B E-COMMERCE IN EAST ASIA: STATUS, DRIVERS, AND PLAYERS

Estimates of the volume and growth of B2B business in Asia vary widely among analysts, but most find that the market has grown significantly and will continue to grow quite rapidly. A report by eMarketer estimated B2B revenues in Asia at more than US$36 billion for 2000 and expected them to reach over $300 billion by 2004.7 So far, revenues and growth of

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business-to-business e-commerce in Asia have surpassed business-toconsumer (B2C) e-commerce. The same report by eMarketer put Asia’s B2C revenues at US$3.2 billion for 2000, but expected they would grow to $38 billion by year-end 2004. Regional Factors in B2B E-commerce Development

The dominance of B2B over B2C e-commerce in Asia is based in part on certain characteristics of the region. For one thing, the diversity of cultures and languages and the sprawling geography in East Asia make it difficult for B2C e-commerce to capture the benefits from serving a wide market. Moreover, in East Asian economies where political and cultural sensitivities run high B2C transactions may face stricter constraints than B2B transactions.8 At the same time, B2B marketplaces in the region are being propelled by the rapid growth of East Asia as a production base, particularly for IT products, and its myriad of manufacturers, subcontractors, and suppliers (Chen 2000). Working against the progress of B2B e-commerce in the region are the levels of technological expertise and infrastructure in certain firms and economies. Some less developed economies currently lack the telecommunications and other physical infrastructure necessary to support a high volume of business transactions over the Internet. Moreover, because many of the parts and other supply firms located in East Asia are relatively small, they lack the resources and technological expertise to move their businesses online (Chen 2000). However, the region stands to gain tremendously in the longer run as the spread of B2B e-commerce levels the competitive playing field between smaller and larger firms. Firms from the United States and the NIEs in the Lead

The spread of B2B transactions in East Asia is being led by non-Asian, mostly American corporations, in collaboration with local firms, mainly ones based in the newly industrialised economics (NIEs). U.S. firms are in the lead because they already implemented B2B e-commerce at home. American corporations spearheaded adoption of Internet technology, and they did so in the context of adopting new models of business organisation. During the 1990s American corporations created a new way of doing business by outsourcing many functions and concentrating resources on core competencies, and they utilised IT extensively to connect

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and co-ordinate the internal and external components of their supply chains, particularly in the IT sector. Dell Computer created an Internetbased organisational model for the PC industry and Cisco Systems did the same for the communications equipment industry. While both firms started out as producers of equipment, both have ceased to manufacture themselves and they now outsource this and other non-core functions. In fact, Dell has become a logistics company, not a manufacturing company. Their timely reorganisation since the 1990s to improve efficiency and speed, particularly in the IT sector, positioned American corporations to take the lead in B2B e-commerce. American corporations are currently global leaders in the operation of B2B exchanges as well as in the application of B2B to supply chain management. More than 60 percent of the slightly more than 1,000 B2B exchanges in the world in October 2000 were based in the United States.9 American corporations have transferred their B2B e-commerce practices to East Asia through the operations of their subsidiaries as well as their transactions with East Asian firms. A case in point is the Taiwanese subsidiary of a certain American IT firm. The subsidiary, which manages production of PCs and other products for the group and engages in system solutions, does no manufacturing itself, but outsources to about thirty local Taiwanese manufacturers. Among all the U.S. parent’s subsidiaries, it is the most advanced in implementing B2B e-commerce, due to the Taiwan government’s aggressive policy support of B2B e-commerce. The subsidiary introduced an ERP (enterprise resource planning) system as early as 1995, and in 1998 it added an SCM system to share information with its suppliers. Now the subsidiary is trying to utilise Converge, a hi-tech-oriented emarketplace, and RosettaNet, a B2B e-commerce standard, both of which are promoted by the Taiwanese government. There are no Japanese firms among this firm’s suppliers. Apparently they are not as aggressive as local Taiwanese suppliers to handle Internet-based transactions with this subsidiary. Other East Asian firms at the forefront of B2B e-commerce include volume producers of commodities and standardised products. China National Petroleum Corporation (CNPC) and Hutchinson-Wampoa, for example, formed a joint venture that will buy and sell petroleum and natural gas products over the Internet. Taiwan Semiconductor Manufacturing Co., Ltd. (TSMC), the world’s largest contract manufacturer of semiconductor products, carries out most transactions with its semiconductor design clients through the Internet.10

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The EMS Challenge

Because of the nature of B2B e-commerce, the American-led challenge in B2B e-commerce is accompanied by a challenge in organisational restructuring. The emergence of the electronics manufacturing service (EMS) is posing a particular threat to Japanese corporations and it will affect how Japanese corporations introduce B2B e-commerce to their operations in East Asia. Electronics firms that adopt the EMS business model, in which they specialise in manufacturing products for multiple original equipment manufacturers (OEMs), gain significant advantages such as economies of scale, speed to volume production, diversification of risk through sales to multiple customers, and specialisation in production. In the global electronics industry, EMS vendors are increasingly taking on the production function for OEM customers and they are expanding into SCM and even product development functions. Their influence in procurement of parts has been growing with the increase in their share of output and their inclination to large volume purchases. In fact, the competitiveness of EMS firms is mainly derived from their SCM function (Kita 2001, p. 109). EMS firms are eager to adopt B2B e-commerce as another means to improve efficiency. The emergence of the EMS model, which is completely unlike the Japanese model of product development and production vertically integrated within a relatively closed corporate group, is beginning to have a profound impact on the production system, including production networks in East Asia. The worldwide output of EMS firms is projected to grow from just over US$500 billion in 1998 to around US$260 billion in 2004 and the rapid growth is expected to continue in line with the trend towards outsourcing. 11 Global players based in the United States, including Solectron, SCI Systems, Celestica, and Jabil Circuit, dominate the industry. The only players from East Asia are firms from Taiwan and Singapore. Japanese EMS players are conspicuously absent (Wong 2000). The EMS industry is becoming more concentrated. Larger EMS firms are acquiring factories from OEMs and also acquiring smaller EMS vendors. OEM customers prefer to deal with larger firms that can supply large quantities quickly so that they can launch brand name products simultaneously around the world. EMS firms will become more involved in B2B e-commerce as they branch out from manufacturing into SCM and product development functions and as the industry becomes more concentrated. Increasingly it will be EMS firms rather than OEMs that organise supply chains, and hence B2B e-market systems. This trend threatens traditional Japanese

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electronics manufacturers and their production networks in East Asia. Unless Japanese players move into the EMS industry, the presence of Japanese firms in East Asian procurement markets will diminish and they will play an insignificant role in B2B e-commerce in East Asia.12 Many East Asian governments have actively fostered B2B e-commerce. For example, the Korean and Taiwan governments supported the development of trade fair websites to showcase the products of local SMEs. Indeed, the Taiwan government has aggressively promoted B2B e-commerce, for instance by subsidising SCM-related investments, as a way to overcome the size handicap of the economy’s SME-dominated industrial sector (Wu 2000). One mission of Taiwan’s government-initiated Institute for Information Industry (III) is to promote and deploy e-commerce applications and techniques. The Institute consults with enterprises to assist them in restructuring for digitalisation.13 The government of Singapore supported Kent Ridge Digital Labs (KRDL), a national software research centre to become an incubator for e-commerce businesses. Also, through its E-commerce Masterplan the Singapore government encouraged the pervasive use of e-commerce in Singapore and provided manpower training and other grants for companies moving into e-commerce. Weakness of Japanese Corporate Organisation in the Face of IT

In contrast to firms in the United States and the NIEs, Japanese firms have had difficulty in implementing B2B e-commerce both at home and in affiliated companies in East Asia. To a large extent, this is due to the weakness of Japanese corporate organisation in the face of IT. The organisational structure of Japanese corporations contributed greatly to the success of Japanese industry under the technology prevailing in the 1970s and 1980s. Lifetime employment and seniority, closely-knit, relatively exclusive corporate groups, and vertically integrated production systems accumulated implicit knowledge in employees and this led to such innovations as TQC and Just-in-Time production management, which made Japanese corporations highly efficient producers during the 1980s. In the 1990s, though, Japanese industry lost competitiveness, particularly in the IT sector. American electronics companies, for example, outperformed their Japanese counterparts and American corporations moved ahead with the rapid application of IT. The declining competitiveness of Japanese industry is likewise attributed to the way Japanese corporations are organised. For instance, vertically integrated Japanese semiconductor corporations, which did everything from design to production to sales,

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missed the global industry trend towards specialisation in core competence and outsourcing.14 Japanese semiconductor firms also put too much emphasis on their own original technologies and competed with each other in minor areas such as product specifications, which raised their cost of production. Moreover, the lifetime employment system and other elements of Japanese corporate structure and the social structure and regulatory regime that complement it, such as low labour mobility, are now seen as restraining corporations from making the organisational changes that are necessary to adapt to information technology. Vertically integrated organisations are particularly out of place in industries that utilise “module” production technology. Firms in such industries, of which most IT products are typical, assemble cheaply and easily transportable components that are produced independently according to technological standards. These industries require organisations that are flexible and can respond quickly. The traditional Japanese-style of corporate organisation is more compatible with industries such as automobile manufacture, where components are not as easily transported or as standardised and where assembly requires close co-ordination and established teamwork. RESPONSE OF JAPANESE CORPORATIONS

By 2000 major Japanese corporations had responded to severe pressure from foreign — particularly American — corporations by refocusing their overall strategy to raise efficiency and improve competitiveness in the era of Internet technology. In the context of these strategic goals, they have started to reorganise and to adopt B2B e-commerce. Typically, they introduce changes first to internal activities at home and then extend them to activities outside of Japan. Thus, Japanese corporations’ B2B strategy for East Asia is in fact an extension of a global strategy to adopt B2B, which itself is part of a comprehensive reorganisation to raise efficiency and survive global competition. This broad strategy of Japanese corporations, which is governed by headquarters and starts from domestic operations, is preventing their East Asian operations from implementing necessary changes in a timely manner. Japanese Manufacturers Gradually Moving to B2B E-commerce

Leading Japanese manufacturers, such as Toyota, Fujitsu, and NEC, have started to conduct transactions with their existing clients, including SMEs,

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over the Internet. At this point larger Japanese manufacturers use the Internet mainly for transactions within the company or the company group and primarily for procurement. Of twenty-seven electronics industry companies that responded to a survey by Japan Machinery Centre for Trade and Investment (JMC 2000) in May and June 2000, eleven companies (41 percent) indicated that they did at least some procurement over the Internet. Two of these companies said that Internet transactions comprised 0–10 percent of their total parts purchases, four companies answered that B2B represented 10–40 percent of parts purchases, and three companies said that they made more than 81 percent of their parts purchases on the Internet. The most-emphasised criteria for selecting a particular supplier for these Internet-based transactions were quality control capability, followed by initial prices offered, and then the ability to achieve target prices (JMC 2000, p. 9). While Japanese firms have increased their use of e-marketplaces, it is mainly to purchase office supplies and maintenance services. Few companies have turned to e-marketplaces on a significant scale. Large manufacturers in particular have taken a long time to study how to integrate B2B e-commerce with their existing EDI systems and how to introduce Internet-based transactions company-wide. Switching from proprietary EDI systems is problematic because constructing these systems involved large investments and collaboration with other keiretsu members. Moreover, it is difficult for individual departments to initiate B2B e-commerce because such transactions are not compatible with company-wide systems and business flows and because they need approval from headquarters. Another factor slowing adoption of B2B e-commerce is the tendency on the part of Japanese corporations to resist disclosing information, which is necessary to participate in some B2B e-commerce. Reorganising to Concentrate and Flatten Structure

Japanese corporations have begun to reorganise to concentrate their businesses and to transform into more horizontal and networked organisations. Major firms in the electronics industry, for example, are moving to break up vertically integrated structures. Both Sony and Matsushita have adopted plans to separate their manufacturing divisions into independent companies to compete with the rapidly growing EMS model of U.S. and East Asian firms. In 2001 Sony established a company for design, production, and customer service by integrating twelve of its twenty-six domestic factories producing audio-visual equipment and PCs.

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It also sold off one factory in Taiwan and one in Japan to Solectron, the leading EMS company headquartered in the United States. Matsushita announced the reorganisation of its traditional product divisions which each had product development, manufacturing, and sales functions. In the new structure, Matsushita is concentrating manufacturing at a number of “factory centres,” which are responsible for profitability and which will take orders both from the company’s product divisions and from outside customers. 15 In order to focus on product development rather than manufacturing, NEC sold three of its overseas factories that produced wireless phones for the European, North American, and East Asian markets (in the United Kingdom, Mexico, and China, respectively).16 Toshiba adopted an organisational and cultural reform called “Management Innovation 2001”, which it based on the Six-Sigma quality improvement process that flattened GE’s hierarchical management structure.17 Changing Production, Procurement, and Managerial Relationships with East Asia

The relationship between Japanese corporations and East Asian firms has had the nature of a production network. Japanese firms invested in manufacturing facilities in East Asia to produce for export and they kept product development and other functions in Japan. These closed networks developed as the sharp appreciation of the yen in the mid-1980s led Japanese manufacturers to shift from domestic facilities to export platforms in East Asia. Electronics sector investments, in particular, shifted significantly to ASEAN. While the Japanese firms gradually purchased more and more parts in the local economies, their key local suppliers remained mostly affiliates of Japanese corporations. When the Japanese firms found that indigenous manufacturers were unable to provide parts of satisfactory quality and sufficient quantity, they encouraged their suppliers from Japan to invest locally as well, creating “Japanese villages” of manufacturing facilities and parts suppliers at various locations in East Asia. This pattern of closed production networks and Japanese villages is breaking down. One reason is the improvement in local suppliers in East Asia. By the late 1990s local firms in Korea, Taiwan, Singapore, and China had significantly strengthened their technological and financial capabilities and some of them could compete on an equal footing with the high-quality Japanese suppliers. Among these are the EMS firms in Taiwan and Singapore and the PC and telecommunication equipment manufacturers tied to

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American and European brand name firms. Japan-affiliated suppliers, for their part, could no longer rely on superior quality for a competitive edge. In order to compete with local suppliers on price, they have started to procure components from local vendors, reduce their Japanese expatriate staff, and turn operations over to local staff. Traditional production networks are undergoing further opening up as Japanese corporations all over the region, including Japan, switch from established sources elsewhere in East Asia to parts suppliers in southern China, which are owned mainly by firms from Taiwan and by a few firms from Hong Kong. Furthermore, Japanese electronics firms are adopting new corporate strategies in the face of increased competition from local Asian suppliers and from the EMS model adopted by American and East Asian firms in the industry. They are retreating from low-margin production functions in East Asia and concentrating on high-margin production and product development functions in Japan. For example, Aiwa Corporation has decided to reverse its aggressive shifting of low-end consumer electronics goods production to Asia. This push, which gave Aiwa an overseas production ratio of 90 percent and an outsourcing ratio of 50 percent, also diluted the company’s production and product development expertise base in Japan. Aiwa is attempting to regain the level of domestic expertise by increasing the shares of domestic and in-house production. Toshiba will consign the production of low-end white goods, such as refrigerators and air conditioners, to four consumer electronics companies in China with which it concluded technology co-operation agreements. Similarly, Hitachi has allied with Bosch-Siemens in the white goods business in East Asia to benefit from economies of scale while sharing the burden of investment.18 An exception to this retreat from manufacturing is a Japanese high-tech company. This firm has been using OEM manufactures in Asia for mature products for the last ten years, but it has more or less completed the cycle of outsourcing. It recently began increasing within-firm manufacturing operations in order to put underutilised employees in Japan to work and to combat a loss of technical know-how. The firm will try to reduce costs by employing a cell-type production method. This general change in strategy by Japanese firms to retreat from lowmargin manufacturing has made some of their facilities redundant, and East Asian EMS firms are keen to buy these unused plants, whether they are located in East Asia or in Japan. In addition, with the increasing efficiency of information transmission, Japanese corporations have started to shift the design as well as the manufacturing function for mature products to local production sites. For example, some design work for

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semiconductors and moulds is being done in other parts of East Asia rather than in Japan. In another change of strategy, Japanese corporations are giving regional headquarters and international procurement offices in East Asia a larger role. This strategy took shape as parts and components became a large share of value added and as East Asia became a major global parts supplier. Matsushita Electric elevated Asia Matsushita Electric (Singapore) to regional headquarters for Asia/Oceania and it will strengthen Matsushita Electric China (Beijing) to make them pillars of the four new business segments in the company’s Value Creation 21 strategy.19 Fujitsu’s outposts in Singapore provide essential co-ordinating and logistics support for the production of hard disk drives (HDDs) in ASEAN. Its international procurement office (IPO) in Singapore procures parts in ASEAN and distributes them to a set-assembly factory in Vietnam and to final assembly plants in Thailand and the Philippines. A consignment storehouse in Singapore stores other key devices obtained by the procurement department in Japan and ships them to these three factories.20 Deferring Implementation of B2B with East Asia

Japanese corporations are significantly behind in using B2B e-commerce for transactions in East Asia. A survey of Japanese affiliates in Hong Kong, Taiwan, Singapore, and Korea by Nomura Research Institute from October to December 2000 found only 29 percent of responding firms had already used B2B e-commerce (Table 11.2). A significant number, 20 percent, said that they would start doing so in fiscal year 2001, starting from March. According to the same survey, utilisation of e-commerce is mostly confined to buy and sell orders, and only 2 percent of responding firms used emarketplaces (Table 11.3). TABLE 11.2 Use of B2B E-commerce by Japanese Firms in East Asia

No. of responses Share of all responses

Already Use

Start in FY 2000

Start in FY 2001

No Plan

83 29%

8 3%

57 20%

141 49%

Note: Effective response of 289 companies out of questionnaires sent to 2,709 companies. Source: Nomura Research Institute.

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37 33% 55 49%

Buy Orders 12 11%

InformationSharing

Note: Effective response of 289 companies out of questionnaires sent to 2,709 companies. Source: Nomura Research Institute.

No. of responses Share of all responses

Sell Orders 2 2%

Marketplace

2 2%

OA Supplies

TABLE 11.3 B2B E-commerce of Japanese Affiliates in East Asia by Type of Transaction

5 4%

No Plan

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There are several reasons behind the slow adoption of B2B e-commerce by Japanese firms in East Asia. First, as discussed above, Japanese corporations generally lag behind American corporations in switching from EDI systems to cheaper and more flexible web-based systems. Japanese affiliates in East Asia used the same established EDI systems developed by Japanese corporations for domestic activities, mostly with Japanese manufacturers and suppliers in Japanese villages in East Asia to maintain the same patterns of transactions that they had established at home. Moreover, Japanese corporations tend to initiate Internet-based systems for some activities within Japan first and then expand the sphere of use outward, including East Asia. The strong role of the central headquarters in introducing computer systems in subsidiaries and the low expectation of network externalities are delaying implementation of B2B e-commerce among Japanese affiliates. The involvement of Japanese establishments in East Asia in B2B ecommerce is usually planned at the headquarters in Japan, which itself is just initiating pilot projects to replace EDI systems with Internet-based B2B systems for domestic facilities. Even if a Japanese subsidiary in East Asia requests approval to invest in a B2B system, the answer will often be to wait until headquarters develops globally optimum systems. In addition, Japanese firms are sceptical of the rewards from a unilateral investment in IT. In other words, they do not perceive sufficient network effects because Japanese colleagues in general are not very receptive to IT. Moreover, Japanese corporations seem to underestimate the level of IT infrastructure and literacy of firms in China, Taiwan, and Hong Kong, which have greatly improved their IT infrastructures in order to engage in B2B transactions with American and European firms. Japanese establishments in East Asia are at a significant disadvantage because of their belated adoption of B2B e-commerce systems. With more and more investment in the region by American and European firms, Japanese suppliers there are frequently asked to participate in Internetbased transactions. Moreover, non-Japanese East Asian firms that have moved onto the Internet also ask Japanese establishments there to join their B2B systems. The poor B2B capability of Japanese suppliers in the region is posing a threat of “Japan passing” to Japanese corporations. Some American and European firms, frustrated by the incompatibility of Japanese-affiliated parts suppliers with their B2B operations have scaled back their transactions with Japanese affiliates and started to enhance relationships with other Asian firms. These include firms in Taiwan and

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Korea, which are now capable of competing head-on with Japaneseaffiliated firms. In such an environment, some Japanese establishments have even invested in temporary, simplified e-commerce systems while they wait for company-wide global systems to be completed. Slowly Making Progress

The ongoing diffusion of the Internet and B2B is forcing Japanese operations in East Asia to respond in a variety of ways. For example, some Japanese parts suppliers in East Asia have been forced to participate in the SCM systems of the American and European clients of final assemblers and EMS firms. These transactions are primarily exchanges of data through EDI. A Japanese company, which manufactures electronics parts in southern China, has been under pressure from EMS firms to use Western EDI standards such as the EDIFACT and ANSI formats. Because this company does not have the technological know-how to meet the client demands within the firm, it has started to outsource to specialised firms. So far, this phenomenon has mainly involved large independent parts suppliers and the electronic device divisions of major set manufacturers that have large market shares. In time, however, smaller parts manufactures will be subject to the same pressure and only those that can and do shoulder the investment burden will be able to survive. The competitive environment has led Japanese corporations to adopt B2B e-commerce more expeditiously in some industries than in others. Take the PC and telecommunications industries, where American and European corporations lead, as an example. Japanese corporations that supply materials and parts to U.S. computer companies such as Dell and Compaq have had to adopt the American model of inter-company transactions and to adjust to exchanging data and design specifications with unrelated firms.21 Furthermore, in order to place orders with EMS vendors, Japanese corporations are obliged to use standard, vendordetermined specifications and electronic formats.22 In consumer electronics, on the other hand, Japanese corporations, which dominate the industry and can control the pace of change, were slow to adopt B2B e-commerce. Our interviews in southern China in 2001 turned up a number of cases of individual Japanese corporations implementing B2B e-commerce there. Company A, which is engaged in OEM production of PC monitors and printers has evolved into an EMS provider utilising the bargaining power derived from its large volume of parts procurement. It has built a powerful

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SCM system linking Japan, Hong Kong, and southern China, where contract manufacturers and suppliers are concentrated. In another approach, Company B sought to maximise efficiency through enhanced supplier relationships. It asked its suppliers to locate their plants within its factory compound in a new “Japanese village” and it is currently building an Internet-based procurement system to facilitate its transactions with these suppliers. Meanwhile, Japanese logistics companies operating in East Asia have been evolving into integrated logistics companies in response to the spread of B2B e-commerce and the requirements of SCM. In the Internet-based e-commerce environment companies cannot differentiate by remaining specialised in particular fields such as forwarding, warehousing, or transportation; they must compete on the basis of the value-added services they offer to clients. Company C, a Japanese transportation company, attracted new clients by constructing a web-based system that enabled it to provide clients with information on the entrance and exit of products from warehouses, on their inventory levels, and on worldwide cargo movements. Japanese establishments in East Asia are making less progress in utilising e-marketplaces than with Internet-based SCM and logistics systems. For example, one firm, which had moved ahead of its competitors in constructing a web-based SCM system that greatly enhanced its supplier relationships, is having difficulty utilising e-marketplaces. The main stumbling blocks are internal constraints such as the company’s quality control rule that requires a new supplier to guarantee recovery and compensation for damage from sub-standard parts. It is impossible to apply that rule to participants in e-marketplaces. Another company, which has an IPO in Hong Kong that procures parts and materials for its major factories in Japan and other parts of the world, gave up using e-marketplaces for these procurement transactions. It found that variations in prices were more pronounced than with traditional transactions, where the company’s volume purchases gave it bargaining power. Policy Support from the Japanese Government

The Japanese government intends to support B2B transactions of Japanese corporations in East Asia. The Ministry of Economy, Trade and Industry (METI, formerly MITI) will co-operate with 2,000 Japanese corporations, including Hitachi, Toyota, NEC, Fujitsu, and Mitsui and Co., to facilitate the development of B2B e-marketplaces and digital government in the

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region. It supports the spread of a Japanese electronic certification standard, the development of legal and regulatory systems, and Asia-wide co-operative e-marketplaces. It intends to use Japanese official development assistance (ODA) for this purpose.23 We think that it is reasonable for the Japanese government to push such measures to support the expansion of B2B transactions in East Asia by Japanese corporations. These steps will strengthen Japan’s regional networks and they will contribute to narrowing the digital divide within the region. These measures will not, however, have a great impact on the implementation of B2B e-commerce in Japanese corporations. Competitiveness and profitability are the primary factors that will determine how soon private Japanese corporations adopt Internet-based business, with East Asia and with the world at large. Progress in reorganising Japanese corporations will have a significant influence on their adoption of B2B e-commerce, and Japanese government policy to facilitate corporate restructuring will be more important than its policy support for the development of B2B. Major Impact on Corporate Networks of Japanese Firms in East Asia

East Asian corporate networks of Japanese corporations will change significantly as they eventually become involved in B2B transactions in the region and increase their sourcing of parts and other manufacturing functions outside their traditional suppliers. Existing networks are organised around vertically integrated companies, such as Japanese electronics companies. Networks based on B2B e-commerce systems, however, will probably be organised in conjunction with the newly formed specialised production entities of Japanese corporations or divisions such as EMS (Figure 11.1). As the specialised production entities become more concentrated, the production facilities of Japanese electronics companies will consolidate in Japan as well as in the rest of East Asia. The specialised production entities of Japanese corporations will use B2B transactions extensively to increase production efficiency and speed. They will expand their use of B2B e-commerce from simple procurement activities to SCM and to product development. To meet the needs of these production entities and to connect with the growing use of Internet-based transactions, local suppliers in East Asia will need to become highly entrepreneurial, technologically oriented, and capable of efficient digital networking.

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FIGURE 11.1 Emerging Organisation of B2B Networks in East Asia

Product Development & Marketing

Production and SCM

B2B ecommerce systems

Number of Brand Companies

Marketing Div. of Company A

Marketing Div. of Company B

American or Asian EMS

EMS of Company A

EMS of Company B

Buyer controlled B2B systems

Co. A’s B2B systems

Co. B’s B2B systems

Industry-wide E-marketplace

Suppliers

Source: Nomura Research Institute.

AGENDA FOR EXPANDING B2B TRANSACTIONS BETWEEN JAPANESE CORPORATIONS AND EAST ASIA

Quite naturally, procurement relations between Japanese and East Asian firms will open up under the emerging networks based on B2B systems. In this way, as Japanese corporations become more involved in B2B transactions, their influence on the development of local industries in the region should grow. Japanese corporations are certainly moving in this direction under the strong competitive pressure from corporations in the West as well as in the Asian NIEs. The speed of that move has been frustratingly slow, however, because it must be accompanied by extensive organisational restructuring — both internal and external. In order to accelerate this desirable as well as inevitable change, both the East Asian economies and Japanese corporations must overcome certain obstacles.

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Obstacles within East Asia

Obstacles on the side of the East Asian economies include • the uneven development of physical infrastructure in areas such as telecommunications, • the uneven development of institutional infrastructure, • the differences in regulation and culture in the East Asia region, and • the varied levels of entrepreneurship in the industrial structure centred on SMEs. With regard to physical and institutional infrastructure, the Asian NIEs have made remarkable progress, even better than Japan. The problems are mainly in the latecomer economies in East Asia (Masuyama 2000). Regulatory and cultural differences may create a bottleneck for international procurement over the Internet in the region. In this regard, Japanese corporations have high expectations for the introduction of the Common Effective Preferential Tariff (CEPT) scheme under the ASEAN Free Trade Area (AFTA). The lowering of customs duties on imports from AFTA members to under 5 percent after 2002 will greatly facilitate international procurement in the ASEAN region and encourage the development of B2B transactions by Japanese corporations in the region. Some Japanese corporations, however, are concerned whether the scheme will be implemented effectively on schedule. In order to engage in B2B e-commerce with Japanese corporations, producers in East Asia must raise their quality standards. According to our interviews with Japanese corporations, the paucity of local suppliers capable of meeting their quality criteria is a barrier to expanding B2B e-commerce with East Asian firms. Some firms in the region, primarily ones based in the NIEs, have become able to produce parts acceptable to quality-conscious Japanese purchasers. In addition, some parts factories in southern China have attained satisfactory product quality under the management and engineering expertise of their owners in Taiwan and, to a lesser extent, Hong Kong. The region must develop more entrepreneurs and engineers who establish and manage high-quality, technology-oriented parts makers. Japan-side Obstacles

Other obstacles to expanding B2B in the East Asia region are found within Japanese corporations and the Japanese economy. First, the slow progress of corporate reorganisation in Japan means that corporations are not yet structured to benefit significantly from expanding domestic B2B

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transactions or extending them to East Asian operations. Second, Japanese corporations’ overemphasis of product quality and underemphasis of network externalities gained through standardisation work against their benefiting fully from outsourcing through B2B transactions. Their drive for standardisation of IT systems, product components, and processes has been weak. Third, Japanese corporations seem to be less inclined than American corporations to encourage employee spin-offs, and thus they have not developed local suppliers in East Asian economies that might join in B2B e-commerce. While “Japanese villages” in East Asia did nurture some local suppliers, Japanese subsidiaries and affiliates tended to confine their local transactions within these villages once the firms were established. Fourth, Japanese corporations need to become more willing to share information with firms outside their groups. Finally, Japanese trading documents are not sufficiently digitalised to support B2B transactions because of institutional problems and delayed development of computer systems. In the future, Japanese establishments in East Asia should try to utilise B2B transactions in order to maintain efficient trade relationships with firms that they have established relationships with and to establish new trade relationships as well as continuously re-evaluate existing trade relationships. The approaches to implementing B2B e-commerce may differ according to industry. “Module-type” industries, such as PC manufacturing, that involve assembling of parts and components based on technical standards, require open systems that enable firms to procure high-quality parts cheaply and quickly. Thus, firms in such industries need to utilise e-marketplaces effectively. To facilitate these transactions, emarketplaces in East Asia need to establish ways to require vendors to guarantee product quality. In industries where technological innovation is rapid and suppliers’ commitment is required from the development stage, business relationships will tend to be confined within Japan for the near future. Japanese corporations should construct flexible internal Internetbased transaction systems, which will enable them to supply Japanese buyers located throughout East Asia quickly and efficiently. Once such systems are in place, Japanese corporations can also use them to supply American and European establishments and local firms in East Asia. Notes 1

Clark (2001) defines e-commerce as “the conduct of commerce in goods and services, with the assistance of telecommunications and

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telecommunications-based tools”. However, B2B transactions over electronic data interchange (EDI) are not usually included in B2B e-commerce. 2 Shukan Daiamondo (in Japanese), 10 November 2000. 3 Litan and Rivlin (2001), p. 41. Network externalities refer to the phenomenon that the benefits of using a particular technology rise as more users join the network. 4 For example, while an EDI system can reduce the cost of processing a health insurance claim to $2–4 from $10–15 in paper-based processing, a web-based system can do the processing for 2–4 cents per claim. Litan and Rivlin (2001), p. 31. 5 According to a survey on the Japanese electronics industry by the Japan Machinery Centre for Trade and Industry (JMC), it is easier to buy general purpose, standardized products such as electronics parts than specialized and customized products over the Internet (JMC 2000, p. 102). 6 Closing remarks by Regis McKenna, Chairman and CEO, Regis McKenna Inc. to “The Digital Economy in International Perspective: Common Construction or Regional Rivalry”, A Conference of the University of California E-conomy Project, Washington, D.C., 27 May 1999. 7 Eddie Cheung, “The B2B Market in Asia”, 17 January 2001. . 8 “B2B is the Password”, Business Week Online, International Edition, 22 May 2000. . 9 “The Frontier of American IT Businesses” (in Japanese), Shukan Daiamondo, 28 October 2000. 10 Nikkei Sangyo Shimbun, 24 August 2000. 11 Based on the forecast chart by Technology Forecaster, cited by Kita (2000). 12 The relatively low level of outsourcing by Japanese electronics firms may be due to the fact that Japanese firms are mainly in the consumer electronics sector, which is based on analogue technology, while American firms are mostly in the IT sector, which is based on digital technology. The production process for analogue technology-based products is less standardized, more complex, and therefore more difficult to outsource than the production process for digital technology-based products. Authors’ interview with a Japanese electronics company in Singapore in November 2000.

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14 15

16 17

18

19 20 21 22 23

See . Also, III is a partner in RosettaNet, a consortium of IT, electronic components and semiconductor manufacturing companies working to create and implement industry-wide, open e-business process standards. . Nihon Keizai Shimbun, 5 December 2000. “Manufacturing Reform in the Electronics Industry: Declaration of Independence by Factories” (in Japanese) Part 1, Nihon Keizai Shimbun, 12 December 2000. Nihon Keizai Shimbun, 1 December 2000. Comment by Tadashi Okamura, president of Toshiba Corporation, in an interview of Shukan Daiyamondo, 28 October 2000. “Manufacturing Reform in the Electronics Industry: Declaration of Independence by Factories” (in Japanese) Part 1, Nihon Keizai Shimbun, 22 December 2000. Nihon Keizai Shimbun, 11 January 2001. Interview with representative of Fujitsu, Inc. in December 2000. Interview with a Japanese electronics company in December 2000. Interview with a Japanese electronics company in December 2000. Nihon Keizai Shimbun, 12 July 2000.

References

Chen, Allen T. 2000. “Picking Asia’s Model”. Asiaweek.com. 29 September. . Clark, Roger. 2001. “Towards a Taxonomy of B2B e-Commerce Schemes”. 12 February. . FTIT. 2000. “Top Stories: B2B Online Exchanges – A case of first come, first served”. 1 November. (Website no longer available.) Japan Machinery Centre for Trade and Industry (JMC). 2000. “The Development of Industrial Concentration in East Asia and the Symbiosis of East Asia and Japan: The Case of Electronics and IT Industries” (in Japanese). Tokyo: JMC. Kita, M. 2001. “Can EMS be a Model for the Reform of Japanese Factory Sector?” (in Japanese). Chitekishisasouzou. January. pp. 101–23. Litan, Robert E., and Alice M. Rivlin. 2001. ”Economic Growth and the Internet”. Tokyo Club Papers 14, edited by H. C. Sherman. Munich:

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Institut fur Wirtschaftsforschung (ifo). Also available from . Masuyama, Seiichi. 2000. “Hastening to Embrace the Internet Revolution in Asia”. NRI Papers No. 20. 1 December. Available to download from . Noguchi, Wataru. 1999. “Virtual Manufacturing: A Future for the Manufacturing Sector” (in Japanese). Economisuto. 4 October. Pastore, Michael. 2001. “Asian Internet, PC Markets Prepare for Takeoff”, CyberAtlas, 26 February. . Suematsu, Chihiro. 1999. “Cyber-Revolution Will Change Japanese Corporate Management This Way” (in Japanese). Ekonomiusto. 4 October. Wong, Poh-Kam. 2000. “Globalization of Electronics Production Networks and the Emerging Roles and Strategies of Singapore Contract Manufacturers”. Paper presented at a conference at the Asian Development Bank Institute, Tokyo. Wu, Ho-Mo. 2000. “E-commerce Development and Government Policies in Taiwan”. Paper presented at the Eleventh Asia Forum, Tokyo Club Foundation for Global Studies, Kyoto, 12 May. Available at .

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