Plugging into production networks : industrialization strategy in less developed Southeast Asian countries 9789812309341, 9812309349, 9789812309358, 9812309357

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The Institute of Developing Economies (IDE-JETRO) is a Japanese government-related institution, founded in 1958 to conduct basic and comprehensive studies on economic, political, and social issues of developing countries and regions. The IDE-JETRO aims to make intellectual contributions to the world as a leading center of social-science research on Asia, the Middle East, Africa, Latin America, Oceania, and Eastern Europe. The Institute accumulates locally-grounded knowledge on these areas, clarify the conditions and issues they are facing, and disseminate a better understanding of these areas both domestically and abroad. These activities provide an intellectual foundation to facilitate cooperation between Japan and the international community for addressing development issues. The Institute of Southeast Asian Studies (ISEAS) was established as an autonomous organization in 1968. It is a regional centre dedicated to the study of socio-political, security and economic trends and developments in Southeast Asia and its wider geostrategic and economic environment. The Institute’s research programmes are the Regional Economic Studies (RES, including ASEAN and APEC), Regional Strategic and Political Studies (RSPS), and Regional Social and Cultural Studies (RSCS). ISEAS Publishing, an established academic press, has issued almost 2,000 books and journals. It is the largest scholarly publisher of research about Southeast Asia from within the region. ISEAS Publishing works with many other academic and trade publishers and distributors to disseminate important research and analyses from and about Southeast Asia to the rest of the world.

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First published in Singapore in 2009 by ISEAS Publishing Institute of Southeast Asian Studies 30 Heng Mui Keng Terrace Pasir Panjang Singapore 119614 E-mail: [email protected] Website: http://bookshop.iseas.edu.sg 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. © 2009 Institute of Developing Economies, JETRO The responsibility for facts and opinions in this publication rests exclusively with the authors and their interpretations do not necessarily reflect the views or the policy of IDE-JETRO, ISEAS or their supporters. ISEAS Library Cataloguing-in-Publication Data Plugging into production networks : industrialization strategy in less developed Southeast Asian countries / edited by Ikuo Kuroiwa. 1. Industrial policy—Southeast Asia. 2. Industrial clusters—Southeast Asia. I. Kuroiwa, Ikuo. HD3616 A9P73 2009 ISBN 978-981-230-934-1 (hard cover) ISBN 978-981-230-935-8 (E-book PDF)

Typeset by International Typesetters Pte Ltd Printed in Singapore by Utopia Press Pte Ltd

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Contents List of Tables

vii

List of Figures

xi

Preface Acknowledgements Contributors 1.

Introduction Ikuo Kuroiwa

I.

Overview of Production Networks in Less Developed Southeast Asia

2.

Expansion of the Production Networks into the Less Developed ASEAN Region: Implications for Development Strategy Fukunari Kimura

3.

4.

xiii xv xvii 1

15

Production Networks and Industrial Policy in Less Developed Southeast Asia Ikuo Kuroiwa

36

ASEAN Economic Integration and Implication for CLMV Countries Denis Hew, Sanchita Basu Das, and Rahul Sen

72

II. Case Studies 5.

Industrialization Strategy of Laos: Agglomeration and Fragmentation Motoyoshi Suzuki

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115

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vi

6.

Contents

Export-oriented Garment Manufacturing and Its Impact on Employment, Productivity and Wages in Cambodia and Laos Rajah Rasiah

7.

FDI and Economic Integration in Vietnam Tuan Bui

8.

Border Industry in Myanmar: Plugging into Production Networks through Border Industry Toshihiro Kudo and Ikuo Kuroiwa

9.

The Batam, Bintan, Karimun Special Economic Zone: Revitalizing Domestic Industrialization and Linking Global Value Chain Toh Mun Heng and Ng Kwan Kee

Index

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146 168

214

245

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List of Tables 1.1

2.1 2.2 2.3

3.1 3.2 3.3 3.4 3.5

Unpacking Agglomeration Economies: Clusters and Their Benefits Four Layers of Transactions in Production/Distribution Networks Factors Affecting Transaction Choices The 2 × 3 Policy Matrix in the Two-dimensional Fragmentation Framework Evolution of Industrial Policies in East Asia, 1950s to 1990s Impacts of the WTO Rules on Industrial Policy Instruments Foreign Direct Investment by Product (Approval Basis) Foreign Direct Investment by Investor (Approval Basis) Trade Performance 2005

4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8 4.9

ASEAN Macroeconomic Indicators ASEAN Human Development Indicators Labour Cost per Worker in Manufacturing, 1995–99 Incidence of Poverty in ASEAN ICT Infrastructure Indicators, 2005 Trade Openness Intra-ASEAN Trade for CLMV countries, 2006 Trade Destinations The 2 × 3 Policy Matrix in the Two-dimensional Fragmentation Framework 4.10 FTAs Provisions and Their Policy Impact on Development of Production Networks

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6

20 21 26

38 41 53 54 55 83 85 86 87 88 91 92 92 97 99

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5.1 5.2 5.3

List of Tables

Direct and Indirect Labour Cost Compared between Thailand and Laos Economic Interactions and Distance Action Recommendations Proposed at the First Meeting of the Lao-Japan Public and Private Sectors Joint Dialogues

Variables, Proxies and Measurement Formulas, Automotive Firms 6.2 Taxonomy and Trajectory of Garment Firms 6.3 Breakdown of Sampled Data, Garment Firms, 2006 6.4 Basic Infrastructure, Garments, Phnom Penh and Vientiane, 2006 6.5 Garment Lead Times, 2004 6.6 High-Tech Infrastructure, Garment Firms in Phnom Penh and Vientiane, 2006 6.7 Network Cohesion, Garment Firms, Phnom Penh and Vientiane, 2006 6.8 Technological Capabilities of Garment Firms in Phnom Penh and Vientiane, 2006 6.9 Employment, Export, Productivity and Wages, Garments, Phnom Penh and Vientiane, 2006 6.10 Employment and Wage Elasticity of Exports of Garment Firms, Phnom Penh and Vientiane, 2000–2006

120 132

139

6.1

7.1 7.2 7.3 7.4 7.5 7.6 7.7 7.8

Export Value and GDP: A Comparison across 5-Year Periods Market Structure in Total Merchandise Value Structure of Investment by Ownership, 2002–2006 The Top 20 FDI Counterpart-Countries during 1988–2006 FDI Realized during 1988–2007 by Economic Activity FDI Approved during 1988–2007 by Region FDI Approved during 1988–2007 by Form of Investment Employed Population by Ownership Sector

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153 153 154 155 155 156 157 160 161 162

173 173 185 185 187 189 191 197

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List of Tables

8.1 8.2 8.3 8.4 8.5 8.6 8.7 8.8

Myanmar’s Trade with Neighbouring Countries, 1980–2006 Number of Factories by Sector in Tak Province, 2005 Year of Establishment Year of Entry to Thailand Comparison between Road and Marine Transport Garment Factories’ Ratings on Infrastructure Services in Yangon, 2005 Comparison of Locational Advantages in Myanmar and Thailand Household Expenditure per Capita by Region

9.1 9.2 9.3 9.4

Sectoral Shares (percentage) in GDP, 1985, 2000 and 2006 Structural Change in the Manufacturing Sector Macroeconomic Indicators Business Competitiveness Index for Indonesia and Trade Partners 9.5 Top 10 Most Deteriorated Factors for BCI from 2005 to 2006 9.6 Ease of Doing Business 9.7 Components of 2007 Ease of Doing Business Ranking 9.8 Constraints to the Operations and Growth of the Establishment 9.9 Comparison of Key Statistics between Batam and Guangzhou, 2006 9.10 Business Activities and Opportunities in the IMS-GT

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ix

218 226 227 230 232 236 237 238 254 254 260 263 264 265 266 267 274 276

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List of Figures 2.1 2.2 2.3 2.4 2.5

3.1

The Original Concept of Fragmentation: An Illustration Two-Dimensional Fragmentation Annual Average Daily Traffic of the ASEAN Highway Major Ports and Trunk Shipping Routes in ASEAN Countries Number of Flight per Week between ASEAN Major Airports

17 19 22 23 24

Spatial Linkages (Backward and Forward) of the Electronics, Automotive, and Apparel Industries in the Five Southeast Asian Countries

48

4.1 4.2 4.3

FDI Inflows to China and ASEAN, 1980–2006 FDI Flows to ASEAN, 1995–2005 Intra-ASEAN Trade, 1980–2005

74 75 78

5.1

Vertical Fragmentation between Pre- and FinalAssemblies (Direct Export from Laos to the World through Bonded Transport in Thailand) Vertical Fragmentation between Pre- and FinalAssemblies (Supply for Assembly Factories in the Core) Boomerang-Type Vertical Fragmentation Vertical Product Differentiation Vertical Fragmentation among Three Countries Total Costs before and after Fragmentation Four Stages Industrialization Processes of Laos

5.2 5.3 5.4 5.5 5.6 5.7 6.1 6.2

Systemic Quad Main Markets and Investment Source of Garment Firms in Phnom Penh and Vientiane, 2006

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122 123 124 126 127 131 134 151 158

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7.1 7.2 7.3 7.4 7.5 7.6 8.1 8.2 8.3 8.4 8.5

9.1 9.2 9.3

List of Figures

Trade Values of Vietnam, 1996–2005 FDI in Vietnam, 1988–2007 FDI Realized in Vietnam during 1988–2007 by Economic Sector Investment by Type of Ownership FDI Contribution to GDP Export Share by Sector A Relationship between Service Link Costs and Border Industry SEZs in Cambodia Tak Province and Mae Sot Yangon and Myawaddy Route Road and Marine Routes for Transport between Bangkok and Yangon Porter’s Value Chain Location Map of BBK The Triangle of Complementarity in IMS-GT

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172 183 188 193 194 195

221 223 225 229 234 248 269 278

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Preface From the perspective of geographical proximity as well as economic, social, and cultural affinity, the experience of industrial development in leading Southeast Asian economies should be most relevant and helpful for their neighbouring countries. After facing difficulties in importsubstitution policies, Southeast Asian countries liberalized trade and investment and promoted integration with the global economy. Moreover, rapid technological progress reduced transportation and logistics costs and made fragmentation of production economically feasible. The change in the policy environment attracted massive foreign direct investment from Japan, Asian NIEs, and others, and allowed Southeast Asian countries to participate in production networks. Less developed countries in Southeast Asia, namely Cambodia, Laos, Myanmar, and Vietnam (CLMV), face the same challenge today as leading ASEAN countries did a few decades ago. In particular, they must build up links with neighbouring East Asian countries and participate in their regional production networks. The authors in this book examine development strategies for less developed Southeast Asian countries. They discuss what policy measures are effective in attracting foreign direct investment, reducing trade and transport costs, and forming competitive industrial clusters. In Chapter 1, location advantages of less developed countries are examined from the viewpoint of five features of location, namely factor costs, market access, public policies, agglomeration economies, and crossborder production networks. The first part of this book (Chapters 2–4) gives an overview of less developed Southeast Asian countries from the perspective of production networks. The authors discuss crucial policy elements for participating in production networks and forming competitive clusters. They also discuss the role of the ASEAN Economic Community (AEC) in extending production networks. In the second part (Chapters 5–9), the focus is on specific countries or regions. Here,

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in addition to CLMV, it also examines the link between Singapore and the Batam-Bintan-Karimun (BBK) Special Economic Zone, Indonesia and clearly demonstrates that it is vital for less developed Southeast Asian countries to strengthen their links with neighbouring East Asian countries if they are to fully utilize their location advantage in low labour costs, and at the same time overcome their handicaps, such as small local markets, less developed infrastructure and institution, and land-locked geographic locations (in the case of Laos).

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Acknowledgements This is the second phase of a research project funded by the Institute of Developing Economies (IDE-JETRO) in Japan on production networks in Southeast Asia. In the first phase, the project aimed to investigate how production networks and industrial clusters were formed in the advanced ASEAN region, particularly in Singapore, Malaysia, Thailand, and Indonesia. The result of the first phase was published by the Institute of Southeast Asian Studies (ISEAS) in 2008 under the title Production Networks and Industrial Clusters: Integrating Economies in Southeast Asia, edited by Ikuo Kuroiwa and Toh Mun Heng. In the second phase, the project expanded the scope of analysis and aims to investigate how production networks can be extended from the advanced ASEAN region into new ASEAN member countries, namely Cambodia, Laos, Myanmar, and Vietnam (CLMV). From the same viewpoint the link between Singapore and the Batam-Bintan-Karimun (BBK) Special Economic Zone in Indonesia is also discussed. The study highlights policy implications and provides policy measures for extending production networks into the less developed countries. After having a closed-door workshop at the National University of Singapore (NUS) Business School, we held a joint workshop with ISEAS and Japan International Cooperation Agency (JICA) in March 2008. The papers collected in this book have been revised to reflect comments and opinions expressed at these workshops. As in the first phase, I owe my sincere gratitude to the researchers and administrative staff of ISEAS for their support on this research work. I would like to acknowledge Dr Dennis Hew and Ms Sanchita Basu Das in particular for their support in organizing the joint workshop, and Mrs Triena Ong for her valuable advice on research activities and the publication of this book. The NUS Business School, with which I was affiliated while I was in Singapore, provided me with much support. In particular I am deeply

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indebted to Professor Toh Mun Heng for his contribution to this research work. I would also like to thank Ms Teo Woo Kim and Ms Jenny See (NUS Business School) for their kind and tireless support. Editor Ikuo Kuroiwa

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Contributors Ikuo Kuroiwa is Director-General, Development Studies Center, Institute of Developing Economies (IDE-JETRO) in Japan. He received his Ph.D. from the University of Pennsylvania. His current research interests include industrial development of East Asia, regional economic cooperation and integration. He has previous experience in the compilation and analysis of international input-output tables and has served as an economic advisor for the Japan Bank for International Cooperation. In 2006–2008, he was a visiting research fellow at the National University of Singapore (NUS) Business School. Fukunari Kimura has been Professor in the Faculty of Economics, Keio University since 2000 and Chief Economist, the Economic Research Institute for ASEAN and East Asia (ERIA) since 2008. He received his Ph.D. in Economics from the University of Wisconsin-Madison, and his Bachelor of Law from the University of Tokyo. He has done numerous advisory/consultancy jobs for the Government of Japan, industrial associations, the World Bank, the Asian Development Bank, and the Inter-American Development Bank, among others. His specialization is in international trade and development economics. In particular, he has recently been active in writing academic/semi-academic books and articles on international production networks and economic integration in East Asia. Denis Hew is Regional Cooperation Specialist at the Asian Development Bank, Manila. Prior to this position, he was Senior Fellow and Coordinator of the Regional Economic Studies Programme at the Institute of Southeast Asian Studies (ISEAS) in Singapore. He is the editor and contributor of the book Brick by Brick: The Building of an ASEAN Economic Community (Singapore: Institute of Southeast Asian Studies, 2007).

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Sanchita Basu Das is currently a Visiting Research Fellow and the lead researcher for economic affairs in the ASEAN Studies Centre at the Institute of Southeast Asian Studies (ISEAS), Singapore. Prior to this position, she worked as a Research Associate for the Regional Economic Studies programme at the same institute. She has also worked in the private sector as an economist with Consulting Engineering Services, India; ABN Amro Bank, India; and United Overseas Bank, Singapore. She received her Master of Arts in Economics from Delhi School of Economics, India, and her Masters in Business Administration from the National University of Singapore (NUS) Business School. She co-edited a special issue of the ASEAN Economic Bulletin entitled “Bridging the ASEAN Developmental Divide: Challenges and Prospects”, which was published by ISEAS in April 2007. She regularly writes book chapters on issues facing ASEAN, including trade and investment, economic and financial integration and the macroeconomic outlook. Rahul Sen is Lecturer in the Business Economics Department at the AUT Business School, Auckland, New Zealand and an Associate Fellow with the Institute of Southeast Asian Studies (ISEAS) in Singapore since 2008. Prior to this, he was a Research Fellow with ISEAS from 2003 to 2007. He is a recognized expert on economic integration in the AsiaPacific, particularly related to Free Trade Agreements (FTAs), having published numerous papers, articles, books and book chapters on the subject. In recognition of his expertise, his paper on FTAs involving the Association of Southeast Asian Nations (ASEAN) member countries was included at the 2006 IMF–World Bank Annual Program of Seminars in Singapore. His research findings have been widely cited by researchers working on Asian economic integration. He has also been invited to referee papers for several international journals, such as the Journal of Asian Economics, Pacific Affairs, The World Economy and the Southern Eonomic Journal. His recently published, peer-reviewed journal articles appeared in The World Economy and the Journal of World Trade. Motoyoshi Suzuki is Professor of Development Economics at the Graduate School for International Development and Cooperation (IDEC), Hiroshima University, and Honorary Professor of Suzuka International University. He received his M.A. from Thammasat University, Thailand and Ph.D. from the University of Hyogo. He also previously served as

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President of Suzuka International University and as JICA Policy Adviser to the Ministry of Finance and Economic Planning, Ghana, and to the Ministry of Planning and Investment, Laos. Rajah Rasiah is Professor of Technology and Innovation Policy at the University of Malaya. He also serves as Adjunct Professor at the University of South Australia and Professorial Fellow at UNU-MERIT. He has published twelve books and over one hundred articles. He obtained his doctorate in economics from Cambridge University. His latest book, Uneven Paths of Development, co-authored with Banji Oyelaran-Oyeyinka, was published in 2009. Tuan Bui is Deputy General Director of Vietnam Institute of Economics. He received his Ph.D. from the Australian National University and his Bachelor degree from Lomonosov Moscow National University, Russia. His main research interests include development economics, international trade, investment, integration, regional cooperation and poverty. Recently, he has been active in publishing a number of works on the issues of investment, regional cooperation and integration. Toshihiro Kudo is Director, Southeast Asian Studies Group II, at the Institute of Developing Economies (IDE-JETRO) in Japan. He received his M.Phil from the University of Cambridge. In 2000–2003 he was a visiting research fellow at Yangon Institute of Economics, Ministry of Education, and Department of Agricultural Planning, Ministry of Agriculture and Irrigation in Myanmar. His research interests include industrial development of Southeast Asia, particularly in Myanmar, and regional economic cooperation in the GMS. Toh Mun Heng is currently an Associate Professor of the Department of Business Policy, National University of Singapore. He obtained his doctoral degree in Economics and Econometrics from the University of London, London School of Economics. His research interests and publications are in the areas of general equilibrium and econometric modelling, input-output analysis, international trade and investment, human resource development, productivity measurement, and household economics and development strategies of emerging economies in the Asia-Pacific. He has co-authored and edited several titles such as The Economics of Education and Manpower

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Development: Issues and Policies in Singapore; Health Policies in Singapore; Economic Impact of the Withdrawal of the GSP on Singapore; Challenge and Response: Thirty Years of the Economic Development Board; Public Policies in Singapore: A Decade of Changes; ASEAN Growth Triangles; Principles of Economics; Competitiveness of the Singapore Economy; Production Networks and Industrial Clusters: Integrating Economies of Southeast Asia. Ng Kwan Kee is a Research Fellow at Asia Competitiveness Institute, Lee Kuan Yew School of Public Policy, National University of Singapore (NUS). He received his Master of Science in Management and Bachelor of Social Science (Honours) in Economics from NUS. He has conducted numerous research and consultancy projects for different government agencies of Singapore. His current research focus is the competitiveness of Batam, Bintan and Karimun, Indonesia, and ASEAN.

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1 Introduction Ikuo Kuroiwa

I. EXPANDING PRODUCTION NETWORKS IN SOUTHEAST ASIA Since the mid-1980s, liberalization in trade and investment in Southeast Asia has encouraged the expansion of production networks into the region. A well-known case study by McKendrick et al. (2000) demonstrated how production networks in the hard disk drive (HDD) industry were established in Southeast Asia, spanning Singapore, Thailand, and Malaysia. In this process, industries in these countries participated in the cross-border production networks and gained access to markets and the transfer of technology from multinational corporations (MNCs). At the same time, the development of industrial clusters has strengthened the competitiveness of industries. The above process is expected to accelerate as new ASEAN member countries — namely Cambodia, Laos, Myanmar, and Vietnam (CLMV) — follow suit in opening up their markets and liberalizing investment. Simultaneously, as a result of spatial concentration of economic

1

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activities in more developed regions, labour and land costs, as well as the burdens of pollution and congestion, have increased dramatically, and some economic activities, especially standardized labour or landintensive activities, have started to shift to less developed regions. For example, due to higher production costs in Thailand, some Japanese firms based in Thailand set up factories or started outsourcing in Laos (see Chapter 5). Similar cases can be found in Vietnam, Cambodia, and Myanmar. In a similar vein, the Singapore and Indonesian governments signed the Framework Agreement on Economic Cooperation in the Islands of Batam, Bintan and Karimun in 2006. This agreement aims to facilitate the access of Singapore firms to abundant land and labour resources in Indonesia, while Indonesian firms gain access to the networks of MNCs centred on Singapore (see Chapter 9). These are typical examples of production fragmentation across borders, which are caused by significant labour costs and land price differences between the countries. Production fragmentation is facilitated by lowering communication, transport, and coordination costs in production (i.e. service link costs) and other costs related to the investment (see Chapter 2). At the same time, the growth of cross-border production networks is breaking down vertically-integrated production processes into smaller incremental steps, so that the range of potential niches appears to be increasing. Such development in production fragmentation will increase opportunities for less developed economies to participate in production networks. Although a less developed region is in a good position to attract foreign direct investment (FDI) and production blocks from more developed regions, the challenges facing the less developed economies are daunting. They include improvement in human capital and physical infrastructure, especially transport and communications network facilities and cost-competitive public utilities, as well as the introduction of an open market-based policy framework and the establishment of the rule of law. As for industrial policy, some developing countries are cautious of active (or selective) government intervention in the market, due to the strong influence of neo-classical economics (e.g. Latin American countries since the 1990s). On the other hand, the Singapore government has targeted specific industries and assisted them actively by plugging

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Introduction

3

them into global production networks and in developing the competitive clusters. The governments of Singapore and other ASEAN countries have also pushed forward regional economic cooperation, which will liberalize flows of goods, services, skilled workers, and investment, and will assist in strengthening production networks. Such industrial policy is helpful in considering the development strategies of less developed economies, which may face stiff competition in an increasingly globalized environment. In the following, the analytical framework of McKendrick et al. (2000) is introduced to discuss how production networks can be extended into a less developed Southeast Asian region. An overview of other chapters is also presented. In addition to CLMV, Indonesia is included in our study. This is because Indonesia is not yet fully integrated into production networks in East Asia, and it is becoming increasingly critical for Indonesia to participate in such networks (see Chapter 9).

II. FIVE FEATURES OF LOCATION A case study by McKendrick et al. (2000) demonstrates how the hard disk drive (HDD) industry developed in Singapore (1982–), Thailand (1983–) and Malaysia (1988–). It introduces five features of location that can contribute to both firm and industry performance: 1. 2. 3. 4. 5.

Factor costs Market access Public policies Agglomeration economies Cross-country production networks

These features of locations are equally important in considering the extension of production networks into a less developed Southeast Asian region.

1. Factor Costs When we consider locational factors of a firm in the developing world, factor costs, especially labour costs, are still one of the most important considerations. As shown in the case of the HDD industry in Southeast Asia, cheap labour can attract standardized labour-intensive production

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activities from advanced countries. It is especially important when we consider development strategies of less developed Southeast Asian countries, since there is a significant difference in labour costs between rich and poor Southeast Asian countries (see Chapter 4). It is often pointed out that a large development gap may be a hindrance to faster integration in Southeast Asia (Salazar and Das 2007, Chapter 4). However, as far as the production network is concerned, such locational heterogeneity in the region could be an impetus rather than a deterrent to further integration.

2. Market Access Market access is a sore point in less developed countries. Poor countries, especially small countries such as Laos and Cambodia, cannot provide lucrative markets for multinational corporations (MNCs). However, with the growing liberalization of trade and the rapid decline in the cost of communication and transport, proximity to customers has become less important; in the case of the computer industry, for example, while Singapore, Thailand, and Malaysia were not major markets for computers, many of their products in the HDD industry, which have relatively low ratios of transport costs to total production costs, were shipped by air to other countries for further processing or assembling. In other words, so long as communication and transport costs are substantially reduced, previously vertically-integrated production processes will be fragmented into a series of production processes, and labour-intensive processes will be shifted to low-wage countries. Then their products will be exported to other countries as intermediate inputs for further processing or final consumption. Markets in Laos or Cambodia, for example, may not be large enough to attract an automotive assembly plant, but still they can participate partially in the network, using their strengths to advantage (see the case of the wire harnesses industry in Chapter 5).

3. Public Policies It has been stressed that East Asian economies, especially Southeast Asian economies, have achieved rapid economic growth owing to an open stance toward trade and investment and other generic policies,

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Introduction

5

such as macroeconomic stability and high investment in human capital (World Bank 1993). Regarding the efficacy of industrial policy, especially industry-specific measures, the World Bank’s East Asian Miracle report took a pessimistic view, emphasizing that Southeast Asian economies have achieved rapid growth and industrialization without resorting to industrial policy or by abandoning it (see Chapter 3). The case study on the HDD industry by McKendrick et al. (2000) considered the efficacy of public policy from the viewpoint of locationspecific assets. Their case study suggests that in addition to the low cost of labour, which is the first and most basic location-specific asset in less developed Southeast Asia, there are two categories of locationspecific assets that are primarily functions of public policies. The first category relates to the generic policy measures which improve the overall business environment in the host countries — macroeconomic policy, labour market condition, general infrastructure, trade policy, and investment regime. The second category involves more aggressive measures which promote agglomeration in a specific industry — business facilitation, tax incentives, infrastructure and skill development, supporting industry, and R&D promotion for the targeted industry. Unlike industrial policies which involved the kinds of protection and subsidies and that were adapted by Northeast Asian economies such as Korea and Taiwan, these industry-specific measures are still applicable and contribute to establishing competitive industrial clusters. However, these policies demand greater institutional resources, and only Singapore has been successful in implementing such policies (McKendrick et al. 2000). As shown later, the institutional capability of the state is particularly important in considering the efficacy of industrial policy (see Chapter 3).

4. Agglomeration Economies Industrial clusters (i.e. spatial concentration of related activities in an industry) are becoming an indispensable feature of location that contributes to the performance of firms and industries, and the competitiveness of industry in each locality is increasingly determined by the attributes of an industrial cluster. McKendrick (1998) classified industrial clusters into operational clusters and technological clusters. In operational clusters, component

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makers and downstream assemblers are collocated due to the economies of proximity in input-output relations (lower transport, logistics, and inventory costs, faster ramp-up in production, etc.), the agglomeration externality (pools of specialized labour, suppliers, etc.), and the diffusion of best practice through information spillover (see Table 1.1). In technological clusters where innovation occurs, tacit knowledge can only be transferred through face-to-face contact between brain workers (e.g. designers of component makers and downstream assemblers),1 and knowledge externalities are expected to occur as a result of such interaction (Fujita 2007). Although technological clusters attract higher value-added activities and are more entrenched in their local environment (i.e. persist longer in the same location) than operational clusters, TABLE 1.1 Unpacking Agglomeration Economies: Clusters and Their Benefits Technological Clusters

Operational Clusters

Early identification of new technological or market opportunities

Lower transportation costs

New technologies or new products or new services through greater numbers of start-ups or technological spillovers (e.g. personnel mobility)

Reduced transport time between stages in value chain

Rapid product development (proximity in problem solving)

Economies of scale in production

Availability of venture capital

Faster ramp up in production

Pools of specialized and heterogeneous labour: programmers, electrical engineers, chemists, physicists, technical marketers, etc. (e.g. disk drive designers or servo engineers)

Pools of specialized labour: process engineers, technicians, procurement managers, experienced assembly workers

Rapid imitation of product innovations

Rapid imitation of innovations in assembly, manufacturing, or logistics Monitor quality in supplier manufacturing process Lower inventory costs

Source: McKendrick (1998), McKendrick et al. (2000).

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Introduction

7

many of the Southeast Asia economies, especially in less developed regions, have not attained such a stage of development.2 Thus, it is still important to strengthen the competitiveness of operational clusters (see also Chapter 6).

5. Cross-country Production Networks The HDD industry, which was previously located in the United States, extended its production network into Singapore in the early 1980s to exploit low wages, government tax breaks, and a liberal trade and investment regime. It subsequently relocated complementary segments of the value chain to nearby Thailand and Malaysia. McKendrick et al. (2000) demonstrate three benefits to an industry of tapping into an international production network. First, locational heterogeneity of international networks generates advantages by integrating different locations, each of which exploits the benefits of specialization such as labour- (skills or capital-) intensive activities in less (more) developed economies. Second, learning is often the main benefit of the network form of organization, which encourages participating firms to acquire new skills or knowledge. Third, flexibility is a network-level benefit that allows firms to reallocate resources quickly and smoothly in response to changing market conditions. In addition, transaction costs can be reduced significantly by utilizing locational advantage of firms in the network, as shown in Chapter 5. On the other hand, each of these benefits comes at some cost; that is, greater locational heterogeneity, diverse knowledge sources, and flexibility imply more locations and thus greater geographic dispersion, which in turn implies higher transport and coordination costs in production. These costs, however, will be sharply reduced if heterogeneous countries are located within a relatively short distance, as in the case of Southeast Asia. Regarding the significance of geographical proximity, Dicken (2007) indicated that: Despite the enormous shrinkage of geographical distance that has occurred, the relative geographical location of parent company and overseas production unit may still be significant. The sheer organizational convenience of geographical proximity may encourage MNCs [TNCs in the original text] to locate offshore production close to their home country even when labour costs there are higher than elsewhere.

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In the Southeast Asian context, the advantage of offshore production in less developed Southeast Asian countries would be especially significant for firms based in the neighbouring Southeast Asian countries, such as Thailand, Malaysia, and Singapore or Northeast Asian countries or regions, such as China, Korea, Taiwan, and Hong Kong. For example, geographical as well as linguistic and cultural proximity to Thailand was critical for Laos to attract production blocks based in Thailand (see Chapter 5). Moreover, liberalization in trade and investment, which is accelerated by AFTA and other regional frameworks, as well as infrastructure development such as the East-West and North-South Corridors are expected to shrink economic distance and enhance the ability of firms to invest and move products easily in Southeast Asia. Thus, corporate activities will be reconfigured considerably so that production networks will extend into less developed regions and production networks spanning the entire region will be shaped accordingly.

III. OVERVIEW OF CHAPTERS Subsequent chapters in this book are composed of two parts: (1) overview of production networks and economic integration in less developed countries in Southeast Asia; and (2) focus on these less developed countries, in particular Cambodia, Laos, Myanmar, Vietnam, and Indonesia. Chapter 2 provides an overview of the two-dimensional fragmentation framework in the context of economic development and it also systematically lists up crucial policy elements required for new ASEAN members to participate in production networks. The framework approach seems to be particularly powerful in initial development phases and its applications in different industries are discussed. Chapter 3 focuses on industrial policy in less developed Southeast Asia. In this chapter, the author reviews industrial policy in Southeast Asia. Then two constraints on industrial policy — shrinking policy space and the constraints on state capability — are discussed in order to consider appropriate industrial policy in the era of globalization. Finally, industrial policy in less developed Southeast Asia is revisited with particular reference to the policy measures whereby the participation in

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Introduction

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production networks, as well as the formation of competitive industrial clusters, plays a crucial role in industrial development. Chapter 4 examines ASEAN economic integration and its implications on CLMV. The authors review a background on the ASEAN Economic Community (AEC) and discuss its origin and rationale. The authors then look at the development divide within ASEAN. It is observed that while the different levels of economic development can be complimentary in nature and therefore facilitate production network development, infrastructure and social gaps can be hurdles for such development. Finally, the role of free trade agreements (FTAs) is analyzed in strengthening production networks in CLMV. In the second part (Chapters 5–9), the focus is shifted to specific countries or regions. Chapter 5 discusses the development strategy of Laos and proposes the industrialization of Laos through sub-regionally complementary fragmentation. The rapid industrial development in the neighbouring countries, especially in Thailand, has raised wages and land prices — as well as increased congestion and pollution — in the metropolitan area, so that production processes may be fragmented and standardized labour-intensive activities are relocated to lower wage countries such as Laos. The author illustrates how the fragmentation can happen between Laos and Thailand or between Laos and other neighbouring countries. Chapter 6 uses the systemic quad to examine the extent of knowledge depth achieved in garment firms and the impact of their expansion on the households located in the Phnom Penh and Vientiane metropolitan locations, which are the key garment manufacturing regions in Cambodia and Laos. The result of analysis shows that whereas learning and innovation have been low, employment and exports have grown more significantly in Phnom Penh and Vientiane. On the other hand, because of low productivity growth — as well as high unemployment and underemployment rates — the real wage did not grow strongly. It is therefore necessary to stimulate technological deepening to ensure that competitiveness and wages rise as unemployment levels fall. Chapter 7 focuses on FDI and its growth in Vietnam. Since Doi Moi (renovation) was started in 1986, many reform measures have been taken by the Vietnamese government to attract FDI as well as to integrate

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the Vietnamese economy into the global and regional economy. As a result, FDI has made a significant contribution, especially in the fields of capital formation, industrialization, export promotion, and technology transfer. Also, local supporting industries were developed in some sectors owing to the linkages with FDI. In conclusion, policy recommendations are presented to address the problems related to FDI. Chapter 8 examines the prospect of the border industry along the Thailand-Myanmar border. The border industry has growth potential, as it can exploit the location advantages of the cheap labour in Myanmar, while avoiding high service link costs and unreliable utility services that accrue from underdeveloped infrastructure there. To promote industrial clusters on the Myanmar side, it is effective to establish SEZs and improve the investment environment in Myanmar. Chapter 9 discusses how Indonesia utilizes a national SEZ strategy as a vehicle to attract FDI and participate in global value chains (GVC) or global production networks (GPN). The Indonesian economy has yet to gain the same vitality as before the Asian financial crisis. The setting up of SEZs on the islands of Batam, Bintan and Karimun (BBK) is viewed as one of the possible steps to regain the growth momentum. The authors explore the progress of economic reform in Indonesia and point out a number of obstacles to overcome in order to join the GVC. Of particular interest is the role of Singapore in assisting BBK to fulfil its aspiration of a SEZ which will play a catalytic developmental role for the whole of Indonesia.

Notes 1. Tacit knowledge is the deeply personalized knowledge possessed by individuals, which is virtually impossible to make explicit and to communicate to others through formal mechanisms. Codified knowledge, on the other hand, is the kind of knowledge that can be expressed formally in documents. Therefore, unlike tacit knowledge, codified knowledge can be transmitted easily across distance using information technology (Dicken 2007). 2. One of very few exceptions is Singapore. Singapore has earnestly developed its own science, technology and innovation capabilities since the 1990s, and has recently targeted a biomedical science cluster as a next leading industry (Toh and Thangavelu 2008).

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References Dicken, Peter. Global Shift: Mapping the Changing Contours of the World Economy, fifth edition. London: Sage, 2007. Fujita, M. “Globalization, Regional Integration, and Spatial Economics: An Introduction”. In Regional Integration in East Asia: From the Viewpoint of Spatial Economics, edited by M. Fujita. New York: Palgrave-Macmillan, 2007. McKendrick, David G. “Dispersed Concentration: Industry Location and Globalization in Hard Disk Drives. Report 98–03”. San Diego: University of California, Information Storage Industry Center, 1998. McKendrick, David G., Richard F. Donner, and Stephan Haggard. From Silicon Valley to Singapore: Location and Competitive Advantage in the Hard Disk Drive Industry. Stanford: Stanford University Press, 2000. Salazar, L.C. and S.B. Das. “Bridging the ASEAN Developmental Divide: Challenges and Prospects”. ASEAN Economic Bulletin no. 24, no. 1 (April 2007). Toh Mun Heng and Shandre Thangavelu. “The Biomedical Science (BMS) Industry in Singapore: Can It Plug into the Global Value Chain?”. In Production Networks and Industrial Clusters: Integrating Economies in Southeast Asia, edited by Ikuo Kuroiwa and Toh Mun Heng. Singapore: Institute of Southeast Asian Studies, 2008. World Bank. The East Asian Miracle: Economic Growth and Public Policy. New York: Oxford University Press, 1993.

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PART I Overview of the Production Networks in Less Developed Southeast Asia

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2 Expansion of the Production Networks into the Less Developed ASEAN Region: Implications for Development Strategy Fukunari Kimura

I. INTRODUCTION In both journalistic and academic literature in North America and Europe, pessimistic views on outsourcing and offshoring, or sometimes on globalization as a whole, have become vigorous and pervasive.1 Against such a wind, it is fortunate to see that East Asia has maintained optimism in utilizing globalizing forces for economic development. It has been widely recognized that international production/distribution networks in East Asia are the most advanced and sophisticated form of international division of labour among countries at different income levels and work as a major source of Asian dynamism.2 An important

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policy implication from the East Asian example is that if a proper policy environment is prepared mechanics of international production/ distribution networks allow us to effectively utilize globalizing forces to accelerate economic development of lagged behind countries or regions. The Economic Research Institute for ASEAN and East Asia (ERIA), which has been established as a policy-research institute supported by ASEAN+6 research institutes, actually applies this economic logic as a central theme of its policy research and concentrates research resources on achieving deeper economic integration and narrowing development gaps in ASEAN and extended East Asia.3 The fragmentation theory initiated by Jones and Kierzkowski (1990) has recently been extended to explain the mechanics of international production/distribution networks in East Asia. Kimura and Ando (2005) propose the conceptual framework of two-dimensional fragmentation that deals with the sophisticated combination of intra-firm and arm’s length (inter-firm) fragmentation of production activities, and Kimura (2008a) attempts to apply it to Southeast Asian countries. The spatial structure of production/distribution networks is further explored with the concept of four layers of transactions, which is proposed in Kimura (2008a) and is more thoroughly developed in Kimura (2008b). A missing link to connect the conceptual framework with concrete policy discussion is the mapping of the mechanics and spatial structure of production/distribution networks into actual policy-making situations at different development phases. Phases of economic development or industrialization apparently affect how each country or region can approach and utilize the mechanics of production/distribution networks. This chapter will attempt to bridge our conceptual framework with phases of economic development/industrialization and to systematically list important policy elements in order to effectively utilize globalizing forces, with special reference to latecomers in ASEAN. The next section of the chapter briefly reviews the framework of two-dimensional fragmentation and the four-layer spatial structure of transactions. The third section presents the link of our conceptual framework with policy needs for countries at different development phases. The fourth and fifth sections apply our approach to extracting policy elements for countries in early development phases.

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II. A BRIEF REVIEW OF THE TWO-DIMENSIONAL FRAGMENTATION FRAMEWORK Although international production/distribution networks in East Asia began to be formulated from the beginning of the 1990s, Jones and Kierzkowski (1990) made a head start in developing the theory of fragmentation. The theory pointed out fundamental differences between intermediate goods trade and finished products trade, particularly in the flexibility of firm’s decision-making in cutting out production blocks and the existence of service link costs. Figure 2.1 illustrates the original idea of fragmentation. Suppose that a firm in the electronics industry has a large factory in a developed country. The factory takes care of all the production processes from upstream to downstream, and each production process requires different inputs of primary factors and intermediate inputs. Therefore, if production Figure 3: The original idea of fragmentation: an illustration FIGURE 2.1 The Original Concept of Fragmentation: An Illustration Before fragmentation

Old big factory

After fragmentation

PB

SL

PB SL

SL

PB

PB SL

SL PB

PB: production block SL.: service link

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processes are split into production blocks (PBs) and located in places with different location advantages, the total production cost may be reduced. This is fragmentation. Fragmentation of production processes makes sense when (i) the saving of production costs per se in PBs is high, and (ii) incurred service link (SL) costs for connecting remotely located production blocks are low. The firm can cut out PBs in various shapes and bulks in order to exploit differences in location advantages in remote areas. On the other hand, SL costs including not only transport costs but also various coordination costs should not be too high. In this sense, international division of labour in terms of production processes cannot be fully explained by a simple extension of traditional trade theories; PBs can be tailor-made rather than a fixed set of production activities, and transactions between PBs tend to be relation-specific rather than those in spot markets. The concept of two-dimensional fragmentation proposed by Kimura and Ando (2005) expands the idea of fragmentation in order to incorporate the sophistication of international production/distribution networks in East Asia. In addition to fragmentation in the dimension of geographical distance, the extended framework introduces fragmentation in the dimension of disintegration, where a firm decides whether to keep some economic activities inside the firm or to outsource them to unrelated firms (see Figure 2.2). This framework explains the sophisticated nature of fragmentation in East Asia where both intra-firm and arm’s length (inter-firm) fragmentation of production processes is developed and production networks with various innovative designs are proliferated. The two-dimensional fragmentation framework also explains why the fragmentation of production processes at the firm level and the formation of agglomeration or industrial clusters at the industry/macro level go together in East Asia. Fragmentation accelerates the formation of agglomeration at least through two channels. First, PBs of a large number of firms can be attracted to one specific place if it provides a favourable environment for production costs per se and service link costs. In particular, service link tends to have strong economies of scale so that more and more PBs would be attracted once a large number of economic activities came. Second, arm’s length fragmentation is particularly activated in cases of short geographical distance because

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FIGURE 2.2 Two-Dimensional Fragmentation Disintegration Competitive spot bidding

Internet auctions

Domestic arm’s length fragmentation

Cross-border arm’s length fragmentation

EMS OEM contracts

Subcontracting

Domestic intra-firm fragmentation

Original Position

Outsourcing

Cross-border intra-firm fragmentation

Distance

Source: Kimura and Ando 2005.

SL costs along the disintegration axis, in other words, transaction costs, are very sensitive to geographical distance. This is one of the major sources for the formation of industrial agglomeration with active vertical links of production. A further thought on the spatial structure of production/distribution networks generates the concept of four layers of transactions (Kimura 2008b). Firms that design, manage, and control production/distribution networks typically organize a number of transactions in the four-layer spatial structure in terms of the gate-to-gate lead time and delivery frequency as in Table 2.1: the first layer (local), the second layer (sub-regional), the third layer (regional), and the fourth layer (world). The first layer transactions typically correspond to just-in-time highfrequency transactions within an industrial agglomeration. The second

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TABLE 2.1 Four Layers of Transactions in Production/Distribution Networks 1st layer (local)

2nd layer (sub-regional)

3rd layer (regional)

4th layer (world)

Lead time

Less than 2.5 hours

1 to 7 days

1 to 2 weeks

2 weeks to 2 months

Frequency

Once or more in a day

Once or more in a week

Once a week

Once a week

Transport mode

Trucks

Trucks/ships/ airplanes

Ships

Ships

Trip length

Less than 100km

Less than 1,500km

Less than 6,000km

Longer

Source: Kimura (2008b).

layer transactions are those between industrial agglomerations or those between an industrial agglomeration and its periphery. The third layer covers transactions of East Asia as a whole. The fourth layer extends to the whole world. The choice of spatial layers depends on the basic properties of each transaction as listed in Table 2.2, which include (i) three kinds of costs in fragmentation along the distance axis (network set-up costs, service link costs, and production costs per se), and (ii) the intimacy of the inter-firm relationship as well as the architecture of the inter-firm interface in fragmentation along the disintegration axis. As for (i), there is a trade-off between location advantages and SL cost; the larger the location advantages and/or lower the SL cost, the more likely that transactions in long distance can be chosen, and vice versa. Network set-up cost or relocation cost also affects the length of transactions; the higher such a cost, the longer the transaction would be. As for (ii), arm’s length transactions are likely to be in short distance, while intra-firm transactions can be in long distance. Among arm’s-length transactions, the weaker the credibility of business partners and/or the more unbalanced the power balance between partners, the more likely the transactions are in short distance. The architecture of the inter-firm interface is also important; the modular-type interface may allow long-

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TABLE 2.2 Factors Affecting Transaction Choices 1st layer (local)

2nd layer (sub-regional)

3rd layer 4th layer (regional) (world)

Re: fragmentation along the distance axis Network set-up cost/relocation cost

small

Service link cost (esp. transport cost (cost, lead time, quality))

large

Location advantages (esp. small production conditions, economies of scale)

large small large

Re: fragmentation along the disintegration axis Intimacy of inter-firm relationship Intra-firm vs. arm’s length arm’s length (capital holdings) Credibility weak unbalanced Power balance Architecture of inter-firm interface Modular vs. integral integral

intra-firm strong balanced modular

Source: Kimura (2008b).

distance transactions while the total integration-type interface requires short-distance transactions. The concept of four layers of transactions provides an important link between the two-dimensional fragmentation framework and practical policy discussion. Figures 2.3, 2.4, and 2.5 present logistic connections among ASEAN countries by highways, maritime transportation, and air transportation. The development of logistic infrastructure and services is not monotonic across the whole region but rather strongly skewed towards dense economic activities. In ASEAN, thick production networks are formulated along the North-South corridor between Bangkok and Singapore where all transportation modes are highly active. In the three maps, vigorous second-layer transactions are depicted, which connect

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FIGURE 2.3 Annual Average Daily Traffic of the ASEAN Highway

Source: JETRO 2008

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FIGURE 2.4 Major Ports and Trunk Shipping Routes in ASEAN Countries

Source: JETRO 2008

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FIGURE 2.5 Number of Flight per Week between ASEAN Major Airports

Source: JETRO 2008

industrial agglomerations in Bangkok, Selangor, Singapore, and others. Jakarta and Manila look like significant agglomerations on the maps although we know that active first-layer transactions have not yet been developed there. Hanoi and Ho Chi Minh City are still too small to be called industrial agglomerations. Cambodia, Laos, and Myanmar are within a geographical distance from Bangkok for potential second-layer transactions, but logistic lines are still too thin and slow.

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III. THE LINK WITH DEVELOPMENT PHASES The analytical framework of two-dimensional fragmentation together with the four-layered spatial structure of transactions presents a set of economic conditions in which international production/distribution networks would effectively work. The next question is how we can link the analytical framework with development issues. Table 2.3, which was presented in Kimura (2008a), is the 2 × 3 policy matrix in the twodimensional fragmentation framework. The importance of each cell in the matrix differs, depending on how far the industrialization of the country has proceeded, as well as where the country is geographically located. To develop a concrete policy package for each developing economy, we should step forward to seek the link with development phases. We must note that our analytical framework has been developed based on our observation of machinery industries and thus may not be completely applicable to cases in other industries. The design of production networks, particularly on their spatial structure, depends on the technological and managerial properties of production processes in each industry and each product line. However, we can surely learn a lot from the case of machinery industries because they present the most sophisticated networks in terms of the number of parts and components as well as production processes. Thus using findings from machinery industries for other industries such as garment industries, agro-industries, and software outsourcing seems to be a promising direction for future research. From the viewpoint of utilizing production/distribution networks in machinery industries, we can identify four phases of industrialization or economic development. The first phase confronts the task of how to get into production networks. In this phase, fragmentation along the distance axis plays a prime role. The improvement of three kinds of costs, i.e. network set-up costs, service link costs, and production costs per se, is essential to successfully inviting fragmented production blocks. The decision on whether to depend on transactions of the second layer or the third layer is also crucial in attracting more investment. When geography allows, the improvement of logistic arrangements may make transactions of the second layer possible so that the concerned country or region can participate in dense production networks.

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TABLE 2.3 The 2 × 3 Policy Matrix for Two-dimensional Fragmentation Framework

Fragmentation along the distance axis

Reduction in fixed costs to develop production/ distribution networks

Reduction in service link costs connecting production blocks

Various policies to reduce investment costs

Various policies to overcome geographical distance and border effects

Examples: (i) improvement in stability, transparency, and predictability of investment-related policies, (ii) investment facilitation in FDIhosting agencies and industrial estates, (iii) liberalization and development in financial services related to capital investment.

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Examples: (i) reduction/removal of trade barriers such as tariffs, (ii) trade facilitation including simplification and improved efficiency in custom clearance/ procedures, (iii) development of transport infrastructure and improved efficiency in transport and distribution services, (iv) development of telecommunication infrastructure, (v) improved efficiency in financial services related to operation and capital movements, (vi) reduction in costs of coordination between remote places by facilitation of the movement of natural persons.

Further cost reduction in production cost per se in production blocks Various policies to strengthen location advantages Examples: (i) establishment of educational/ occupational institutions for personnel training to secure various types of human resources, (ii) establishment of stable and elastic labour-related laws and institutions, (iii) establishment of efficient international and domestic financial services, (iv) reduction in costs infrastructure services such as electricity and other energy, industrial estates services, (v) development of agglomeration to facilitate vertical production chains, (vi) establishment of economic institutions such as investment rule and intellectual property rights, (vii) various trade and investment facilitation.

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TABLE 2.3 (Cont’d ) Reduction in fixed costs to develop production/ distribution networks Fragmentation along the disintegration axis

Reduction in service link costs connecting production blocks

Further cost reduction in production cost per se in production blocks

Establishment of economic environment to reduce set-up costs of arm’s length transactions

Development of institutional environment to reduce the cost of implementing arm’s length transactions

Various policies to strengthen competitiveness of potential business partners

Examples: (i) establishment of economic system to allow co-existance of various business partners as well as making various types of contracts, (ii) various policies to reduce costs of information gathering on potential business partners, (iii) securing fairness, stability, and efficiency in contracts, (iv) establishment of stable and effective institutions to secure intellectual property rights.

Examples: (i) policies to reduce monitoring cost of business partners, (ii) improvement in legal system and economic institutions to activate dispute settlement mechanism, (iii) policies to promote technical innovations in modulation to further facilitate outsourcing.

Examples: (i) hosting and fostering various types of business partners including foreign and indigenous firms, (ii) strengthening supporting industries, (iii) various policies to promote the formation of agglomeration.

Source: Kimura (2008a).

The second phase requires the development of industrial agglomeration. Production blocks invited in the first phase do not typically have any significant local procurement system and thus are limited and unstable. Technological transfers or spillovers from multinationals to local firms/ entrepreneurs are also minimal. To construct a stable and self-evolving industrial base, the formation of industrial agglomeration is essential. In this phase, both types of fragmentation, along the distance axis and the disintegration axis, become important, and the overall improvement of

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six kinds of costs is required. Both an efficient economic environment for transactions of the first layer and mass infrastructure for transactions of the second and third layers must be established. In the third phase, countries that almost reach the stage of newly industrialized economies face a new challenge. Congestion effects in industrial agglomeration blow up production costs, and competitiveness in unskilled labour-intensive activities becomes fragile. At this point, countries must upgrade the industrial structure and climb the ladder toward fully developed economies. Fostering human resources is crucial in this phase, and the industrial structure excessively biased toward the manufacturing sector must also be corrected. The international competitiveness of indigenous firms must be enhanced so as to compete with world giants. The fourth phase is for fully developed economies. Their firms become multinationals and develop international production/distribution networks. In this phase, the international competitiveness of corporate firms and the attractiveness of the home country as industrial base do not necessarily share the same vector. Thus de-industrialization or a hollowing-out problem might occur. Countries need to solve policy questions of how to avoid negative effects of outsourcing or offshoring and instead use it to generate economic dynamism. Our analytical framework is particularly powerful in sketching policy packages for countries in the first and second phases. The following two sections will discuss policy elements drawn from our framework for the first and second phases, with special reference to latecomers in ASEAN.

IV. POLICIES FOR COUNTRIES IN THE FIRST PHASE In Southeast Asia, countries in the first phase include Cambodia, Laos, and Myanmar. In intra-national settings, some of the local cities in Thailand and islands in Indonesia, for example, may also fall into this category. It is often said that these countries/regions have a comparative advantage in producing primary products and thus should concentrate on the primary sector development rather than attempting industrialization. However, our framework suggests that some of these countries/regions have good potential for participating in production networks.

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These countries/regions are not typically in the vicinity of industrial agglomeration, and thus fragmentation along the distance axis becomes a major target. These countries/regions are, in many cases, abundant in unskilled labour at low wages. For example, the wage level for workers in Laos is much lower than in Thailand; it is a quarter or even onefifth of wages in the relatively poor Northeast part of Thailand. Hence, the policy task is how to effectively utilize this strength. Reductions in three kinds of costs, i.e. network set-up costs, service link costs, and production costs per se, become policy issues. They may seem to be overwhelming tasks, but actually we do not have to realize cost reductions all at once for every aspect in every part of the country. Since our immediate target is to attract an initial wave of FDI, we just need to achieve cost reductions for relevant economic activities in the short term. In addition, the flexibility in cutting out production blocks by multinationals may allow host countries to improve cost conditions only partially so as to pick up small niches in attractiveness. Local and partial improvement of cost conditions targeting immediate bottlenecks is the minimal requirement in this phase. To reduce network set-up costs, minimal FDI facilitation must be established. Countries in the first phase are not typically accustomed to hosting FDI, and their institutional arrangements are unnecessarily complicated and cumbersome. Investors must complete multiple documents and obtain the clearance of a number of ministries and agencies, which takes enormous time and energy with a lot of uncertainty. The first thing to do is to show enthusiasm in hosting FDI and then streamline necessary bureaucratic procedure. A one-stop service for foreign investors is desirable, but it may not be easy to establish it immediately. In such a case, we at least need to strengthen the services of FDI-hosting agencies to make them more open and helpful. Management offices of industrial estates or special economic zones may also play an important role in FDI facilitation. Service link costs are obvious bottlenecks in hosting FDI in many cases. Logistic infrastructure and services are typically poor, and customs clearance at national borders is a nightmare. Logistic services including bureaucratic procedures at national borders are evaluated in three dimensions: incurred costs and fees, expected time duration, and their reliability or stability. Without meeting certain levels in the three-dimensional evaluation, production blocks cannot be attracted.

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A certain level of logistic infrastructure and services together with substantial trade facilitation at customs clearance are essential. It is however important to understand that short-term demand for service link can be relatively small and specific. If sufficient trade facilitation for routine cargos or for containers in and out of special economic zones is established, we may start working with production networks. Rather than taking too long to reform everything, we had better solve immediate bottlenecks. As for production costs per se, inexpensive labour is likely to be an immediate strength, and thus overly strict regulations on employment should be avoided. Although basic human rights of workers are of course important, keeping flexibility in employment conditions is sometimes crucial in attracting production blocks. Other inputs for production must be provided, including supplies of electricity, energy, and water, and basic services of industrial estates. These can, however be, small-scale at the beginning. Countries may also allow foreign developers to supply these services in a proper regulatory framework. Such arrangements would be beneficial in learning essentials to improve the investment climate; Suzhou Industrial Park jointly developed with Singaporeans4 and a number of industrial estates developed by Japanese general trading companies in China and ASEAN5 are good examples. From the viewpoint of four layers of transactions, whether the second-layer transactions can be established or not, in addition to the third-layer transactions, is crucial. Production fragmentation in the third layer is in long distance and thus requires a strong commitment by firms. As a consequence, such fragmentation is mostly intra-firm, and players are prone to be large multinationals. To attract such investment, host countries must demonstrate strong location advantages. Fragmentation in the second layer, on the other hand, can be much more casual and tentative. Relatively small investors might set up satellite plants, and arm’s length fragmentation would also be possible. A crucial point is geographical and economic distance from industrial agglomeration. By effectively reducing service link costs, transactions of the second layer may become possible. For example, Laos has a good potential to attract satellite plants from the congested Bangkok area. The most important thing is a change in the mind set in hosting FDI. Intuitive fear of foreign giants is quite understandable, but MNEs

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are not always dangerous as far as they are competing with each other. Low-income countries often have good potential for attracting the first wave of FDI, which leads to participating in international production networks. They do not have to give up traditional policies of fostering resource-based and labour-intensive industries along with today’s comparative advantage. The improvement in the investment climate can be uneven at the beginning. Successful participation in international production networks will drastically extend the scope of the utilization of globalizing forces.

V. POLICIES FOR COUNTRIES IN THE SECOND PHASE Vietnam, Indonesia, and perhaps the Philippines fall into the category of countries in the second phase. These countries have been successful in attracting a certain amount of production blocks. However, links among production blocks in these countries are still thin, FDI may be limited, and efficient industrial agglomeration is yet to be formed. To establish a stable industrial base and generate a virtuous circle between efficient production and human capital development, the formation of industrial agglomeration becomes an important task for countries in this phase. Of course, whether proactive policies for forming industrial agglomeration are appropriate or not depends on the size, density, and mobility of population in the concerned countries. Since Southeast Asian countries such as Vietnam, Indonesia, and the Philippines have ample human resources in high density, they have good potential for developing significant industrial agglomeration. In this phase, the overall improvement of cost conditions cannot be avoided. For fragmentation along the distance axis, three elements of costs become important. As for network set-up costs, substantial FDI liberalization and facilitation are expected. Redundant regulations and restrictions imposed on incoming FDI must be removed so that firms can freely apply creative business models. In FDI facilitation, we can learn a lot of creative ideas from successful cases in the region, which include one-stop services, aftercare and monitoring services, breaking language barriers, rental factories/floors, and others. To form industrial agglomeration, FDI promotion, particularly for small and medium parts

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Fukunari Kimura

and components producers, is essential, even if they themselves will not export directly. Hosting an influential multinational giant is sometimes effective in attracting a whole network. As for service link costs, competition among industrial agglomerations has been enhanced at very high standards. Logistic infrastructure and services including customs clearance must be improved in terms of incurred costs and fees, expected time duration, and their reliability. For transactions of the first layer, logistic infrastructure and services for efficient industrial agglomeration must be established. Urban transport systems should provide efficient connections among industrial estates and factories, together with a proper zoning including residential areas. The access to mass infrastructure, such as airports and ports, to serve for transactions of the second, third, and fourth layers is also crucial. The issue is how much economic activity can be catered to in one industrial agglomeration while avoiding too much congestion. For transactions of the second and third layers, efficient and reliable mass infrastructure becomes crucial. As presented in Figures 2.3, 2.4, and 2.5, highways, ports, and airports are major transport channels, and being a hub or at least a major spoke in these transport modes is not an easy task. The construction of huge infrastructure as well as running infrastructure services often requires efficient financing; publicprivate partnership (PPP) and other arrangements may be needed. Trade facilitation at the border is also important. As for production costs per se, in order to cater to a wide range of economic activities, a holistic approach is needed again. Countries in the second phase are typically losing their competitiveness in unskilled labour intensive activities due to secular wage hikes. Although labour migration from rural areas or foreign countries may mitigate them to some extent, countries must eventually find strengths in other types of inputs beyond inexpensive unskilled labour. In this regard, the shortage in human capital, particularly managers and technicians, should be resolved through the improvement of middle to higher education. Capital costs also become important; this calls for the development of both domestic and external financial services. Infrastructure services and industrial estates must meet capacity for mass production. Technological capability should also be strengthened, and positive externalities from industrial agglomeration and economies of scale must be exploited aggressively.

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In the dimension of fragmentation along the disintegration axis, the issue is how to attract a large number of firms with different firmspecific assets (such as technologies, managerial ability, and inter-firm connections) to industrial agglomeration. Geographical concentration of various types of firms is essential to generate a variety of arm’s length transactions. Short distance helps reduce search costs for new business partners, design fine-tuned delivery timing in just-in-time systems monitor product quality, conduct quick trouble-shooting, and realize technological transfers/spillovers. Invited foreign firms can be of a wide variety in terms of nationality, firm/plant size, positioning in value chains, business model, etc. In addition, local firms/entrepreneurs can also be important players in arm’s length transactions. It is important to enhance technological and managerial capability of local firms/entrepreneurs, provide matchmaking opportunities for foreign and domestic firms, and promote technological transfers from foreign firms to domestic firms. To nurture various types of arm’s length transactions, legal and economic systems are also crucial in ensuring the stability and flexibility of contracts and conducting effective trouble-shooting and dispute settlement.

VI. CONCLUDING REMARKS This chapter further develops the two-dimensional fragmentation framework in the context of economic development and systematically lists crucial policy elements for ASEAN latecomers to come into production networks. Although each policy element may not seem to be completely new to existing policy discussions, our conceptual approach should be useful in coordinating and prioritizing policy modes along the development path in a comprehensive manner. The approach seems to be particularly powerful in initial development phases. We may need to fine-tune a little on our conceptual framework in order to apply it to industries other than machinery industries. Different technological and managerial conditions in different industries may certainly generate peculiar spatial structure of outsourcing/offshoring and a different interface with economic development. However, the basic framework seems to hold pretty well because production/

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distribution networks in machinery industries are the most advanced and sophisticated. The next step will be to apply this approach for policy discussion in Southeast Asian countries. The author hopes that useful feedbacks on analytical framework will be provided by practical application.

Notes 1. See, for example, Samuelson (2004) and Blinder (2006). 2. For a set of empirical observations on international production/distribution networks in East Asia, see Kimura (2006). 3. For the activities of ERIA, see Soesastro (2008). 4. See . 5. See, for example, .

References Blinder, A.S. “Offshoring: The Next Industrial Revolution?”. Foreign Affairs 85, no. 2 (2006): 113-28. JETRO. ASEAN Logistics Network Map. Tokyo JETRO, 2008. Jones, R.W. and H. Kierzkowski “The Role of Services in Production and International Trade: A Theoretical Framework”. In The Political Economy of International Trade: Essays in Honor of R.E. Baldwin, edited by R.W. Jones and A.O. Krueger. Oxford: Basil Blackwell, 1990. Kimura, Fukunari. “International Production and Distribution Networks in East Asia: Eighteen Facts, Mechanics, and Policy Implications”. Asian Economic Policy Review 1, no. 2 (2006): 326–44. ———. “The Mechanics of Production Networks in Southeast Asia: the Fragmentation Theory Approach”. In Production Networks and Industrial Clusters: Integrating Economies in Southeast Asia, edited by Ikuo Kuroiwa and Toh Mun Heng. Singapore: Institute of Southeast Asian Studies, 2008a. ———. Corporate Activities and the Spatial Structure of Production/Distribution Networks in East Asia. To be posted at JRP, Institute of Developing Economies , 2008b. Kimura, Fukunari and Mitsuyo Ando. “Two-dimensional Fragmentation in East Asia: Conceptual Framework and Empirics”. International Review of Economics and Finance 14 (special issue on “Outsourcing and Fragmentation: Blessing or Threat” edited by Henryk Kierzkowski) no. 3 (2005): 317–48.

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Samuelson, P. “Where Ricardo and Mill Rebut and Confirm Arguments of Mainstream Economists Supporting Globalization”. Journal of Economic Perspectives 18, no. 3 (2004): 135–46. Soesastro, Hadi, ed., ERIA Research Project 2007 No. 1–1: Developing a Roadmap toward East Asian Economic Integration, March 2008. Available at .

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3 Production Networks and Industrial Policy in Less Developed Southeast Asia Ikuo Kuroiwa

I. INTRODUCTION In view of their geographical proximity, as well as social and cultural affinity, the experiences of industrial development in the neighbouring Southeast Asian economies can provide invaluable lessons to the less developed economies in the region. In the more advanced Southeast Asian economies, a rapid decline in transport and communication costs and diminishing trade and investment barriers have reduced the costs of organizing production networks across borders, so that extensive production networks have been established through the activities of multinational corporations (MNCs). At the same time, local industries have enhanced their capacities by participating in such networks, and the emergence of local suppliers and local workforce with industry-specific

36

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skills have become important factors in determining the competitiveness of industries (Kuroiwa and Toh 2008). Less developed economies in Indochina — Cambodia, Laos, and Vietnam — are northern neighbours of Thailand, Malaysia, and Singapore. At the same time, they are southern neighbours of China and other Northeast Asian economies. Such geographical proximity facilitates the movement of goods, services, natural persons, and investment across borders. Moreover, AFTA and other regional frameworks, as well as infrastructure development such as the East-West, North-South, and Southern Economic Corridors, are leading to the reconfiguration of corporate activities, so that production networks spread into the region. This chapter focuses on the industrial policy in less developed Southeast Asia with particular reference to Indonesia and the three Indochinese countries of Cambodia, Laos, and Vietnam. In this chapter, industrial policies in Southeast Asia are first reviewed. In Southeast Asia, liberalization in trade and investment was crucial in extending production networks into less developed regions. At the same time, two constraints on industrial policy — shrinking policy space and the constraints on state capability — are examined to consider feasible and appropriate industrial policy in an era of globalization, at a time when participation in the WTO and FTAs are becoming the norm. Industries such as electronics, automotive, and clothing are expected to expand production networks. Production networks in Southeast Asia are examined with the use of input-output analysis and statistical data. Finally, industrial policies in less developed Southeast Asia are revisited with particular reference to policy measures whereby participation in production networks, as well as the formation of competitive industrial clusters, plays a crucial role in industrial development.

II. INDUSTRIAL POLICES IN SOUTHEAST ASIA There are similarities in industrial policies in Southeast Asian countries. Table 3.1 shows that Singapore was the only country which switched to an export-oriented industrial (EOI) policy after its independence from Malaysia in 1965. Other larger economies, on the other hand, adopted an import substitution industrial (ISI) policy in the 1950s or 1960s and then proceeded to secondary ISI policies. Although Malaysia switched to

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1965–76 Defence/industry (heavy industrialization)

1959– EO

1960s

1977–1978 Plant importation

1967– Liberalization

1970s

1986– Liberalization 1990s Strategic independence (high technology and services) Regionalization

1958–80 EO

1960s–1980s EO

1950s IS (while still part of Malaya)

Singapore

1990s Deregulation since mid1980s (innovation-oriented)

1953–57 IS

1980– Liberalization (trade, investment, finance)

1990s Upgraded support for technology

1990s Infrastructure High technology

Internationalization

1990s

Taiwan

1973–79 EO IS (heavy industry)

1979– Improved institutional support for industry

1980s Coastline liberalization (light industries)

Mid-1980s Deregulation

1980s

1961–72 EO

1950– EO (laissez-faire, education, infrastructure, institutional support)

1950–58 IS

1950s

Korea, Republic of

Hong Kong (China)

China

Japan

Economy

TABLE 3.1 Evolution of Industrial Policies in East Asia, 1950s to 1990s

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Note: IS — import substitution, and EO — export orientation. Source: Masuyama, Vandenbrink and Chia (1997), Table 1.1.

Continued IS

Philippines

1950– IS

1967–73 Stabilization Beginning IS

Indonesia

1960s

1961–71 IS

1950–70 Moderate IS Added EO

1950s

Thailand

Malaysia

Economy

1980s

1974–85 Strong IS

1980s Liberalization (political instability)

1971–86 IS (capital goods, beginning in 1981)

1971–85 Continued IS EO

1970s

TABLE 3.1 (Cont’d )

1990s Continued liberalization (strengthened political stability)

1986– Liberalization EO

1986– EO Technology-incentive Industries Some EO

1986– Liberalization

1990s

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an EOI policy in the 1970s, its ISI policy was continued simultaneously. In the middle of the 1980s, after Southeast Asian countries were faced with adverse economic conditions, such as declining and fluctuating prices of primary commodities and the limited success of ISI policies, all of these countries started to liberalize trade and investment. Since the mid-1980s, CLMV (Cambodia, Laos, Myanmar, and Vietnam) have been undergoing economic transition in various ways: from central planning to market economies, from inward-looking to outward-looking economic development strategies, and from close economic relations with the Soviet bloc to closer economic relations with market economies (Chia 2006). Moreover, CLMV adopted trade and investment liberalization policies that had been adopted by the more advanced Southeast Asian countries, i.e. removal or relaxation of foreign ownership restrictions and performance requirements and various investment incentives such as tax exemptions, duty drawbacks, and the establishment of EPZs. Vietnam, for example, undertook substantial trade reform during its Doi Moi process in the late 1980s by addressing the anti-export bias in its earlier protective regime and introducing privatization (Chia 2004; Narjoko and Amri 2007). As shown below, liberalization in trade and investment was critical in assisting the spread of production networks in Southeast Asia, and similar development is expected to happen in the late-coming countries.

III. SHRINKING POLICY SPACE Since the late 1990s, economic reform in the Indochinese countries has been accelerated by their accession to the WTO and the establishment of FTAs. Cambodia and Vietnam joined the WTO in 2004 and 2007 respectively. Laos applied for WTO membership in 1997 and negotiations are still ongoing. On the other hand, Vietnam, Laos, and Cambodia acceded to ASEAN in 1995, 1997, and 1999 respectively. Unlike economic reform undertaken by countries at their own initiative, the forces establishing liberalization under the WTO and FTAs are formal and rule-based. Therefore, the rules are more stringently enforced and policy space, which defines a range of policy choices available to member countries for industrial development, is constrained accordingly. The impacts of the WTO on the industrial policy instruments, such as tariff protection, SCM, TRIMs, TRIPS, and GATS, are summarized in Table 3.2, while

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TABLE 3.2 Impacts of the WTO Rules on Industrial Policy Instruments WTO rules

Impacts on industrial policy instruments

1. tariff protection

Average tariff protection has declined except for certain sensitive industries.

2. The Agreement on Subsidies and Countervailing Measures (SCM)

The Agreement on Subsidies and Countervailing Measures (SCM) prohibits export subsidies by countries with income per capita above US$1,000. Subsidies that are conditional on exports are prohibited, as are subsidies that encourage the use of domestic rather than imported inputs.

3. The Agreement on TradeRelated Investment Measures (TRIMs)

Under the TRIMs Agreement, a number of investment performance-related measures that have an effect on trade are prohibited. Such measures include local content requirements, trade balancing requirements, technology transfer, local employment and R&D, and so on. The required strengthening of protection of intellectual property rights under the TRIPS agreement increases a need for local companies to innovate and compete dynamically; reverse engineering and imitation have become less feasible. Trade sanctions can now be applied to countries deemed to be deficient in protecting intellectual property rights.

4. The Agreements on Trade-Related Aspects of Intellectual Property Rights (TRIPS)

5. General Agreement on Trade in Service (GATS)

The GATS allows sectoral commitments to be made for the four modes of supplying services: crossborder, consumption abroad, commercial presence, and movement of natural persons. Through the inclusion of commercial presence as a mode of supply, rules on foreign investment in services have now become part of the multilateral trading system.

6. Infant industry protection

GATT Article XVIII, Sections A and C, allow members that are in early stages of development to use trade barriers to protect domestic industry. As tariff bindings expand, developing countries may have to rely increasingly on Article XVIII, along with safeguards and domestic subsidy programmes, to protect domestic industry.

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TABLE 3.2 (Cont’d ) WTO rules 7. Special and differential (S&D) treatment by WTO

Impacts on industrial policy instruments The WTO has numerous special and differential treatment provisions in favour of developing countries. The approach to S&D treatment in the WTO, however, has typically been limited to transitional arrangements, complemented by the de minimis provisions.

Source: Adapted from Bora, Lloyd, and Pangestu (2000), Pangestu (2002) and Lall (2003).

AFTA and other regional trade agreements are discussed in Chapter 4. Note that in addition to the ban on export promotion and import restrictions, the WTO, for example, does not allow the member countries to support the local suppliers through local content requirements under the TRIMs; reverse engineering and imitation have become less feasible under the TRIPs. Furthermore, many developing countries face strong pressures for market liberalization from the governments of developed countries and international organizations, notably the World Bank and IMF. Market liberalization has derived policy measures from the government, and hence it has become increasingly difficult to protect industry through industrial policy. In view of the rising constraints on policy space to be brought about by the WTO and FTAs, some industrial economists, including Lall (2003), argued that if accompanying costs are unduly high for developing countries, their rules must be reviewed or relaxed. However, it is not realistic to expect that such rules will be relieved or relaxed in the foreseeable future. Moreover, as the economic integration of the Southeast Asian economies proceeds from AFTA to the formation of the ASEAN Economic Community (AEC) — the policy space available to each Southeast Asian country will be constrained further. In such a context, the traditional debate about efficacy of infantry industry protection has become less relevant, as many of these policies are illegal under the rules of the WTO and FTAs (Bora, Lloyd, and Pangestu 2000; Sturgeon and Lester 2004). It is thus more relevant to explore the industrial policies that are effective in the age of market liberalization in trade and investment.

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IV. CONSTRAINTS ON STATE CAPABILITY One of the important lessons learned from the public policy dispute in the 1990s was the importance of institutional capabilities in considering appropriate industrial policies for developing countries. For example, the World Bank (1993) admitted that appropriate industry-specific policies, such as directed credit, might have worked in the first-tier Asian newly industrialized economies (NIEs) — Korea and Taiwan. However, the second-tier Asian NIEs — Thailand, Malaysia, and Indonesia — did not have the necessary state capabilities, such as competent, meritocratic, and insulated technocracies. Thus selective government intervention would do more harm than good; the World Bank concluded that the second-tier Asian NIEs have achieved rapid growth and industrialization without resorting to industrial policies (in the case of Thailand) or by abandoning them (in the case of Malaysia, and Indonesia), as summarized by Jomo et al. (1996). Although the assertions by the World Bank have been criticized by Jomo and other economists and may need further assessments, it is still important to take into account the state capability in considering the efficacy of industrial policy. For example, if the state capability is too weak, selective government intervention, which gives government officials strong discretion over which industries are to be protected by the state, will not work or may simply induce opportunistic activities such as rent-seeking and lead to allocative inefficiency. Then the costs of government intervention (i.e. loss in economic efficiency due to government failures) may exceed its benefits (i.e. gain in economic efficiency due to correction of market failures). Thus, to prevent government intervention from becoming too costly, it is urged to match the state’s role with its capability (World Bank 1997).1 State capability relevant to industrial policy is not easy to assess, and ordinary governance indicators, such as the rule of law and corruption, may not be appropriate; in fact, the first-tier Asian NIEs, such as Korea and Taiwan, were not free from corruption in their early phase of development but still enjoyed rapid economic growth. On the other hand, McKendrick et al. (2000) argues that two sets of related institutions are important for successful implementation of industry policy; cohesive and autonomous bureaucracies and mechanisms for public and private sector consultation. It is also important to establish

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a well-organized monitoring system for promoted industries and avoid political intervention. Although more efforts must be made to assess state capabilities of less developed Southeast Asian economies, it is still uncertain if they are endowed with sufficiently strong institutional capabilities. Ohno (2003), for example, argued that Vietnam lacks state capability for industrial policy and has made recommendations on institutional reforms in the government sector. According to Ohno, Vietnam’s policy process has no effective mechanisms for collecting detailed and upto-date information on domestic industries and global markets. Thus he urged the government to institutionalize regular dialogue between policy-makers and domestic and foreign firms for policy formulation. He also pointed out the lack of coordination among sectoral ministries and urged the concentration of authority by setting up a special team under the prime minister. In considering the efficacy of industrial policy, the above two constraints — shrinking policy space and the constraints on state capability — are becoming increasingly important. In the following sections, the author discusses an industrial development strategy whereby participation in international production networks, as well as the formation of competitive industrial clusters, plays a crucial role. In this strategy, liberalization in trade and investment, which has been accelerated by the WTO and FTAs, is fully incorporated and even encouraged to seize opportunities provided by the momentum of market liberalization.

V. PRODUCTION FRAGMENTATION The production of a final product usually consists of a number of processes that are vertically integrated. Production fragmentation means to divide such vertically integrated production processes into separate production blocks and to locate them at various sites that are most suitable for each activity. Jones and Kierzkowski (1990) present an initial framework for analysing production fragmentation. They formulated an analytical framework in which an increase in the number of production blocks lowers total production costs: lower production costs are realized when a labour-intensive production block is relocated to a lower-wage country. On the other hand, an increase in the number of production

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blocks incurs higher fixed costs (i.e. set-up costs of a new factory in the lower-wage country), and additional service link costs (i.e. costs for transporting intermediate inputs and coordinating production activities across borders) are required to join up distant production blocks.2 Therefore, insofar as the set-up costs and service link costs are reduced substantially, previously vertically integrated production processes are fragmented into separate production blocks, and activities of firms are dispersed geographically. It is, however, notable that production fragmentation does not occur in all industries. According to Lall et al. (2004), the intensity of fragmentation differs according to industry, depending on four factors: • The technical “divisibility” of production processes: Engineering activities like automobiles or electronics have discrete (separable) stages of production and components with differing scale, skill and technological needs whose production can be located at different sites and under different ownership. By contrast, continuous process industries, such as chemicals, are more difficult to break up economically. • The factor intensity of the process: It is only economical to relocate processes if they are labour-intensive and reduce production costs significantly by shifting to lower-wage sites. The reduction in production costs must more than offset a rise in service link costs and set-up costs. • The technological complexity of each process: Some labour-intensive processes (e.g. design and development) can not be shifted to lowerwage sites with low skills and capabilities; only simpler and more stable ones can be efficiently relocated. • The value to weight ratio of the product: The scope for fragmentation depends on the weight of the product relative to its value. For example, lightweight and high-value products can be shipped long distances to exploit cost differences while heavyweight and low-value ones can only be shipped to nearby areas or remain in the original producing site due to higher transport costs relative to its value. Considering the above factors, Lall (2003) concluded that: (1) in high-technology industries, fragmentation is strong in electronics; (2) in medium-technology industries, fragmentation is strong in automotives

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but the weight of the product and its high basic capability requirements mean that it only extends to a few proximate, relatively industrialized locations; and (3) in low-technology industries, production fragmentation is strong in clothing, footwear, sports goods and toys. It is notable that the above four factors are major determinants in industries where production fragmentation occurs. In the electronics industry, for example, many parts and components (e.g. semiconductors, magnetic heads, PCBs) are small and light. At the same time, they have relatively high added value, so that they can be shipped long distances. Moreover, since export-oriented industries, such as electronics, have been given preferential treatment (e.g. unlimited access to imported inputs, exemption from import duties), the electronics industry can expand production networks without incurring high service link costs. On the other hand, many parts and components in the automotive industry (e.g. body parts, engine parts, brakes, suspension assemblages) are bulky and heavy. Therefore, automotive assemblers have strong incentives to save on transport and inventory costs by procuring their parts and components locally (in addition, just-in-time production increases the importance of geographical proximity). Furthermore, until recent years, East Asian countries had protected automotive parts suppliers through local content requirement. Sewing and assembly of garments accounts for 80 per cent of all labour costs in clothing manufacture (Dicken 2007). Thus, such an extremely labour-intensive process is separated from other processes (e.g. design, fabric production, preparation, advertisement, sales), and relocated to lower-wage countries, particularly through outsourcing. In Southeast Asia, there is a significant difference in labour costs between neighbouring countries; for example, labour costs in Thailand were 4.8–8.0 times higher than in Laos (see Chapter 5), and the worker’s minimum wage in Singapore was 5.4 times as high as in Batam in 2006 (JETRO 2008). Moreover, advancement in technology and infrastructure, as well as liberalization in trade and investment, has reduced service link costs. Thus, in Southeast Asia, where the above factors for accelerating production fragmentation are prevalent, production networks are expected to expand geographically. In the following section, the spatial linkages of the electronics, automotive, and apparel industries are examined to explore the trends of production networks in Southeast Asia.

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VI. SPATIAL LINKAGES IN THE FIVE SOUTHEAST ASIAN COUNTRIES, 1990–2000 With the acceleration of production fragmentation, a part of production processes that were previously undertaken by domestic industry relocate to another country, and these different processes of production are linked through intermediate goods trade. In the case of relocation of the (labour-intensive) downstream industry, the upstream intermediate goods that are still produced by the domestic industry are exported to the (labour-abundant) partner country for further processing. Thus, with the acceleration of production fragmentation, industrial output in one country would be affected by the other country more than in the past. Here, this kind of inducement mechanism on production is called “spatial linkages”. There are two types of spatial linkages — spatial backward and forward linkage effects. Suppose that, as a result of production fragmentation, inputs produced in Country A are utilized by an industry in Country B. Then, as the industrial output in Country B increases, the demand for the inputs will increase, leading to an increase in the industrial output in Country A through the spatial backward linkage effects. On the other hand, an increase in the industrial output in Country A will increase the production capacity of the downstream industry and thereby induce an increase in the industrial output in Country B through the spatial forward linkage effects. As shown above, production fragmentation increases inter-industrial dependency across borders, and the spatial linkages are expected to be strengthened with the acceleration of production fragmentation. In the following, the strengths of spatial linkages are calculated using the Asian international input-output tables3 (see Appendix 3.1 for details of the methodology). Figure 3.1 shows the spatial linkages of the electronics, automotive, and apparel industries in the five Southeast Asian countries (Indonesia, Philippines, Thailand, Malaysia, and Singapore), China, Taiwan, Korea, Japan and the United States for 1990 and 2000. Figure 3.1 indicates the pairs of strong spatial linkages, with extremely strong spatial linkages indicated by bold lines.4 Figure 3.1 indicates that there was strong interdependency between the industries across borders, and an extensive production network of the electronics industry was already established in 1990. In particular, the

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FIGURE 3.1 Spatial Linkages (Backward and Forward) of the Electronics, Automotive, and Apparel Industries in the Five Southeast Asian Countries Electronics Sector 1990

IND

PHI

SIN

USA

Basic Metal

Service

THA

MAL

SIN

JAP

USA

Electronics

Electronics

2000

KOR

TWN

KOR

TWN

USA Services

IND

PHI

TW N

THA

MAL

SIN

JAP

USA

Electronics

Electronics

Precision Machinery

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FIGURE 3.1 (Cont’d ) Automotive Sector 1990

2000

Wearing Apparel(Downstream) Sector 1990 (Upstream)

(Upstream)

(Downstream)

PHI Wearing Apparel

SIN Spinninglinkage Backward

25–35%

Forward linkage

15–25%

MAL Wearing Apparel

SIN

8–15% Wearing

IND: Indonesia

KOR: Korea

MAL: Malaysia

PHI: the Philippines

TWN: Taiwan

SIN: Singapore

THA: Thailand

JAP: Japan

CHN: China

Source: Asian international Input-Output Table (2000).

2000

Apparel

TWN Spinning Weaving

USA: the United States

JAP Spinning Weaving

SIN Spinning Wearing

PHI Wearing Apparel

MAL Spinning Weaving

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35%~

Wearing

MAL Wearing Apparel

TWN Spinning Weaving

USA Wearing Apparel

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FIGURE 3.1 (Cont’d ) (Downstream)

(Upstream)

(Upstream)

(Downstream)

Backward linkage Forward linkage

35%~ 25–35% 15–25% 8–15%

IND: Indonesia

KOR: Korea

MAL: Malaysia

PHI: the Philippines

TWN: Taiwan

SIN: Singapore

THA: Thailand

JAP: Japan

CHN: China

USA: the United States

Source: Asian international Input-Output Table (2000). Source: Author’s calculations based on the Asian International Input-Output Tables for 1990 and 2000.

electronics sector in Indonesia, the Philippines, Thailand, and Singapore had strong backward linkage effects on Japan and the United States, while the electronics sector in the Philippines, Malaysia, and Singapore had strong forward linkage effects on U.S. industries. In Southeast Asia, strong linkages can be seen only between Singapore and Thailand and between Singapore and Malaysia, while other linkages were relatively weak; in particular, Indonesia was the least integrated into the system. In 2000, the spatial backward linkage effects on Japan became weaker in several countries, while the spatial forward linkage effects on the U.S. and Japanese electronics industry were strengthened. Moreover, Southeast Asian economies strengthened the spatial forward linkages with each other, so that the structure of interdependency became more complex and broad-based. As shown above, the spatial linkages of the electronics industry changed significantly during 1990–2000. The role of Japan as a supplier of inputs declined significantly, and the sources of procurement of inputs for the Southeast Asian countries became more diversified, increasing interdependency within the region. On the other hand, dependency of Japan and the United States on inputs supplied by the Southeast Asian counties increased and thus resulted in their receiving strong spatial forward linkage effects. In 1990, the automotive industry in the five Southeast Asian countries had strong backward linkage effects on the Japanese automotive industry, and no other industries had such strong spatial linkage effects. Thus, the structure of spatial linkages was quite simple. In 2000, the spatial backward linkage effects on Japan declined drastically, and a new form

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of interdependency emerged, such as strong spatial forward linkage effects of the Thai and Philippines automotive industry on the Japanese and the U.S. automotive industry; the rubber industry in Thailand and Malaysia also had strong forward linkage effects on the Japanese and U.S. automotive industry. In the automotive sector, the one-sided dependency on inputs from the Japanese automotive industry declined considerably, and the production network in the automotive industry spread within the neighbouring Southeast Asian countries. This seems to have occurred due to trade liberalization within ASEAN, which was accelerated by the BBC, AICO, and AFTA. However, the production network in the automotive industry was more geographically confined than in the electronics industry. In 1990, the apparel industry in the Philippines, Malaysia, and Singapore had strong backward linkage effects on the Taiwanese spinning and weaving industry; the strong backward linkage effects on Taiwan imply that Taiwan became a major supplier of fabrics and other materials to the ASEAN countries.5 Unlike the electronics and automotive industries, spatial linkages with Japan and the United States were not strong, and the apparel industry in Indonesia and Thailand did not have any strong linkage effects. In 2000, however, these strong linkage effects disappeared except in the Philippines, and the number of strong linkage effects declined. In Southeast Asia, only forward linkage effects of the Singapore spinning and weaving industry on the Malaysian apparel industry continued to be strong. As a result, the apparel production network did not expand in the five Southeast Asian countries. This occurred because the apparel industry had already lost competitiveness in these countries, and thus it had shifted to less developed countries, including CLMV. Moreover, the number of inputs in the apparel industry is much smaller than in the electronics and automotive industries, so that the production network cannot be as dense as the latter industries. Production networks in the five Southeast Asian countries expanded during 1990 and 2000 in the electronics and automotive industries. In particular, the electronics industry, which had established a dense production network, became a leading force of economic integration. On the other hand, the apparel industry did not expand its network. Indonesia, notably in electronics, was the least integrated into the regional production networks in Southeast Asia.

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VII. EXPANDING PRODUCTION NETWORKS INTO LESS DEVELOPED REGIONS Production networks have been a driving force of economic integration in the advanced Southeast Asian countries. Such networks will extend into less developed regions if trade and investment barriers are removed substantially. To examine the spread of production networks into less developed regions, a discussion of trends in FDI and trade follows. Tables 3.3 and 3.4 show FDI (on approval basis) in Indonesia, Vietnam, Cambodia, and Laos for the period of 1999 (2000)–2003 by industry and country of origin respectively. Table 3.5 shows export and import for 2005. Note that Thailand is included for comparison with these countries. In Indonesia, the shares of primary commodities, such as petroleum products (43.4 per cent), rubber and plastic products (15.2 per cent), and foods products (7.7 per cent) were still overwhelmingly high, while in Thailand, electronics industries, such as radio, television, and communication equipment (33.0 per cent), accounted for the highest share of FDI. On the other hand, major investors in Indonesia were Japan, the European Union, Hong Kong, and Taiwan. Among the ASEAN countries, Singapore was the largest investor in Indonesia. Table 3.5 shows that, as in FDI, the share of mineral fuels and oils was overwhelmingly large in both Indonesian export and import (27.7 per cent and 30.4 per cent respectively). Japan and Singapore were the largest trade partners of Indonesia (in terms of export and import respectively), where mineral fuels and oils had a dominant share in trade. Electrical and electronic equipment, boilers and machinery also accounted for relatively large shares, but these were much lower than in Thailand; note that these two industries had become leading exporters in Thailand, followed by vehicles other than railway. Such a structure in trade, as well as in FDI, clearly indicates that primary industries still had a significant presence, and that Indonesia lagged behind more advanced Southeast Asian countries in the integration of production networks, especially in the electronics and other machinery industries. However, as in more advanced Southeast Asian countries, the major investors in Indonesia were developed countries, reflecting the global nature of its networks.

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Food products Tobacco products Textiles Apparels Leather products Wood and wood products Paper and paper products Publishing and printing Petroleum products Chemical products Rubber and plastic products Other non-metallic mineral products Basic metals Fabricated metal products Machinery and equipment Office and computing machinery Electrical machinery and apparatus Radio, television, and communication equipment Precision, and optical equipment Motor vehicles Other transport equipment Furniture, and other manufacturing Recycling Others

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24

Source: ASEAN Secretariat, ASEAN FDI Database, 2004.

Products

S/N 1690 13 347 242 199 1052 1147 11 9535 1621 3332 478 822 112 166 30 47 452 59 311 177 121 13

1999–03 7.7 0.1 1.6 1.1 0.9 4.8 5.2 0.0 43.4 7.4 15.2 2.2 3.7 0.5 0.8 0.1 0.2 2.1 0.3 1.4 0.8 0.6 0.1

%

Indonesia 562 28 778 632 602 305 141 30 0.3 317 263 344 172 321 206 66 328 151 28 322 98 178 1

2000–03 9.6 0.5 13.3 10.8 10.3 5.2 2.4 0.5 0.0 5.4 4.5 5.9 2.9 5.5 3.5 1.1 5.6 2.6 0.5 5.5 1.7 3.0 0.0

%

Vietnam

0.4

11.6 14.9 0.8 0.2

2

50 64 3 1

1.7

0.5 1.1

2 5

7

3.9 0.8 13.6 43.4 3.6 0.5 2.2 0.7

%

17 4 59 188 16 2 10 3

1999–03

Cambodia

TABLE 3.3 Foreign Direct Investment by Product (Approval Basis)

23 1 2 2 1 5 10 0.4 4 1 2 23 7 1 2 2 0.4 0.1 3 3 4 5 0.3 1

1999–03

Laos 22.8 0.6 1.7 1.5 1.1 5.0 9.6 0.4 3.5 0.8 1.6 23.1 6.7 0.6 1.9 2.1 0.3 0.1 3.1 3.1 3.9 5.1 0.2 1.0

%

1.7 33.0 0.8 7.4 0.1 1.3 0.1

3.6 0.5 0.3 0.1 0.4 0.1 0.5 18.2 7.4 2.8 2.0 5.8 10.6

518 69 45 11 55 20 77 2631 1077 401 291 841 1534 252 4768 120 1066 19 193 9

3.2

% 470

1999–03

Thailand

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21975 100

8.4 19.4

Source: ASEAN Secretariat, ASEAN FDI Database, 2004.

Total

1842 4263

1.6 0.0 0.3 6.5 0.1

346 0.2 57 1419 13

ASEAN Others

22.9 0.0

5029 6

Northeast Asia Brunei Darussalam Cambodia Indonesia Lao PDR Malaysia Myammar Philippines Singapore Thailand Vietnam

49.3 3.5 8.2 7.2 4.0

10841 767 1799 1579 884

Developed countries ROK Hong Kong Taiwan China

26.4 0.8 22.1

%

5807 173 4861

1999–03

Japan USA European Union

Major Investors of the Countries

Indonesia

5873

100

9.3 14.1

0.7 3.3 1.9

43 192 113 546 826

3.1

0.2

12 181

55.2 0.1

21.4 15.6 5.3 31.3 3.1

10.4 4.3 6.6

%

3245 5

1257 913 310 1841 180

612 255 390

2000–03

Vietnam

433

37 5

1 12 4 1

18

1

346

44 88 53 147 58

1 26 16

1999–03

100

8.6 1.2

0.3 2.7 1.0 0.3

4.1

0.2

80.0

10.1 20.2 12.2 34.1 13.5

0.3 6.0 3.7

%

Cambodia

TABLE 3.4 Foreign Direct Investment by Investor (Approval Basis)

11.9

102

24 3

1 14 4

1 5

60

100

24.1 3.3

0.6 13.9 4.3

0.7 4.6

59.0

13.6 9.1 13.7 2.6 33.6

12 14 9 14 3 34

1.7

%

2

1999–03

Laos

14464

1294 541

425 2 16 806

46

1504

11125 209 188 883 224

6484 2784 1857

1999–03

%

100

8.2 3.7

2.9 0.0 0.1 5.6

0.3

10.4

76.9 1.4 1.3 6.1 1.5

44.8 19.2 12.8

Thailand

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TABLE 3.5 Trade Performance 2005 (in US$ thousands) Indonesia Export by main exported product All industries 1 2 3 4 5 6 7 8 9

Mineral fuels, oils, etc. Electrical, electronic equipment Animal, vegetable fats and oils, etc. Boilers, machinery, etc. Rubber and articles thereof Ores, slag, and ash Wood and articles of wood Apparel (not knitted or crocheted) Paper and paperboard

% 85,659,948

100.0

23,717,226 7,328,428 4,950,578 4,560,042 3,580,477 3,499,497 3,111,308 3,073,677 2,282,400

27.7

18,049,140 9,889,196 7,836,585 7,085,636 6,662,354

21.1 11.5 9.1 8.3 7.8

57,700,881

100.0

17,518,062 8,076,194 3,344,949 3,329,167 3,244,199 3,061,437 1,748,870 1,482,080 884,387

30.4 14.0 5.8 5.8 5.6 5.3 3.0 2.6 1.5

9,470,718 6,906,255 5,842,863 3,885,796 3,446,959

16.4 12.0 10.1 6.7 6.0

8.6

5.8 5.3 4.2 4.1 3.6 3.6

2.7

Export by main destination 1 2 3 4 5

Japan United States of America Singapore Korea China Import by main imported product All industries

1 2 3 4 5 6 7 8 9

Mineral fuels, oils, etc. Boilers,machinery, etc. Iron and steel Electrical, electronic equipment Organic chemicals Vehicles other than railway Plastics and articles thereof Articles of iron and steel Cereals Import by main origin

1 2 3 4 5

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Singapore Japan China United States of America Thailand

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TABLE 3.5 (Cont’d ) Vietnam Export by main exported product All industries 1 2 3 4 5 6 7 8 9

Mineral fuels, oils, etc. Footwear Apparel (not knitted or crocheted) Furniture. Fish Electrical, electronic equipment Apparel ( knitted or crocheted) Coffee, tea, mate, and spices Boilers, machinery, etc. Export by main destination

1 2 3 4 5

United States of America Japan Australia China Singapore

% 33,957,368

100.0

8,095,917 4,898,058 3,107,810 2,031,798 2,000,237 1,944,834 1,712,676 1,090,835 987,336

23.8 14.4 9.2 6.0 5.9 5.7 5.0 3.2 2.9

7,206,079

21.2

4,544,013 2,569,040 2,552,838 1,816,551

13.4 7.6 7.5 5.3

33,524,957

100.0

4,883,584 4,262,737 2,608,863 2,583,067 1,906,939 1,512,272 728,454 704,463 702,650

14.6 12.7 7.8 7.7 5.7 4.5 2.2 2.1 2.1

5,643,899 4,420,970 4,057,066 3,591,659 3,431,654

16.8 13.2 12.1 10.7 10.2

Import by main imported product All industries 1 2 3 4 5 6 7 8 9

Mineral fuels, oils, etc. Boilers,machinery, etc. Electrical, electronic equipment Iron and steel Plastics and articles thereof Vehicles other than railway Man-made chemicals Organic chemicals Knitted or crocheted fabric Import by main origin

1 2 3 4 5

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China Singapore Taiwan Japan Korea

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TABLE 3.5 (Cont’d ) Cambodia Export by main exported product All industries 1 2 3 4 5 6 7 8 9

Apparel (knitted or crocheted) Apparel (not knitted or crocheted) Footwear Pearls, precious stones, etc. Other made textile articles Meat, fish, and seafood preparations Wood and articles of wood Fish Tobacco Export by main destination

1 2 3 4 5

United States of America Germany United Kingdom Canada Japan

% 3,095,506

100.0

1,590,371 1,105,746 160,112 39,986 24,338 17,608 15,986 15,371 15,329

51.4 35.7 5.2 1.3 0.8 0.6 0.5 0.5 0.5

1,874,619

60.6

325,615 161,629 108,605 105,456

10.5 5.2 3.5 3.4

3,334,042

100.0

501,522 333,541 261,222 214,429 196,592 187,117 95,893 93,010 87,153

15.0 10.0 7.8 6.4 5.9 5.6 2.9 2.8 2.6

914,988 536,031 496,549 331,079 303,042

27.4 16.1 14.9 9.9 9.1

Import by main imported product All industries 1 2 3 4 5 6 7 8 9

Knitted or crocheted fabric Cotton Mineral fuels, oils, etc. Boilers,machinery, etc. Electrical, electronic equipment Vehicles other than railway Tobacco Man-made chemicals Plastics and articles thereof Import by main origin

1 2 3 4 5

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Thailand China Hong Kong Taiwan Singapore

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TABLE 3.5 (Cont’d ) Laos Export by main exported product All industries 1 2 3 4 5 6 7 8 9

Wood and articles of wood Apparel (knitted or crocheted) Apparel (not knitted or crocheted) Coppers and articles thereof Mineral fuels, oils, etc. Coffee, tea, mate, and spices Pearls, precious stones, etc. Commodities n.e.s. Cereals

% 516,690

100.0

100,946 95,017 83,932 72,566 66,884 15,253 13,105 8,766 7,048

19.5 18.4 16.2 14.0 12.9 3.0 2.5 1.7 1.4

226,804 52,029 43,122 34,843 25,545

43.9 10.1 8.3 6.7 4.9

1,066,723

100.0

187,366 127,737 112,949 88,007 55,296 37,961 32,979 24,580 23,530

17.6 12.0 10.6 8.3 5.2 3.6 3.1 2.3 2.2

768,878 103,377 39,966 19,496 18,041

72.1 9.7 3.7 1.8 1.7

Export by main destination 1 2 3 4 5

Thailand France United Kingdom Germany China Import by main imported product All industries

1 2 3 4 5 6 7 8 9

Mineral fuels, oils, etc. Vehicles other than railway Boilers,machinery, etc. Electrical, electronic equipment Beverages, spirits, and vinegar Knitted or crocheted fabric Iron and steel Plastics and articles thereof Articles of iron and steel Import by main origin

1 2 3 4 5

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Thailand China Singapore Japan Australia

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TABLE 3.5 (Cont’d ) Thailand Export by main exported product All industries 1 2 3 4 5 6 7 8 9

Electrical, electronic equipment Boilers, machinery, etc. Vehicles other than railway Rubber and articles thereof Plastics and articles thereof Minerals fuels, oils, etc. Meat, fish, and seafood preparations Pearls, precious stones, etc. Cereals

% 110,110,034

100.0

20,673,441 19,345,488 8,152,289 6,230,852 5,991,314 4,768,037 3,376,411 3,210,170 2,358,550

18.8 17.6 7.4 5.7 5.4 4.3 3.1 2.9 2.1

17,024,771 15,029,432 9,134,204 7,458,893 6,127,864

15.5 13.6 8.3 6.8 5.6

118,164,338

100.0

23,402,888 20,942,851 17,020,108 8,434,155 4,238,680 4,041,716 4,035,743 3,547,635 2,788,688

19.8 17.7 14.4 7.1 3.6 3.4 3.4 3.0 2.4

26,049,684 11,157,871 8,723,676 8,088,424 5,695,938

22.0 9.4 7.4 6.8 4.8

Export by main destination 1 2 3 4 5

United States of America Japan China Singapore Hong Kong Import by main imported product All industries

1 2 3 4 5 6 7 8 9

Electrical, electronic equipment Mineral fuels, oils, etc. Boilers, machinery, etc. Iron and steel Plastics and articles thereof Pearls, precious stones, etc. Vehicles other than railway Organic chemicals Articles of iron and steel Import by main origin

1 2 3 4 5

Japan China United States Malaysia United Arab Emirates

Note: * Exported and imported products are classified by HS code (2 digits). Source: Trade competitiveness map, International Trade Center, UNCTAD/WTO.

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In Vietnam, FDI was more evenly distributed among industries. In the period 2000–03, the shares of FDI in textile, apparel, and leather products were relatively high with each exceeding 10 per cent. It is also notable that the shares of FDI in electrical machinery and apparatus, and motor vehicles were relatively high. In Vietnam, in all of the three industries — apparel, electronics, and automotive, which Lall (2003) anticipated being active in production fragmentation, there was already a certain level of FDI (although FDI in the latter two industries was still at an early stage). As for investors, Taiwan was a leading investor in Vietnam, followed by Korea. It is notable that, unlike Indonesia, the share of FDI of Asian NIEs (excluding Singapore) and China was overwhelmingly large (55.2 per cent), and their investment was heavily concentrated in textile, apparel, and leather products. Among the Southeast Asian countries, Singapore was the largest investor in Vietnam. In line with the concentration of FDI in apparel, Vietnam became a major exporter of apparel to the United States and Japan in 2005. At the same time, it imported a large amount of materials for the apparel industry (e.g. man-made filaments, knitted or crocheted fabric) from origin countries of FDI, namely Taiwan, Korea, Hong Kong and China. These facts suggest the presence of triangle manufacturing in clothing industries, an arrangement where the United States and other overseas buyers place their orders with Asian NIEs manufacturers they have sourced in the past, who in turn shift some or all of the requested production to affiliated offshore factories in low-wage countries such as Vietnam and Cambodia (Gereffi 1996; Dicken 2007). It is also notable that electrical and electronic equipment, boilers and machinery also became major trade commodities in Vietnam. FDI in Cambodia was much smaller than in Vietnam and Indonesia, and its distribution of FDI was highly skewed; more than 60 per cent of FDI was concentrated in three sectors: textiles, apparel, and leather products. As in Vietnam, major investors in Cambodia were the Asian NIEs and China; their combined share of FDI was as high as 80 per cent, and 56.7 per cent of their investment was directed towards the above three sectors. In these countries, a rapid increase in labour costs, as well as quotas imposed by developed countries, were strong incentives to relocate their production facilities to lower wage countries. On the other hand, electric machinery and apparatus, radio, television,

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and communication equipment had a share in excess of 10 per cent, and major investors in these industries were Asian NIEs, particularly Korea and Taiwan. Among the ASEAN countries, Malaysia was the largest investor in Cambodia. Cambodia had a skewed structure of trade, particularly in export; apparel and footwear combined accounted for as much as 92.3 per cent of its exports, and they were directed to major markets in developed countries, such as the United States, Germany, the United Kingdom, Canada, and Japan. On the other hand, materials for the apparel industry — knitted or crocheted fabric, cotton, and man-made staple fibres — were imported from origin countries of FDI, such as Taiwan, Korea, Hong Kong, China, and Malaysia. Moreover, Cambodia exported a large amount of footwear and primary commodities (e.g. pearls, precious stones, wood and articles of wood, fish, and tobacco) while it imported mineral fuels and oil, and machinery (e.g. boilers and machinery, electrical and electronic equipment, and vehicles other than railway) from Thailand and Singapore. FDI in Laos was extremely small, so that distribution of FDI could be changed drastically by a single large investment. It is, however, notable that a share of FDI in food products and other non-metallic mineral products respectively exceeded 20 per cent, owing to investments by Hong Kong, Thailand, Korea, and China. Other natural resourcerelated industries, such as paper and paper products, accounted for a relatively large share, but FDI in other industries was very small. As for the countries of origin, FDI in Laos was dominated by the northern and southern neighbours — China and Thailand — as well as Hong Kong and Korea. Apparel was the only manufactured product in Laos exported in significant amount to European countries, such as France, the United Kingdom, and Germany. On the other hand, Thailand was the largest exporter of knitted or crocheted fabric to Laos. At the same time, Thailand was the largest importer of primary products (e.g. wood, copper, minerals, and fuels) from Laos as well as the largest exporter of manufactured products (e.g. mineral fuels and oils, vehicles other than railway, boilers and machinery, electrical and electric equipments) to Laos. Such a close relationship with Thailand should be taken into account in considering the development strategy of the Lao economy (see Chapter 5).

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As shown above, Indonesia lagged behind more developed Southeast Asian countries in integrating into the production networks in the electronics and other machinery industries. Indonesia’s industries need to become more integrated into production networks to promote its industries. In the Indochinese countries, although major markets for their final products were in developed countries, foreign direct investment, as well as materials for their final products, particularly in the apparel industry, came from Asian NIEs, China, and the neighbouring Southeast Asian countries, notably Singapore, Malaysia, and Thailand. In this regard, production networks in the Indochinese countries were more region- or East Asia-based in comparison with more advanced Southeast Asian countries. In particular, the Lao economy had a close relationship with the Thai economy. Cambodia had a skewed structure of trade, centred on apparel export, and was heavily dependent on FDI, as well as imports of materials, from the Asian NIEs, China and Malaysia. On the other hand, Vietnam had a more diversified structure in FDI and trade. However, even in Vietnam the triangle manufacturing in the clothing industry still accounted for a large share of trade and investment, and industries such as electronics and automotive are expected to play a more vital role to encourage industrial development.

VIII. INDUSTRIAL POLICY REVISITED A. Attracting Production Blocks — From Where? As in the case of more advanced Southeast Asian countries, less developed Southeast Asian countries would have an opportunity for industrial development by participating in production networks: they would obtain access to not only the international market but also technology. Fortunately, they would not need to be engaged in the production networks from scratch; they can instead utilize the existing production networks based in the neighbouring countries. For example, Laos could participate in the production networks based in Thailand due to its geographical proximity, as well as cultural and linguistic affinity to Thailand (see Chapter 5). Similarly, Batam, Bintan, and

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Karimun in Indonesia have a strong advantage over other regions in attracting production blocks from Singapore and forging complementary relationships. Here, it is important to emphasize that production networks in East Asia are becoming increasingly regionalized, while the market for their final products is more globalized, directed mostly at the developed world. As emphasized by Dicken (2007), “simple geographical proximity is, itself, a very powerful stimulus for integrating operations”. Geographical proximity, for example, reduces the time involved in managerial oversight, facilitates rapid resource exchanges, and lower transportation and coordination costs (McKendrick et al. 2000).6 It is thus important for the less developed Southeast Asian countries to fully utilize these advantages for deeper integration into the regional economy. In recent years, rising labour costs and an appreciation of currencies in neighbouring countries, notably China and Thailand, have been pushing up production costs sharply. At the same time, political risk in these countries has also become a pull factor of foreign direct investment into Vietnam, Cambodia, and Laos.

B. Attracting Production Blocks — In Which Industry? As shown above, in labour-intensive industries such as clothing, footwear, sports goods and toys, many Asian NIEs manufacturers have already shifted labour-intensive activities to low-wage countries. Furthermore, production blocks in other prospective industries, such as electronics and automotive, could be attracted to the less developed countries. However, as pointed out by Lall (2003), the automotive industry goes only to a few proximate, relatively industrialized locations. Thus, large countries such as Vietnam, which can offer a lucrative domestic market, have a strong advantage in attracting the automotive industry, while it is far more difficult for Cambodia and Laos to participate in the network — with the notable exception of labour-intensive activities in producing automotive parts such as wire harnesses (see Chapter 5).7 On the other hand, as shown in Figure 3.1, the production network in the electronics industry may spread more extensively. Tables 3.3–3.5, however, indicate that Cambodia and Laos had yet to be involved in the electronics production network; in a similar vein, Vietnam and

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Indonesia were not fully involved yet. In view of the vast opportunities provided by the electronics industry, participating in such a network seems critical. The governments of those countries, therefore, need to adopt clear and decisive policies to attract as many production blocks as possible and to diversify and upgrade the industrial base. At the same time, more efforts must be made to attract production blocks that may require a more sophisticated investment environment than primary and light industries.

C. Attracting Production Blocks — How? To attract production blocks, governments need to adopt appropriate policies to reduce set-up costs, service link costs, and production cost per se in each production block (see Chapter 2 for details of the policy measures to reduce these costs). In this context, AFTA and other regional frameworks, as well as infrastructure developments such as the East-West, North-South, and Southern Economic Corridors, are becoming increasingly important in reducing service link costs. Moreover, the establishment of special economic zones (SEZs), in tandem with the development of transport nodes, will contribute to the improvement in the investment environment. SEZs are especially helpful in (1) reducing the tax burden of firms due to the tax holiday, import duty and other tax exemptions; (2) improving infrastructure, such as transportation, telecommunications, electricity, gas and water supply; and (3) providing one-stop services for company registration and investment licensing, export/import and work permits. Such improvements in the investment environment are crucial to reducing the above-mentioned costs; past experiences indicate that the establishment of SEZs was effective in attracting the electronics and other machinery industries, while some light industries such as garment are likely to avoid locating factories inside SEZs due to their fear of stiffer competition in recruiting workers and higher wages.8 SEZs and industrial estates are being developed in the less developed Southeast Asian countries. The government of Cambodia, for example, has approved eighteen SEZs and some of them are located in strategically important areas (e.g. Phnom Penh, Sihanoukville Port Area, and Vietnam and Thai borders). Such development in Cambodia

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will increase opportunities to attract more production blocks in more diversified industries. SEZs are also used in other Southeast Asian countries for the industrial development of strategically important areas, such as Batam, Bintan, and Karimun (BBK) in Indonesia (see Chapter 9).

D. Developing Competitive Clusters — Generic or Selective Policy Measures? The phase of participating in production networks is followed by a more difficult task of developing competitive clusters. Locations with low labour costs can lose competitiveness of an industry if they fail to generate agglomeration economies, such as the emergence of specialized personnel, parts suppliers, and technological spillovers. On the other hand, locating in an industrial cluster can enhance productivity and hence improve the competitiveness of industry, even if wages are rising. The case study on the HDD industry by McKendrick et al. (2000) explores the efficacy of public policy from the viewpoint of locationspecific assets. Their case study suggests that there are two categories of location specific-assets that are primarily functions of public policies. The first category relates to the overall business environment, such as the flexibility of labour markets, macroeconomic stability, provision of general infrastructure, free trade and open investment policies; in addition, building human capital and ensuring good governance (such as establishing the rule of law, eradicating corruption) are particularly important to fill the initial gaps between developed and less developed countries in Southeast Asia. These generic policies are market-friendly and improve the overall business environment in the host countries, so that they can provide the baseline for entry into production networks. The second category involves measures which promote agglomeration of specialized personnel, suppliers, and information spillover in specific industries so that industrial clusters become more competitive and sticky. These policy measures include generous tax incentives and business facilitation for specific industries, building sophisticated physical infrastructures (in particular transportation and communication network facilities, industrial parks, and public utilities), providing access

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to capital, upgrading industry-specific skills and the capacity of local suppliers, and active R&D promotion in specific industries. However, these policy measures are highly selective in targeting specific industries and demand greater institutional resources. As shown above, many Southeast Asian countries (with the notable exception of Singapore), lack strong institutional capabilities and have failed in implementing industry-specific policies. It is therefore more practical for the less developed Southeast Asian countries to focus on generic policies. Then as the industry becomes more mature and upgraded — and if, at the same time, the institutional capability of the state grows sufficiently — the measures that promote industrial clustering of specific industries may become more relevant. In particular, Laos and Cambodia need to improve their investment environment to attract more production blocks, whereas industrial cluster development should receive more attention in Vietnam and Indonesia, where the lack of strong industrial bases affects the competitiveness of industry.

IX. CONCLUSION Since the mid-1980s, the Indochinese countries have been undergoing economic transition from central planning to market economies. Moreover, since the late 1990s, economic reforms in these countries have been accelerated by their accession to the WTO and FTAs. Such development in the less developed Southeast Asian countries will increase opportunities to attract production blocks from neighbouring countries. In Southeast Asia, it was shown that production networks expanded in the electronics and automotive industries. In particular, the electronics industry diversified procurement of inputs and became a leading force of economic integration. The Indochinese countries are already involved in the apparel production network, but it is becoming crucial for them, as well as for Indonesia, to be engaged in other promising industrial activities through participating in production networks. The government thus needs to adopt clear and decisive policies to attract as many production blocks as possible and to diversify and upgrade the industrial base. The two constraints — shrinking policy space and constraints on institutional capability of the state — must be considered in exploring

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the feasible and appropriate industrial policies. Many of those policy measures that focus on participation in production networks and formation of competitive clusters are still applicable and conform to one of the above constraints — shrinking policy space. However, the generic policies should be given priority for the less developed Southeast Asian countries, taking into account both their institutional capabilities and stages of economic development. AFTA and other regional frameworks, as well as infrastructure development such as the East-West, North-South, and Southern Economic Corridors, will contribute to a reduction in service link costs. At the same time, the establishment of special economic zones (SEZs), in tandem with the development of transport nodes, is effective in attracting more production blocks in more diversified industries.

APPENDIX 3.1 Spatial Linkages (1) Backward Linkage Effects In this study, the hypothetical extraction method is used to calculate the strength of linkage effects. In the hypothetical extraction method, a situation in which a column vector of Sector j in its own country is hypothetically extracted from the international input-output table (i.e. all the input coefficients of Sector j are replaced with zero and assume the case in which inputs for Sector j are all imported from the non-endogenous countries) is assumed. Then the repercussion effects of Sector j are suppressed, and consequently the outputs of the industries in the endogenous countries are reduced. Here the reduced outputs are considered to represent the magnitude of spatial backward linkage effects. Suppose that A(–sj) is a matrix in which a column vector of Sector j in Country S is hypothetically extracted. Then x(–sj) = [I – A (–sj)]–1f indicates the outputs induced in the hypothetical case. And the difference from the actual output x x – x(–sj)

(1)

represents the magnitude of backward linkage effects induced by Sector j in Country S. To measure the relative strength of linkage, it

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is more convenient to use an index. Then, dividing Equation (1) by Xjs , we obtain BL(–sj) = [x – x(–sj)]/Xjs

(2)

which is considered to represent the strength of the spatial backward linkage effects and that actually represents the output in each sector induced by one unit of output in an inducing sector, Xjs . (2) Forward Linkage Effects In recent years, the hypothetical extraction method which utilizes the output coefficients rather than input coefficients has become established as a widely used methodology for measuring the magnitude of forward linkage effects. Analogous to Equation (1), let us consider a case in which a row vector of Sector i in Country r is hypothetically extracted from the output coefficient matrices of the international input-output table (i.e. all the output coefficients of Sector i in Country r are replaced with zero and a situation in which intermediate outputs of the above sector are all exported to the non-endogenous countries is assumed). Then x(–ri)’ = v’[I – B(–ri)]–1, where B(–ri) is an output coefficient matrix in which a row vector of Sector i in Country r is hypothetically extracted, represents output induced in the hypothetical situation, and hence the magnitude of spatial forward linkage effects is measured by FL(–ri) = [x‘ – x(–ri)’]/Xjs , which is equal to output in each sector induced by one unit of output in an inducing sector, Xjs . Finally, only the spatial linkage effects which satisfy the condition that BL(–sj) ≥ 0.08 or FL(–rij) ≥ 0.08 are demonstrated in Figure 3.1.

Notes 1. This approach was officially demonstrated by the World Bank’s two-part strategy (World Bank 1997). The two-part strategy has two elements. Matching the state’s role to its capability is the first element. In particular, where state capability is weak, how the state intervenes — and where — should be carefully assessed; many states try to do too much with little capability and often do more harm than good. The second element of the strategy is to raise state capability by reinvigorating public institutions.

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2. Production blocks are connected via service links, i.e. bundle of activities consisting of transportation, insurance, telecommunication, quality control, and management coordination to ensure that the production blocks interact in the proper manner (Arndt and Kierzkowski 2001). 3. The Asian Tables are the Isard-type international input-output tables covering the ten countries. The Asian Tables register entire flows of intermediate goods and final goods transactions between the sectors in origin and in destination countries. The original Asian Tables for 1990 and 2000 respectively have seventy-eight and seventy-six sectors. These tables are available at the IDE-JETRO. 4. Figure 3.1 indicates the pairs of strong spatial linkages whereby output of the recipient industry of production stimulus increased by more than eight per cent of the output of the inducting industry, and extremely strong spatial linkages which exceeded fifteen per cent of the output are indicated by the bold lines. The arrows indicate the direction of spatial linkage effects, either backward or forward. 5. Gereffi (1999) pointed out that in each of the East Asian NIEs (such as Taiwan and Korea), a combination of domestic supply constraints (labour shortages, high wages, and high land prices) and external pressures (currency revaluation, tariffs and quotas) led to the outward shift of apparel production by the late 1980s and early 1990s. The strong backward linkage effects on Taiwan imply that Taiwan became an important supplier of fabric and other materials to the ASEAN countries. This, of course, is associated with outward shift of apparel production from Taiwan. 6. McKendrick et al. (2000) emphasizes the effectiveness of networks in geographically proximate clusters of countries, such as regional production networks in the hard disk drive (HDD) industry, stretching over Singapore, Malaysia, and Thailand. 7. Compared with the automotive industry, the motorcycle industry, for example, requires smaller set-up costs for a new factory, and the economy of scale is less significant. Therefore, the motorcycle industry may seem more accessible and feasible in small countries than the automotive industry. In fact, some motorcycle companies, including major Japanese companies, have already set up assembly plants in Cambodia and Laos. However, such involvement in the production network is fragile, given that (1) there is no competitive local parts supplier; and thus (2) completely built units (CBU) that are produced in the neighbouring countries, such as Thailand, may become cheaper if the tariff barriers are removed by AFTA and other regional frameworks. In the end, industrial capability, which is encouraged by industrial clustering, will be crucially important for remaining within the network.

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8. Presentation by the Nomura Research Institute, in the Cambodia Investment Seminar organized by the ASEAN-Japan Centre and Council for the Development of Cambodia, Singapore, 5 December 2007.

References Arndt, Sven W. and Henryk Kierzkowski. “Introduction”. In Fragmentation: New Production Patterns in the World Economy. Oxford: Oxford University Press, 2001. Bora, Bijit, Peter J. Lloyd, and Mari Pangestu. “Industrial Policy and The WTO”. Policy Issues in International Trade and Commodities Studies Series no. 6. Geneva: United Nations Conference on Trade and Development. 2000. Chia Siow Yue. “Integrating East Asia’s Low Income Countries into the Regional and Global Market”. Paper presented at OECD Research Project on The Impact and Coherence of OECD Country Policies on Asian Developing Economies. Paris, 10–11 June 2004. ———. “Integrating the Mekong Region into ASEAN”. Paper presented at the seminar on Accelerating Development in the Mekong Region: The Role of Economic Integration. Siem Reap, Cambodia, 26–27 June 2006. Dicken, Peter. Global Shift: Mapping the Changing Contours of the World Economy. 5th ed. London: Sage, 2007. Gereffi, Gary. “Commodity Chains and Regional Divisions of Labour in East Asia”. Journal of Asian Business 12 (1996). ———. “International Trade and Industrial Upgrading in the Apparel Commodity Chain”. Journal of International Economics 48 (1999). JETRO. “Comparison of Investment Cost, JETRO-FILE”. (accessed on 20 February 2008). Jomo K.S., Chen Yun Chung, Brian C. Folk, Irfan ul-Haque, Pasuk Phongpaichit, Batara Simatupang, and Mayumi Tateishi. Southeast Asia’s Misunderstood Miracle: Industrial Policy and Economic Development in Thailand, Malaysia, and Indonesia. Boulder: Westview Press, 1996. Jones, Ronald W. and Henryk Kierzkowski. “The Role of Services in Production and International Trade: A Theoretical Framework”. In The Political Economy of International Trade: Essays in Honor of Robert E. Baldwin, edited by Ronald W. Jones and Ann Krueger. Oxford: Basil Blackwell, 1990. Kuroiwa, Ikuo and Toh Mun Heng. “Introduction”. In Production Networks and Industrial Clusters: Integrating Economies in Southeast Asia, edited by Ikuo Kuroiwa and Toh Mun Heng. Singapore: Institute of Southeast Asian Studies, 2008. Lall, Sanjaya. “Reviving Industrial Strategy: The Role of Government Policy in Building Industrial Competitiveness”. G–24 Discussion Paper 28 (April 2003).

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Lall, S., M. Albaladejo, and J. Zhang. “Mapping Fragmentation: Electronics and Automobiles in Southeast Asia and Latin America. Oxford Development Studies 32, no. 3 (2004): 407–32. Masuyama, Seiichi, Donna Vandenbrink, and Chia Siow Yue eds. Industrial Policies in East Asia. Singapore: ISEAS; Tokyo: Nomura Research Institute, 1997. McKendrick, David G., Richard F. Donner, and Stephan Haggard. From Silicon Valley to Singapore: Location and Competitive Advantage in the Hard Disk Drive Industry. Stanford: Stanford University Press, 2000. Narjoko Dionisius A. and Puspa Delima Amri. “The Development Gap between the ASEAN Member Countries: The Perspective of Indonesia”. ASEAN Economic Bulletin 24, no. 1 (2007). Ohno, Kenichi. “Vietnam’s Industrialization Strategy in the Age of Globalization”. 2003. (accessed on 20 February 2008). Pangestu Mari. “Industrial Policy and Developing Countries”. In Development, Trade, and the WTO: A Handbook, edited by Bernard Hoekman, Aaditya Mattoo, and Philip English. Washington, D.C.: World Bank, 2002. Sturgeon, Timothy and Richard Lester. “The New Global Supply-base: New Challenges for Local Suppliers in East Asia”. In Global Production Networking and Technological Change in East Asia, edited by Shahid Yusuf, M. Anjum Altaf, and Kaoru Nabeshima. New York: Oxford University Press, 2004. Toh Mun Heng and Shandre Thangavelu. “The Biomedical Science (BMS) Industry in Singapore: Can It Plug into the Global Value Chain?”. In Production Networks and Industrial Clusters: Integrating Economies in Southeast Asia, edited by Ikuo Kuroiwa and Toh Mun Heng. Singapore: Institute of Southeast Asian Studies, 2008. World Bank. The East Asian Miracle: Economic Growth and Public Policy. New York: Oxford University Press, 1993. ———. World Development Report 1997: The State in a Changing World. Washington, D.C.: World Bank, 1997.

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4 ASEAN Economic Integration and Implication for CLMV Countries Denis Hew, Sanchita Basu Das and Rahul Sen

I. INTRODUCTION It is generally said that economic regionalism has a positive impact on economic development as it strengthens economic linkages through trade and investment and encourages the development of production networks. Sen (2007) in his analysis of ASEAN regionalism observes that ASEAN has the potential to promote economic development and facilitate the newer and economically less developed ASEAN members in building up production networks that would facilitate the economic integration process. In this context, this chapter examines ASEAN economic integration and its implications for the CLMV countries, namely Cambodia, Laos, Myanmar and Vietnam. The chapter begins by giving a background on the ASEAN Economic Community and discusses its origin, rationale

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and challenges. It then looks at the development divide within ASEAN. It is observed that while the different levels of economic development can be complimentary in nature and therefore facilitate production network development, infrastructure and social gaps can be hurdles for reducing costs. The chapter also examines in more detail the extent of integration of Cambodia, Laos and Vietnam within ASEAN and the rest of the world. Finally, prior to providing some concluding remarks, the chapter analyses the role of free trade agreements (FTAs) in strengthening production networks in the region, especially in the light of newer members of ASEAN.

II. THE ASEAN ECONOMIC COMMUNITY ASEAN, established in 1967, is one of the world’s most successful regional organizations. It comprises ten countries, namely, Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand and Vietnam. ASEAN countries combined constitute a population of about 567 million, spanning a total area of 4.5 million square kilometers. In 2006, ASEAN generated a combined gross domestic product of US$1.07 trillion and total trade of US$1.44 trillion, accounting for more than a quarter of Asia’s total exports and imports.1 Since its inception, ASEAN has managed to successfully foster closer political and security cooperation, creating a peaceful and stable region. As a result, ASEAN, especially its five original members (ASEAN-5), i.e. Indonesia, Malaysia, the Philippines, Singapore and Thailand, enjoyed impressive economic growth rates, reduced poverty and improved living standards over the past three decades. However, in recent years, the region has begun to face stiff competition from China, particularly in attracting foreign direct investments (FDIs). Since FDI has been an important driver of economic growth in ASEAN over the past three decades, this has raised serious concerns among ASEAN policymakers about the longer-term economic sustainability of this region. Against this backdrop, ASEAN leaders agreed to embark on a bold project to integrate their economies and create an economic community. At the 2003 ASEAN Summit in Bali, Indonesia, ASEAN leaders agreed to integrate their economies by 2020 and establish an ASEAN Economic Community (AEC). The AEC is one of three components or pillars that make up the ASEAN Community as declared by ASEAN leaders in

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the ASEAN Concord II (better known as the Bali Concord II).2 At the ASEAN Summit held in Cebu, Philippines in January 2007, the deadline to realize the AEC was brought forward by five years to 2015.3 The end-goal of the AEC is the creation of a single market and production base where there is free flow of goods, services, investments, capital and skilled labour. Although the approach towards achieving this end-goal was not elaborated in the Bali Concord II, what seems clear at the start was the need to have a significantly higher degree of regional economic integration and institutional development. Why is there an urgent need for ASEAN to integrate? The loss of economic competitiveness to emerging markets such as China has been the major driving force in ASEAN’s efforts to accelerate economic integration. A study on ASEAN undertaken by McKinsey found that ASEAN has lost its competitive edge in terms of labour costs to China (Schwartz and Villinger 2004). Furthermore, China has now overtaken ASEAN as the world’s prime location for FDI. This may have serious repercussions for ASEAN’s economic well-being over the medium to long-term as FDI has long played an important role in the region’s economic development (Freeman and Hew 2002). See Figures 4.1 and 4.2. FIGURE 4.1 FDI Inflows to China and ASEAN, 1980–2006 80,000 70,000

US$ millions

60,000 50,000 40,000 30,000 20,000 10,000 0

1980

1990

2000

2001 ASEAN

2002

2003

2004

2005

2006

China

Source: UNCTAD.

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FIGURE 4.2 FDI Flows to ASEAN, 1995–2005

ASEAN, 4.2%

US, 18.4%

Asian NIEs, 29.2%

Japan, 19.1%

EU, 29.1%

Source: Kawai (2007)

FDI has played an important role in Southeast Asia’s economic development. First in Singapore in the 1970s and later in Malaysia, Thailand and Indonesia in the 1980s, the economic development model adopted by these ASEAN countries were driven by strategies that favoured FDI from multinational corporations (MNCs) and exportoriented domestic industries. More recently, Vietnam and China have adopted similar economic strategies as these countries make the transition to becoming more market-oriented economies. Therefore, economic integration will provide the means to revitalize ASEAN’s economies. Given that ASEAN countries are at very different levels of economic development, this diversity can be an advantage as it maximizes the complementarities among its member countries. An integrated market and production base would clearly boost intraregional trade and investment flows across the regions while ASEAN’s consumer market of over half a billion would be a lucrative place for companies to do business. In 2003, the ASEAN High Level Task Force (HLTF) on Economic Integration recommended a slew of economic initiatives to kick-start the AEC project.4 These initiatives included: • Fast-track integration of priority sectors • Faster customs clearance and simplified customs procedures

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• Elimination of barriers to trade • Accelerated implementation of the Mutual Recognition Arrangements (MRAs) for key sectors (e.g. electrical and electronic equipment and telecommunications equipment) • Harmonization of standards and technical regulations Eleven priority sectors were highlighted by the ASEAN HLTF on Economic Integration which are: electronics, e-ASEAN (information and communication technology), healthcare, wood-based products, automotives, rubber-based products, textiles and apparels, agro-based products, fisheries, air travel and tourism.5 At the 2007 ASEAN Cebu Summit, a twelfth priority sector was endorsed by ASEAN leaders which was the logistics sector. These priority sectors were identified based on their potential to maximize the complementarities among ASEAN economies and serve as a catalyst for expediting the integration process. In the area of trade in goods, ASEAN officials also improved the Common Effective Preferential Tariffs (CEPT) Scheme’s Rules of Origin (ROO). This would include making the ROO more transparent, predictable and standardized and taking into account the best practices of other Regional Trading Arrangements (RTAs) including the World Trade Organization (WTO)’s ROO. To ensure transparency on Non-Tariff Measures (NTMs) and eliminate those that are barriers to trade, the following measures have been undertaken over the past few years: • Establish an ASEAN database on NTMs • Set clear criteria to identify measures that are classified as barriers to trade • Set a clear and definitive work programme for the removal of such barriers • Adopt the WTO agreements on Technical Barriers to Trade; Sanitary and Phyto-Sanitary and Import Licensing Procedures and develop implementation guidelines appropriate for ASEAN To effectively implement the AEC, a six-year action plan was launched at the 2004 ASEAN Summit in Vientiane, Laos. This plan, which is known as the Vientiane Action Programme 2004–10 (VAP), has three broad objectives:

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• Intensify current economic cooperation initiatives which are targeted for completion on or before 2010 as well as accelerate the integration of the eleven priority sectors; • Remove barriers to free flow of goods, services, and skilled labour and freer flow of capital by 2010; and • Develop and implement economic measures that would put in place the essential elements for ASEAN to function as a single market and production base.

III. BUILDING BLOCKS OF THE AEC ASEAN has already put in place important building blocks to support the AEC. These building blocks include the ASEAN Free Trade Area (AFTA), the ASEAN Investment Area (AIA) and the ASEAN Framework Agreement on Services (AFAS). These are discussed separately below.

ASEAN Free Trade Area (AFTA) AFTA was launched with the signing of a Common Effective Preferential Tariff (CEPT) Scheme on 28 January 1992. The CEPT scheme requires member countries to reduce their tariff rates on a wide range of products traded within the region to 0 to 5 per cent. ASEAN-5 plus Brunei (ASEAN-6) have already complied with the CEPT scheme in 2003. Vietnam achieved its tariff elimination target in 2006, Laos and Myanmar in 2008 and Cambodia in 2010. To date, 99.77 per cent of products in the CEPT Inclusion List of the ASEAN-6 countries have been reduced to 0 to 5 per cent. In November 1999, ASEAN Economic Ministers went further in their efforts to realize the vision of a regional free trade area by agreeing to adopt a target of zero tariffs by 2010 for the ASEAN-6 and 2015 for the CLMV countries. For products in the priority sectors, tariffs are targeted to be eliminated for the ASEAN-6 by 2007 and 2012 for the CLMV. Hence, having a fully operational AFTA by 2015 should provide a solid foundation for the AEC. However, AFTA is not fully functional yet as NTBs still remain a problem. The prevalence of NTBs are reflected to some extent in intraASEAN trade which remains relatively low and has not risen significant since the signing of AFTA over a decade ago (Figure 4.3).

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FIGURE 4.3 Intra-ASEAN Trade, 1980–2005 30 24.1

25

%

20

20.3 18

25.7 22.1

22.6

2001

2002

24

24.3

25

2003

2004

2005

18.9

15 10 5 0 1980

1985

1990

1995

2000

Source: ASEAN Secretariat.

ASEAN Investment Area (AIA) The AIA, signed on 7 October 1998, aims to make ASEAN a highly competitive investment area that will attract FDI flows from ASEAN and non-ASEAN investors. This agreement binds member countries to reduce or eliminate investment barriers and grant national treatment to ASEAN investors by 2010 and to all investors by 2020. The AIA will encourage investors, particularly from ASEAN countries, to adopt a regional investment strategy and to promote regional production networks. The AIA is thus expected to provide greater scope for division of labour and industrial activities across the region, creating opportunities for greater industrial efficiency and cost competitiveness. Investors can benefit from the AIA through greater investment access to industries and economic sectors, as well as from more liberal and competitive investment regimes that should reduce the transaction costs of doing business in the region.

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The AIA currently covers manufacturing, agriculture, mining, forestry and fishery sectors and services incidental to these sectors. Recognizing that the services sector accounts for a sizeable portion of investment flows to the region, ASEAN policymakers are considering whether the scope of the AIA should be expanded to include industries in the services sector, viz. education, healthcare, telecommunications, tourism, banking and finance, insurance, trading e-commerce, distribution and logistics, accounting, engineering and advertising. It is worth noting that the AIA is supported by the ASEAN Industrial Cooperation (AICO) scheme. AICO, which was launched in 1996, aims to promote closer industrial collaboration through the sharing of resources to manufacture products, which enjoy preferential tariff rates of 0–5 per cent under the CEPT scheme. Clearly, the AIA and AICO provide the necessary foundation to create a single production base (one of the AEC’s end-goal objectives). However, there may be a need to extend national treatment under the AIA to non-ASEAN multinational corporations, particularly to those that can potentially establish production networks in the region.

ASEAN Framework Agreements on Services (AFAS) AFAS, which was signed on 15 December 1995, aims to enhance cooperation in the services sector among ASEAN countries by eliminating intra-regional trade restrictions and facilitating free flow of services by 2015. Under AFAS, the scope of liberalization in services goes beyond those already undertaken under the WTO’s General Agreement on Trade in Services (GATS). In other words, the AFAS is designed to be a GATS-Plus agreement. AFAS uses a positive list approach to services liberalization under a GATS framework. Seven sectors are covered under AFAS, which are: air transport, business services, construction, financial services, maritime transport, telecommunications and tourism. Presently, ASEAN has concluded six packages of commitments under AFAS. These packages provide details of commitments from each ASEAN country to the other member countries. The ASEANX principle is currently being applied as a means to expedite the implementation process. This principle allows member countries that are ready to liberalize to go ahead first with other members joining at a later stage.

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Regional cooperation in the services sector took another important step with Mutual Recognition Agreements (MRAs). MRAs will facilitate freer movement of professional services providers in the region. ASEAN will use the value of intra-regional trade, existence of technical barriers, and indication of strong interest from member countries as criteria for identifying the sectors that would be suitable for MRAs. MRAs on engineering services and nursing services have been concluded in December 2005. ASEAN is also considering having MRAs in architecture, accountancy, surveying, medical practitioners and tourism.

Stronger Institutional Structure It is also important to note that deeper economic integration in ASEAN cannot be successfully achieved without establishment of a stronger institutional structure with a better enforcement mechanism. There is thus a need to streamline, strengthen and enhance coordination among the existing institutions, as well as design better enforcement mechanisms in order to facilitate and expedite economic integration. ASEAN still maintains a very loose institutional structure and does not presently operate on the overriding principle of using a formal, detailed, and binding institutional structure to prepare, enact, coordinate, and execute policies for economic integration. The “ASEAN Way” of making decisions continues to be very much entrenched i.e. Musyawarah (discussion and consultation), Mufakat (unanimous decision) and Consensus. ASEAN’s weak institutional structure may be one of the reasons for the relatively low impact of ASEAN’s initiatives to reduce tariffs and eliminate non-tariff barriers (Schwartz and Villinger 2004). Nonetheless, ASEAN has, in recent years, been moving towards a more structured rule-based system to regulate and enhance economic relations and integration amongst its members. Progressive steps have also been achieved in terms of the content and directives contained in the newer ASEAN trade and investment agreements since the 1990s, with binding rules and procedures now more clearly set out in such documents. Furthermore, the ASEAN Charter, which was signed at the Singapore ASEAN Summit in November 2007, will pave the way towards a more rule-based institutional structure for ASEAN.

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For ASEAN to move towards the formation of a viable and vibrant AEC, there needs to be stronger institutions to oversee and coordinate the administrative tasks of establishing and setting policies, coordinating, implementing, and enforcing present and future agreements and protocols. As it stands, the present ASEAN Secretariat does not have the resources, authority and expertise to carry out such tasks effectively. Akrasanee and Arunanondchai (2005) propose that ASEAN needs to adopt a more centralized institutional structure and suggested that two supranational institutions be established to realize the AEC which are: an ASEAN Court of Justice (to be responsible for dispute settlements) and an ASEAN Economic Secretariat to manage regional economic integration. Soesastro (2004) suggested that a major institutional innovation for ASEAN would be the creation of “regional units” staffed by professionals who are independent of governments to manage the integration process. These bold ideas would require a change in the political mindset of ASEAN policymakers with regards to concepts of national sovereignty and economic integration.

ASEAN and the Developmental Divide6 As has been mentioned above, while ASEAN is not lacking in institutional initiatives to integrate its economies, progress has been very sluggish. Other than tariff reductions, non-tariff barriers such as restrictive regulations and technical measures have not been removed. Negotiations to free up trade in services are moving slowly and there are still too many restrictions on cross-border financial operations. Thus, although ASEAN is a market of 567 million people, the region, in reality, remains a chain of disparate markets. Intra-regional trade currently makes up only about a quarter of ASEAN’s total trade volume, compared to more than 70 per cent in the European Union (EU). More importantly, a wide economic and social rift divides ASEAN’s six more developed nations (Brunei, Indonesia, Malaysia, Singapore, Thailand and the Philippines) from its four other members (Cambodia, Laos, Myanmar and Vietnam or CLMV), which is considered a major hindrance to economic integration. However, in addition to the institution-led process, another factor that drives integration is through the international production sharing of multinational companies (MNCs). This is possible by the reduction of

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barriers to trade and investment, and the rapid development of physical and soft infrastructure. Under the production sharing or network scheme, different stages of production are spread to locations that offer significant advantages in production costs and access to export markets. In the case of ASEAN, the ten economies exhibit complementary economic structure and this leads to new opportunities in setting up a strong regional production network. While manufacturing and services is an important growth driver for ASEAN-6, agriculture accounts more than 40 per cent in CLMV GDP. Again, for a cost-effective production network, the labour-intensive segment of the production chain could be located in developing countries where wages are low. For example, although Vietnam may be a poorer country in terms of finance, infrastructure or technical resources, it has excellent human resources with low cost. This enables Vietnam to specialize itself in labour-intensive activities, whereas capital and technical assistance could be provided by more developed ASEAN member countries like Singapore and Malaysia. International production sharing is commonly applied more intensively in trade in electronics and semiconductors, automotive, and textiles and garments. Keeping this in mind, examining some of the macroeconomic and human development performances of ASEAN member countries exposes the many facets of developmental gaps among them. Though measurement of development divide is an arduous task, some macroeconomic indicators are presented in Table 4.1 to gauge this “divide”. The following observations are made on the basis of information from this table. GDP per capita: In current U.S. dollar terms, there is a significant gap between ASEAN-6 and CLMV’s GDP. Similarly, ASEAN-6’s population is about two and half times greater than that of CLMV’s population. Hence, in terms of per capita income in current prices, ASEAN-6 figure is nearly five times that of CLMV. This is primarily because of Singapore (US$25,207), which has a First World per capita income level that is 152 times higher than that of Myanmar (US$166), the poorest country in the region. The fact that ASEAN-6 is considerably richer than CLMV nations represents the widening economic gap between the nations in the region.

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45.4

Vietnam

83.1

56.0

5.9

13.9

65.0

4.3

84.2

26.2

219

0.4

Population (mn), 2005

554

166

423

358

2537

25207

1042

4625

1193

13879

Per Capita GDP (US$), 2004

39.7

17.3

21.1

40.5

25.1

24.6

*

38.5

35.4

44.0

68.8

46.7

49.8

39.6

39.5

Share of Services in GDP, 2003

27.9

45.8

31.1

33.5

42.1

45.0

58.4

Share of Industry in GDP, 2003

^

42.9

50.2

36.8

10.2

0.1

19.8

8.1

15.4

2.1

Share of Agriculture in GDP, 2003

Note: ^ The share pertains to year 2002; * share pertains to year 2000. Source: ASEAN Yearbook of Statistics, various issues.

9.1

Myanmar

163.5

Thailand

2.4

106.9

Singapore

Laos

86.1

Philippines

4.9

118

Malaysia

Cambodia

258

5.2

Indonesia

Brunei

GDP (US$ bn), 2004

TABLE 4.1 ASEAN Macroeconomic Indicators

—

20.9

—

40.8

58.3

152.5

51.1

89.2

18.0

28.8

Imports /GDP (per cent), 2004

—

42.9

—

51.0

59.6

167.4

46.1

107.2

27.8

98.1

Exports /GDP (per cent), 2004

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However, amongst ASEAN-6 countries, there are also considerable differences in terms of per capita income. For instance, Brunei’s and Malaysia’s per capita income are one-half and one-fifth of Singapore’s respectively. Meanwhile, Indonesia’s and the Philippines per capita income are about a quarter of Malaysia’s. External Sector: ASEAN as a group is highly integrated with the world economy. However, trade imbalances between the CLMV countries and more developed ASEAN economies are sizable. The ASEAN-6 is dominant in exports, which comprises an average of 85 per cent of their GDP in 2004. While exports accounted for 31 per cent of the CLMV’s GDP, imports accounted for around 21 per cent of its total GDP (vis-à-vis ASEAN-6’s 66 per cent of GDP) over the same period. This variation could be attributed to the difference in tariffs. Although tariff barriers to intra-ASEAN trade have been declining, they have not done so between the ASEAN-6 and the CLMV. Protectionism through tariffs has fallen faster for the ASEAN-6. The goal of ASEAN is to remove all import duties by 2010 for ASEAN-6 and by 2015 for the CLMV members. Moving away from economic indicators, one must also study the development divide from a broader angle of human development. This was also stressed in the ASEAN’s Vientiane Action Programme of November 2004 as it pointed out: The development gap is often manifested by disparity in per cepita GDP (income). It can also be manifested by disparities in other dimensions of human development, such as life expectancy and the literacy rate.

Human Development Index (HDI): Under this, ASEAN members can be categorized into two main groups. While the small states of Singapore, Malaysia and Brunei fall within the “high human development” category, the rest falls under the “medium human development category”. Table 4.2 provides a snapshot of the state of human development in the region. In terms of adult literacy, while Vietnam and Myanmar are almost at the same level as the ASEAN-6, Cambodia and Laos are lagging behind. However, literacy rates alone do not reflect the quality of education that is available. The gross enrolment rate for CLMV countries is much lower than the more developed ones. This is consistent with the Asian

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2039

1027

63

90

25

78

131

130

132

105

Malaysia

Philippines

Singapore

Thailand

Cambodia

Laos

Myanmar

Vietnam

73.0

59.9

61.9

56.8

68.6

78.8

70.3

73.0

68.6

76.3

90.3

89.9

68.7

73.6

92.6

92.5

92.6

88.7

90.4

92.7

63

49

61

60

74

87

82

73

68

77

1.5

0.3

0.8

1.7

2.3

1.3

1.4

2.2

1.0

2.6

—

1.3

2.3

1.9

4.2

3.7**

2.7

6.2

0.9

—

Public expenditure Public on Education expenditure on Health (percent (per cent of GDP) (2002–05)* of GDP) (2004)

Note: * Data refer to the most recent year available during the period specified; ** data pertains to 1999-2001. Source: UNDP Human Development Report 2006, 2007; ASEAN Secretariat, Selected Basic ASEAN Indicator (2005).

3071

2727

8677

29663

5137

10882

3843

107

Indonesia

28161

30

Brunei

Gross enrolment GDP per Life Human Adult literacy rate ratio for primary, expectancy at (per cent aged secondary & Development capita tertiary schools Index (Rank) (PPP US$) birth (years) 15 & above) (2005) (2000–05)* (1995–05)* (per cent) (2004) (2005)

TABLE 4.2 ASEAN Human Development Indicators

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Development Bank findings (ADB 2000) that the enrolment rates in higher education in some of Southeast Asia’s economies are lower than expected, given their level of development and availability of public resources. In addition, there appears to be insufficient orientation of higher education toward scientific, technical and other applied fields such as business and management (Yussof and Ismail 2002). This again relates to the fact that there are lower percentages of the workforce at the operational level in less developed ASEAN countries, which reflect a characteristic of a relatively labour-intensive economy and hence generates wage differentials between the ASEAN member countries (Table 4.3). Incidence of Poverty: The disparity between these two groups of countries is very stark regarding the incidence of poverty (see Table 4.4). Based on the international poverty line (i.e. population living below US$1 a day), while Laos and Cambodia have the highest percentage of people below the poverty line, Singapore has nil, closely followed by Malaysia, where just 0.2 per cent of its population are considered poor. Among the ASEAN-6 countries, the Philippines has the highest incidence of poverty, with 15.5 per cent of its population living on less than US$1 a day. TABLE 4.3 Labour Cost per Worker in Manufacturing, 1995–99 (US$ per year) Labour cost per worker in manufacturing Brunei Indonesia Malaysia Philippines Singapore Thailand Cambodia Laos Myanmar Vietnam

— 3,054 3,429 2,450 21,317 3,868 — — — 711

Source: World Development Indicators (2006).

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TABLE 4.4 Incidence of Poverty in ASEAN Population in poverty (National Poverty Line, in percentage) Indonesia Malaysia Philippines Singapore Thailand Cambodia Laos Myanmar Vietnam

18.2 7.5 30.4 — 9.8 35.9 38.6 22.9 28.9

Proportion of population below US$1 (PPP) a day (in percentage) 7.5 0.2 15.5 — 1.9 34.1 39.0 — 13.1

Source: ADB Key Indicators (2005).

Infrastructure: Similar to the other indicators mentioned thus far, the development divide between the CLMV countries and their other ASEAN counterparts is also evident through the physical infrastructure such as road systems, railways, power grids, gas pipelines, and water and sanitation. The infrastructure system in the CLMV countries is characterized by various weaknesses — low responsiveness to users, organizational inefficiencies, insufficient funding, lack of foreign direct investments, heavy reliance on official development assistance, and lack of environmental awareness. Besides, the CLMV countries also lack the “soft” infrastructure (Information and Communication Technology, ICT systems), which are important prerequisites for the next stage of development. Table 4.5 presents the “digital divide” among ASEAN members measured in terms of fixed, mobile and internet users. Beyond these economic and social gaps, there exist further significant disparities in institutional capacity and human resources. The current weak human resource capabilities in the CLMV countries together with weak policies, as well as institutional and legal frameworks, make it difficult for these countries to raise their productive capacities, which further constrain their absorptive capacity in making use of foreign aid and investments. While Vietnam is fast catching up with the less-

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TABLE 4.5 ICT Infrastructure Indicators, 2005

Brunei Indonesia Malaysia Philippines Singapore Thailand Cambodia Laos Myanmar Vietnam

Main Telephone per 100 inhabitants

Cellular subscriber per 100 inhabitants

Internet User per 100 inhabitants

22.43 5.73 16.79 4.00 42.39 10.95 0.23 1.27 0.93 18.81

62.27 21.06 75.17 41.30 100.76 42.98 7.55 10.77 0.34 11.39

36.08 7.18 42.37 5.32 40.22 11.03 0.28 0.42 0.06 12.72

Source: International Telecommunications Union, Measuring the Information Society: ICT Opportunity Index and World Telecommunications /ICT Indicators 2007. Geneva: ITU, 2007.

advanced countries in the ASEAN-6, Cambodia, Laos and Myanmar still have a long way to go. Hence, to set up a regional production network by taking advantage of cost competitiveness, ASEAN needs to fill the development gap in terms of human resource development and capacity building. This has to be further supported by better infrastructure, particularly in the CLMV group, as high transport costs constrain economic opportunities, thus limiting growth. This is being further taken care of in a programme called the Initiative for ASEAN Integration.

V. THE INITIATIVE FOR ASEAN INTEGRATION In recognition of the need to narrow the development divide, ASEAN leaders launched the Initiative for ASEAN Integration (IAI) in November 2000. The word integration was used evidently to emphasize three things — ASEAN’s continuing commitment to regional economic integration; the notion that integration would not exclude the newer members; and the association’s determination to integrate the newer members into the ASEAN mainstream (Severino 2007).

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In July 2001, the ASEAN Ministerial Meeting adopted the Ha Noi Declaration on Narrowing the Development Gap. The declaration laid down the four areas on which the IAI would concentrate: • Infrastructure, particularly transportation and energy; • Human resource development, particularly the strengthening of training institutes and programmes, English proficiency, skills for the knowledge-based economy and the information age, and civil service training; • Information and communications technology; and • Regional economic integration, implicitly meaning the capacity of the newer members to integrate their economies in the regional economy. The IAI project mostly concentrates on studies and training provided by the older members or financed with funds mobilized by ASEAN from the international financial organizations. For example, the studies on and training in transport and energy would help the CLMV countries manage and operate the infrastructure projects. This is especially important in the light of the massive need of human resources by the CLMV countries. Similarly, adequate skills are needed for the development and use of the information and communications technology, in which the CLMV countries are clearly behind the ASEAN-6. Over the years, the IAI has evolved from a platform of mutual assistance between the ASEAN-6 and the CLMV to an expanded framework to involve Dialogue Partners and development agencies (Hew 2007). With Japanese funding, an ASEAN workshop drew up a six-year (2002–08) IAI Work Plan. This policy framework drew up over a hundred projects, mainly in four areas — infrastructure, human resource development, information and communications technology, and regional economic integration. The IAI Work Plan also involves the development of legal, institutional and regulatory frameworks and the building of technical capabilities and capacities of the CLMV. Though a lot has been done under the programme, it lacks focus. Many times, areas that are important for the CLMV countries to narrow the gap with the ASEAN-6 are conspicuously missing. The programme also suffers from lack of a sense of ownership. As Severino (2007) notes:

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The descriptions of the projects reveal their uneven nature in terms of quality and relevance to the IAI’s purposes — and, therefore, presumably their effectiveness. The programme seems to suffer also from insufficient participation of the CLMV countries on the projects’ design and the consequent lack of a sense of ownership of the projects on the part of those countries. At the other end of the process, most projects carry no provisions for follow-through, for implementation, for the effective dissemination of knowledge or skills gained, or for the assessment of the projects’ impact.

Hence, to have a more effective IAI programme, coordination has to be strengthened among the member countries. The CLMV countries have to be involved at all stages of project development — conception, design, implementation, etc. Finally, selection of projects has to be needs-based, thus giving adequate importance to CLMV’s requirement to move up the social and economic ladder.

VI. CLMV COUNTRIES AND ASEAN INTEGRATION Being the less developed members of ASEAN, CLMV countries are going to benefit the most from the ASEAN Integration. The four countries should benefit from increased foreign investment, which can eventually help them to catch up with the rest. Looking at their current state of integration with the rest of the world, the countries vary in terms of pace of integration. This is evident from Table 4.6, where Cambodia and Vietnam are far more integrated with the world economy than Myanmar or Laos. For Vietnam, this is largely attributed to reshaping the former closed command economy into a relatively open, market-based economy in the 1990s. Under the reform measures, Vietnam dismantled the quantitative import restrictions, reduced the tariffs, exposed the public sector to more market discipline, relaxed restrictions on foreign direct investments, etc. Similarly for Cambodia, as its manufacturing sector expanded, the government developed a new labour policy in response to major trade reforms in the textile sector. Against this, trade integration for Laos and Myanmar is less than fifty per cent, reflecting Laos’ position as a land-locked state and Myanmar’s international isolation because of its domestic politics. It is thus not surprising that for Vietnam and Cambodia, trade plays an important role in growth dynamics, and is indicated by their high merchandise trade to GDP ratio.

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TABLE 4.6 Trade Openness (Ratio of total trade to GDP) Cambodia Laos Myanmar Vietnam

2005

2006

94.7 30.6 42.6 115.5

88.7 28.1 47.1 126.7

Source: ASEAN Secretariat website, ASEAN Statistics.

However, Laos and Myanmar are far more integrated to ASEAN as a region as the share of intra-ASEAN trade in total trade is around 80 and 60 per cent respectively in 2006 (see Table 4.7). This encourages the fact that the CLMV countries, more particularly Laos and Vietnam (as Myanmar may be isolated by the Western powers), could be plugged into the Asian production networks for electronic products, textiles, etc. In other words, there are good prospects for relocation of investments from the more advanced economies of ASEAN or other East Asian countries to CLMV countries as these offer abundant low-wage labour and a way to diversify risk from China. To further examine the extent of CLMV countries’ role for regional production network, Table 4.8 presents details on the main trading partners of the three countries (Cambodia, Laos, and Vietnam) on the basis of which the following observations may be made. First, for Cambodia and Vietnam, the United States and the Rest of the World (ROW) was a more important market than East Asia. For both countries, the shares of exports going to the U.S. markets has increased significantly between 1998 and 2004; while for Laos the share increased from 48 to 63 per cent with the ROW over the same period. This implies that the CLV countries are one of the major players in the global export market and hence are well integrated with the global economy. Second, import patterns are very different. The share of imports from outside East Asia for CLV has been fairly stable between 1998 and 2004, changing from 34.1 per cent in 1998 to 33.2 per cent in 2004. Individually, Cambodia’s import share from outside East Asia has

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TABLE 4.7 Intra-ASEAN Trade for CLMV countries, 2006 Ratio of total intra-ASEAN trade to GDP

Share of intra-ASEAN trade to total trade

17.0 23.0 28.0 31.0

19.1 79.8 59.0 24.2

Cambodia Laos Myanmar Vietnam

Source: ASEAN Secretariat website, ASEAN Statistics.

TABLE 4.8 Trade Destinations Export Share

Import Share

1998

2004

1998

2004

Cambodia: East Asia USA ROW

51.0 31.0 18.0

12.5 55.9 31.6

60.7 3.5 35.9

83.4 1.8 14.8

Laos: East Asia USA ROW

47.0 5.4 47.7

36.6 0.6 62.8

89.0 0.6 10.5

86.0 0.6 13.7

Vietnam: East Asia USA ROW

48.6 5.0 46.4

37.6 20.2 42.2

65.1 2.9 32.0

64.5 3.9 31.6

CLV: East Asia USA ROW

48.7 7.4 43.9

35.4 23.0 41.6

66.0 2.8 31.3

67.0 3.6 29.6

Source: IMF Directions of Trade Statistics, Sussangkarn (2006).

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declined substantially between 1998 and 2004, from 39.4 per cent to only 16.6 per cent. This shows a reduced attraction to import from nonEast Asian countries. On the other hand, import share from East Asian countries has gone up slightly and for Cambodia there is a significant increase from 61 to 83 per cent during 1998 to 2004. These trade patterns suggest that the CLV countries have been able to link to the supply chain within the region, for eventual export outside East Asia. A broader network of production hence could be developed with increasing share of exchanges of parts, components and other intermediate products, reflecting the development of intraregional production networks. To further integrate into the regional economy and fully benefit from these integrations, the CLMV countries need to continue with various domestic reforms — develop the required human capacity among others — and hence reduce business and transaction costs. Infrastructure development that makes trading easier has to be funded as it increases economies of speed and efficiency and reduces transportation and trading costs substantively. Trade facilitation measures are also needed to speed up trading processes, thus reducing transaction and business costs. A reduction of tariffs and non-tariff barriers plays an important role in the increase of trade and investment. Again, favourable policy, rules and regulations conducive to investment promotion in different businesses by private sectors needs to be encouraged in individual member countries thus enhancing facilitation of international trade and investments further. Finally, sustainable development of the CLMV countries is not only in the interest of the CLMV countries themselves, but is also a critical factor for the formation of the AEC. The AEC envisages a single market and production base, it should therefore not exhibit large development disparities among member countries because if disparities become too large, negative side effects (smuggling, illegal immigration, etc.) can show up in years to come.

VII. THE ROLE OF FTAS IN REGIONAL ECONOMIC DEVELOPMENT AMONG NEWER ASEAN MEMBERS7 While East Asian economic integration has been largely market-driven and characterized by international division of labour in manufacturing industries, FTAs have now become a reality, with ASEAN and its

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individual members creating a network of FTAs around the major economies of Asia. Indeed, in the wake of the current deadlock in the WTO, FTAs are now more of a norm in ASEAN rather than an exception, and are increasingly being regarded by policymakers as effective and expeditious instruments for achieving economic cooperation and trade liberalization among “like minded” trading partners, while concomitantly pursuing multilateral trade liberalization through the WTO. These agreements, largely providing preferential market access to its signatory members on a reciprocal basis, are discriminatory by definition against non-members. Until the year 2001, AFTA was the only regional trade agreement involving the ten-member grouping. The agreement was restricted to trade in goods and involved a phased elimination of tariffs on intraASEAN trade. AFTA is now by and large fully implemented for the older ASEAN members, viz. Brunei, Indonesia, Malaysia, the Philippines, Singapore, and Thailand, with the newer members expected to comply with it by the year 2010. However, it is important to note that for some specific categories of products, some of the older ASEAN members have not yet fully complied with AFTA guidelines. It is also important to note that this agreement involves only a 40 per cent value-added cumulative Rules of Origin (ROOs)8 for non-originating goods, one of the simplest ROOs to be administered under any Free Trade Area. With new FTA initiatives being announced frequently, it is becoming increasingly difficult to determine an exact figure on the number of existing and proposed FTAs involving ASEAN (and its individual members). Sen (2006) provides details on the progress of all the FTAs in ASEAN over the period 2001–06 (numbering about fifty) that are being proposed or is being negotiated by these countries. He observes that among all the FTA initiatives launched so far in ASEAN since 2001, the ones that have been mostly implemented and are currently in force are Singapore’s FTAs (involving New Zealand, Japan, EFTA, Australia, the United States, Jordan, India and Korea), ASEAN-China and ASEAN-Korea (trade in goods only), and Thailand’s FTAs (involving Bahrain, Australia and New Zealand).9 Apart from these, most of the other initiatives are either at the stage of being studied before formal negotiations, or are being currently negotiated. Thus, the likely content and coverage of many of these agreements and their possible impacts on regional and global trading patterns cannot be comprehended.

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It is also observed that current FTA activity in ASEAN ranges from that of limited FTAs on trade in goods with large exclusion lists and limited product coverage, to that of highly comprehensive bilateral agreements, especially of Singapore, that cover not just trade in goods and trade facilitation, but also services, investments, non-tariff barriers, and regulatory measures for trade and investments, besides including complex issues of government procurement, competition policy and intellectual property protection that have not yet been put on the agenda for negotiations at the multilateral trade negotiations under the auspices of the WTO. It is important to note that most of the other FTAs of ASEAN have not included these issues in the negotiations so far, or have very broad provisions that do not include much substance in terms of liberalization and regulation provisions.10 Why does ASEAN prefer the FTA route to trade liberalization? The general view among many policymakers in ASEAN, and increasingly in the rest of Asia, is that there are several perceived benefits from entering into FTAs, apart from that of gaining greater market access, and lowering business costs by reduction of tariff barriers. It is often argued that FTAs in ASEAN have the potential to promote regional economic development and particularly facilitate newer ASEAN members in building up production networks to strengthen their economic integration within ASEAN and East Asia.

VIII. FTAS AND DEVELOPMENT OF REGIONAL PRODUCTION NETWORKS The study by Kimura (2008, 2009) develops an analytical framework based on the spatial nature of production networks, applying it to the ASEAN context. He links it to the policy elements according to the phase of economic development and argues that the ability of each ASEAN country to utilize the mechanics of production/distribution networks is affected to the extent to which it is industrialized or developed. The role of foreign direct investment (FDI) and a liberal policy towards the same is absolutely crucial for any country to be able to enter and benefit from emerging production networks in ASEAN. Kimura (2009), outlining the policy needs in various development phases of ASEAN, provides an interesting backdrop as to how FTAs in ASEAN could be used as a policy tool to satisfy the needs of each ASEAN country

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so that they are able to effectively participate in regional production networks, and therefore promote regional economic development. This section therefore tries to follow this approach and link it to various FTA provisions to argue how FTAs can promote regional economic development for less developed ASEAN members. Kimura (2009) identifies four phases of industrialization based on their current participation in production/distribution networks. The first phase essentially consists of countries that need to get into the production networks, e.g. Cambodia, Laos and Myanmar among new ASEAN members, and therefore build a business-friendly investment climate in order to attract new production blocks. Vietnam, the more developed member among the newer ASEAN members is already placed into the category of second phase due to its recent success in attracting FDI, which also requires development of industrial agglomeration to support and strengthen the existing production blocks.11 How can FTAs influence policies to support the formation of production networks in the newer ASEAN members? Kimura (2008) develops a 2×3 matrix that identifies the set of policies that can impact upon the three set of costs that essentially influence development of a fragmented production network as similar to the one that exists in East Asia (Table 4.9). These costs include (a) network set-up costs to develop new production networks; (b) service link costs to connect each production block within a network, and (c) production costs, in each production block. As observed from Table 4.1, these policies do not only relate to removing cross-border barriers, but also to reducing behind-the border impediments to trade and investment among ASEAN countries. Table 4.10 links provisions in ASEAN FTAs to the policy analysis in Table 4.9. It is observed that the impact of FTAs on policies affecting the participation of countries in production networks is very much dependent on the extent of comprehensive coverage of an FTA. Thus, FTAs that only emphasize liberalizing trade in goods and tariff reduction are likely to impact positively on policies to overcome geographical distance and border effects, and thereby reduce service link costs in production networks, while not being able to reduce network set-up or production costs. In the context of ASEAN, this implies that AFTA, when fully implemented for newer ASEAN members, can facilitate them to lower service link costs and thereby enhance their participation in

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Fragmentation along the distance axis

(iii) liberalization and development in financial services related to capital investment.

(ii) investment facilitation in FDI hosting agencies and industrial estates

Examples: (i) improvement in stability, transparency, and predictability of investment-related policies.

Various policies to reduce investment costs

Type of Reduction in fixed costs to develop fragmentation production/distribution networks

Examples: (i) reduction/removal of trade barriers such as tariffs, (ii) trade facilitation including simplification and improved efficiency in custom clearance/ procedures (iii) development of transport infrastructure and improved efficiency in transport and distribution services (iv) development of telecommunication infrastructure, (v) improved efficiency in financial services related to operation and capital movements

Various policies to overcome geographical distance and border effects

Reduction in service link costs connecting production blocks

Examples: (i) establishment of educational/ occupational institutions for personnel training to secure various types of human resources; (ii) establishment of stable and elastic labour-related laws and institutions; (iii) establishment of efficient international and domestic financial services; (iv) reduction in costs of infrastructure services such as electricity and other energy, industrial estates services; (v) development of agglomerations to facilitate vertical production chains;

Various policies to strengthen location advantages

Further cost reduction in production costs per se in production blocks

TABLE 4.9 The 2x3 Policy Matrix in the Two-dimensional Fragmentation Framework

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(vi) reduction in costs of coordination between remote places by facilitation of the movement of natural persons.

Reduction in service link costs connecting production blocks (vi) establishment of economic institutions such as investment rules and intellectual property rights; (vii) various trade and investment facilitations.

Further cost reduction in production costs per se in production blocks

Examples: establishment of economic system to allow co-existence of various business partners as well as making various types of contracts, various policies to reduce costs of information gathering on potential business partners, securing fairness, stability, and efficiency in contracts, establishment of stable and effective institutions to secure intellectual property rights.

Examples: (i) policies to reduce monitoring cost of business partners; (ii) improvement in legal system and economic institutions to activate dispute settlement mechanism; (iii) policies to promote technical innovations in modulation to further facilitate outsourcing.

Examples: (i) hosting and fostering various types of business partners including foreign and indigenous firms; (ii) strengthening supporting industries; (iii) various policies to promote the formation of agglomeration.

Development of institutional Establishment of economic Various policies to strengthen competitiveness of potential business environment to reduce set-up costs environment to reduce the cost of implementing arm’s length transactions partners of arm’s length transactions

Source: Kimura (2008).

Fragmentation along the disintegration axis

Type of Reduction in fixed costs to develop fragmentation production/distribution networks

TABLE 4.9 (Cont’d ) 98 Denis Hew, Sanchita Basu Das and Rahul Sen

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Various policies to reduce investment costs

(i) improvement in stability, transparency, and predictability of investmentrelated policies; (ii) investment facilitation in FDI hosting agencies and industrial estates;

(i) hosting and fostering various types of business partners including foreign and indigenous firms; (ii) strengthening supporting industries; (iii) various policies to promote the formation of agglomerations

Establishment of economic environment to reduce set-up costs of arm’s length transactions

policies to reduce costs of information gathering on potential business partners

Various policies to strengthen competitiveness of potential business partners

Various policies to strengthen location advantages

(vii) various trade and investment facilitation.

Network set-up costs and production costs

Network set-up, service link and production costs

Various policies to overcome geographical distance and border effects

trade facilitation including simplification and improved efficiency in custom clearance/procedures

Trade facilitation (improvement in customs procedures and customs clearance) including mutual recognition and harmonization of product standards

MFN and National Treatment in Trade in Services and Investment

Service link costs

Various policies to overcome geographical distance and border effects

reduction/removal of trade barriers such as tariffs

Tariff reduction and/ or elimination on trade in goods

Impact on cost type in production network

Type of policy

Policy areas and possible impact

Key FTA provisions

TABLE 4.10 FTAs Provisions and Their Policy Impact on Development of Production Networks ASEAN Economic Integration and Implication for CLMV Countries 99

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Network set-up costs

Establishment of economic environment establishment of economic system to to reduce set-up costs of arm’s length allow co-existence of various business partners as well as making various types transactions of contracts, various policies to reduce costs of information gathering on potential business partners, securing fairness, stability, and efficiency in contracts.

Competition Policy

Source: Based on Table 4.9 and Sen (2006).

Network set-up costs

Establishment of economic environment to reduce set-up costs of arm’s length transactions

establishment of stable and effective institutions to secure intellectual property rights.

Strengthening the intellectual property regime

Service link costs

Various policies to overcome geographical distance and border effects

(vi) reduction in costs of coordination between remote places by facilitation of the movement of natural persons.

Service link costs

Development of institutional environment to reduce the cost of implementing arm’s length transactions

Liberalizing movement of professionals

Various policies to overcome geographical distance and border effects

improved efficiency in financial services related to operation and capital movements,

Network set-up costs and service link costs

Impact on cost type in production network

(ii) improvement in legal system and economic institutions to activate dispute settlement mechanism.

Various policies to reduce investment costs

Type of policy

(iii) liberalization and development in financial services related to capital investment.

Policy areas and possible impact

Dispute settlement mechanism for investments

Liberalization of Trade in Services

Key FTA provisions

TABLE 4.10 (Cont’d ) 100 Denis Hew, Sanchita Basu Das and Rahul Sen

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regional manufacturing production networks. They can do so by taking advantage of their relative abundance of unskilled labour compared to more developed ASEAN members. However, Table 4.10 also indicates that this may be a necessary, but not a sufficient condition for firms to set up production blocks in these countries. This is so as more than tariff reduction, it is trade and investment facilitation by improving customs clearance and procedures that have a stronger impact on the policy mix and thereby on reduction of overall costs to encourage production networks. Trade facilitation initiatives in an FTA impact not just on policies that overcome geographical distance and border effects, but also on policies that strengthen location advantages and facilitate establishment of an economic environment to reduce set-up costs of arm’s length transactions. This, in turn, has an impact on reduction of all three costs involved in setting up a production network. While not addressed in the AFTA, trade facilitation is an important objective in the ASEAN Economic Blueprint, and newer ASEAN members will need to undertake these measures in order to benefit from regional production networks, as ASEAN moves towards its objective of being a single market, the goal of which is presently slated to be attained by 2015. Liberalization of trade in services and investment, particularly the inclusion of Most Favoured Nation (MFN) and National Treatment obligations in an FTA are also likely to have a favourable impact on policy in terms of reduction in investment costs, strengthening competitiveness of potential business partners, as well as overcoming geographical distance and border effects. It is likely to significantly reduce network set-up costs and service link costs within a production network. In the ASEAN context, while there has been some efforts at regional liberalization of services and investment via AFAS and the AIA, the efforts towards this are yet to gather momentum among newer ASEAN members. Except for Singapore’s bilateral FTAs, most ASEAN FTAs have so far ignored liberalization of movement of professionals, which also has a substantial impact on reduction of service link costs in a production network. Competition policy and intellectual property protection that have a favourable impact on reducing network set-up costs have also not been tackled so far in the FTA context for most ASEAN members. For newer ASEAN members, who are likely to be initially involved more

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in fragmentation along the distance axis (viz. Cambodia, Laos and Myanmar), the above could be considered more at the next phase of industrialization when they have already attracted several production blocks. It is therefore evident that FTAs that involve economic partnership agreements, which are comprehensive and involve deeper liberalization beyond tariff reduction in goods, can provide a catalyst for enhancing the pace of policy liberalization, and are likely to have a domino effect on non-members, who would want to avoid being discriminated against and therefore forced to liberalize faster. In this context, a framework for the Comprehensive Economic Partnership in East Asia (CEPEA), involving ten member ASEAN countries and China, India, Japan, Korea, Australia and New Zealand, encompassing most of the FTA coverage areas indicated in Table 4.10 will have the potential to develop a policy environment that would enhance the ability of East Asian countries and therefore newer ASEAN members to participate in regional manufacturing production networks. However, while a comprehensive FTA involving newer ASEAN members has the potential to enhance their ability to participate in production networks, there remain important policy constraints in these countries that need to be addressed unilaterally through domestic reforms rather than bilaterally through an FTA. In Table 4.9, these relate to policies that strengthen location advantages and development of an institutional environment to reduce set-up costs of arm’s length transactions. These include policies towards institutional development to improve the business environment as well as developing infrastructure to support the same. Establishment of educational/occupational institutions for personnel training to secure various types of human resources, establishment of stable and elastic labour-related laws and institutions, reduction in costs of infrastructure services such as electricity and other energy, industrial estates services, as well as establishment of economic institutions such as investment rules and intellectual property rights would be examples of areas wherein domestic reforms would be crucial to support the business-friendly environment that could potentially be created by FTAs. It can therefore be concluded that while a basic FTA involving tariff reductions as in the case of AFTA has the potential for newer ASEAN members to reduce their service link costs to attract new production

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blocks within the existing network, behind the border and non-tariff measures involving trade and investment facilitation are absolutely crucial for them to develop a business-friendly environment to reduce overall costs for participating in the production network. In the long run the FTA measures would need to be supported by strong domestic reforms in the area of institutional and infrastructure development. While this would be absolutely essential for countries in the first phase, viz. Cambodia, Laos, and Myanmar, newer ASEAN members in the second phase, viz. Vietnam, would also have to improve on the policy environment in the area of liberalizing services and investment and strengthening existing institutions and infrastructure to promote agglomeration and development of vertical production chains among the industries. Notwithstanding the above, the creation of a complex hubs and spokes network of overlapping FTAs within Asia, with a potential for trade diversion away from the spokes towards the emerging hubs of these FTAs continues to prompt concerns about the extent to which FTAs might actually promote regional economic development and positively impact on policies to reduce costs for strengthening the East Asian production network. There is no single hub for ASEAN FTAs, with ASEAN as a group, as well as Singapore, Thailand, and increasingly others, creating multiple FTA hubs. At the same time, India, China, and Korea are also creating their own FTA hubs, creating a multitude of FTA hubs wherein a spoke country in one FTA is becoming a hub in another. Further, varieties of Rules of Origin (ROOs) to determine preferential treatment for non-originating goods have been applied or are currently being negotiated across ASEAN’s FTAs. While the value-added (VA) rule is generally applied across Singapore’s FTAs, a mix of other criteria such as the change in tariff classification (CTC) and other restrictive rules have also been applied. Even in other ASEAN FTAs, restrictive rules seem to have prevailed over simple ones. There is also a great deal of overlapping among the FTA partners of ASEAN and the individual member countries. Thus, while Singapore has already implemented its agreements with New Zealand, Australia, India, Korea, and Japan, it is also a negotiating member in ASEAN-wide FTA initiatives with these countries. Similarly, Malaysia and Thailand are negotiating a bilateral agreements with Japan, India, Australia, New Zealand, and Korea, and

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are also involved as part of the ASEAN-wide negotiations with this same set of countries. The application of a variety of Rules of Origin (ROOs) with respect to preferential trade liberalization in goods in this hub and spoke network of FTAs makes it costly for businesses to comply with and implement, thus negating the very purpose of a FTA to reduce business costs. It also provides increasing avenues for corruption, since customs officials can exercise significant discretion in deciding which tariff or rules to apply for a certain product (Newfarmer 2005). Referred to as the “spaghetti-bowl” argument in Bhagwati (1995) and also in Krueger (1997), this is manifesting itself more seriously as a far more complex “Asian noodle-bowl”, wherein businesses have to either consider using these FTAs and therefore adjust their strategies for compliance, or else continue to pay MFN tariffs for their goods, ignoring FTA preferences. If the utilization of these restrictive ROO preferences adversely affects any of the three costs involved in participation in a production network, ASEAN FTAs could actually end up adversely affecting existing production networks in ASEAN and East Asia, which has largely been market-driven. More research is warranted in this area to examine the impact of FTAs that have already been implemented. It is important to note that it has recently been estimated that AFTA, ASEAN’s first regional FTA, which has one of the simplest ROOs for tariff preferences, has remained grossly underutilized at about 5 per cent of total trade, with many exporters preferring to pay the MFN tariffs instead. Not only does this observation raise concerns regarding the effectiveness of AFTA in promoting ASEAN’s regional production networks, it also raises serious doubts about implementation of new and proposed FTAs. With new FTAs proliferating every year and each FTA being different, requiring different conditions for compliance, businesses have to devise new strategies to utilize them. As an exporter, they need to comply with ROOs and match their requirements for each FTA partner, if exporting to multiple countries. As a service provider, they need to fulfil the entry requirements and conditions to be fulfilled for granting temporary entry of professionals and national treatment for investments. These have significant adjustment costs associated with them, and require proper implementation, to ensure that businesses find it cost-effective in utilizing FTAs for trading and investment purposes.

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These costs are likely to be higher for newer ASEAN members, and particularly for those in the first phase of industrial development that need to get into regional production networks. An overarching East Asia-wide comprehensive regional FTA might therefore help them more in this regard than individual bilateral FTAs. With negotiations in current ASEAN FTAs having generated minimal business interest, there is therefore an urgent need to not only improve implementation procedures in these FTAs, but to involve more business participation in their negotiations to ensure that they are utilized upon completion and complement the market-led initiatives for integration. Further, with individual ASEAN members having already enforced some of their own bilateral deals with major trading partners, an important issue that remains unresolved is how these countries are to treat the ASEAN-wide agreements with the same trading partners, once they are enforced. It is not yet clear whether regional agreements would subsume these bilateral deals, therefore posing a concern as to their applicability and consistency in the negotiating framework.12 With no common framework for negotiations evolving so far in ASEAN, the possibility of bilateral deals being subsumed by regional ones seems remote. Finally, it is important to note that apart from differences in terms of ROOs, there also exist dissimilarities in these FTAs with respect to the choice of their major internal parameters (the depth of trade liberalization commitments and sectoral coverage) that constitute the negotiating framework.13 The information on FTAs made available by the Asia-Pacific Preferential Trade and Investment Agreements (APPTIAD) database aptly demonstrates this divergence across not just ASEAN, but also the members of the United Nations Economic and Social Commission for Asia and the Pacific (UNESCAP),14 highlighting the fact that most of the current FTAs in Asia, that involve developing countries negotiating partners, are too shallow in terms of product coverage and liberalization commitments, with complex and restrictive ROOs.15 These trends prompt concerns that while FTAs could be effective policy tool for ASEAN in promoting regional economic development by increasing their participation in production networks, the current design, coverage and implementation of FTAs proliferating in East Asia are emerging in a direction that may not have a very significant

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positive impact on regional economic development. Indeed, if not properly designed and implemented, these agreements could indeed have potentially adverse welfare consequences, especially if it leads to trade diversion. Last, but not least, these FTA initiatives in ASEAN need to be supported by unilateral liberalization and important domestic economic reforms which are critical for the growth prospects of the newer ASEAN members and to sustain competitiveness of ASEAN as a regional production base. As observed by Sally and Sen (2005), the engine of liberalization and regulatory reform by ASEAN countries has to be home-driven, with FTAs playing at best a supportive role. It also needs to be supported by institutional and infrastructural development that is critical for the development of regional production networks involving the less developed ASEAN countries.

IX. CONCLUDING REMARKS There is no evidence to indicate that there is any political desire by ASEAN leaders to establish a European-style common market by 2015. Nevertheless, ASEAN could still be a highly competitive economic region by 2015. It is possible for ASEAN to realize an “AFTA Plus” arrangement in less than a decade if non-tariff barriers are successfully tackled. An “AFTA Plus” AEC would be a fully functioning free trade area with minimal non-tariff barriers and freer movement of goods, services, investments, capital and skilled labour. Also around this time, ASEAN could be a potential free trade hub for the region. Most of the “ASEAN+1” FTAs with its major trading partners will be operational over the next seven to ten years. ASEAN currently has FTA arrangements with China, Japan, Korea, Australia, New Zealand, and India (and is currently negotiating one with the European Union). Two important documents were launched at the Singapore ASEAN Summit in November 2007. One was the ASEAN Charter which should provide the regional grouping not only with a legal personality but also set out the long-term economic direction for the region. The second was the AEC blueprint which provides the necessary action plans, targets and timelines for implementing specific economic measures to realize the AEC by 2015.

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Having an ASEAN Charter should provide a more rule-based institutional structure for ASEAN. However, a change in mindset is required if ASEAN wishes to remain economically competitive. This includes reviewing the consensual “ASEAN Way” of making decisions that clearly slows down the economic integration process. At the same time, ASEAN policymakers must be cognizant of the need to ensure that the less developed CLMV countries do not get left behind as the pace of economic integration quickens over the next few years.

Notes 1. Basic ASEAN Statistics, see . 2. See Declaration of the ASEAN Concord II (Bali Concord II), Bali, Indonesia, 7 October 2003 . 3. Cebu Declaration on the Acceleration of the Establishment of an ASEAN Community by 2015, Cebu, Philippines, 13 January 2007 . 4. The ASEAN High Level Task Force’s Recommendations are annexed to the Bali Concord II. 5. The recommendations of the ASEAN High Level Task Force on Economic Integration . 6. This section largely draws on Salazar and Das (2007). 7. This section largely draws on Sen (2007). 8. This refers to the conditions that determine preferential treatment for import of goods in an FTA. 9. Thailand has entered into a Framework Agreement for an FTA with India in 2004, which currently involves tariff elimination only on eighty-two selected goods. Although the framework agreement indicates this FTA will be comprehensive, there has not been significant progress after the Early Harvest Scheme. 10. See Banda and Whalley (2005) for a detailed analysis of non-trade issues dealt with in the ASEAN FTAs. 11. Kimura (2009) argues that for countries in the second phase, e.g. Vietnam, it is important to host a number of production blocks by removing bottlenecks in location advantages and service link arrangements. This phase would require attractive policies for FDI by foreign small and medium enterprises (SMEs) that play a crucial role in the formation of vertical production links. 12. See Rajan and Sen (2005).

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13. See Sen (2006) for further details. 14. See . 15. Plummer (2006) observes that ASEAN FTAs that have involved developed country partners are fairly liberal in content and coverage, except for ROOs.

References Akrasanee, N. and J. Arunanondchai “Institutional Reforms to Achieve ASEAN Economic Integration”. In Roadmap to an ASEAN Economic Community, edited by D. Hew. Singapore: Institute of Southeast Asian Studies, 2005. ASEAN-ISIS. “Towards an ASEAN Economic Community — A Track Two Report to ASEAN Policy Makers”. Unpublished manuscript. Jakarta, 2003. ASEAN. ASEAN into the Next Millennium: ASEAN Vision 2020 and Ha Noi Plan of Action. Jakarta: ASEAN Secretariat, 1999. ASEAN Secretariat. ASEAN: An Overview. Jakarta: ASEAN Secretariat, 2005. ———. ASEAN Statistical Pocket Book 2006. Jakarta: ASEAN Secretariat, 2007. Asian Development Bank (ADB). Annual Report. Manila: Asian Development Bank, 2000. ———. “Preferential Trade Agreements in Asia and the Pacific”. In Asian Development Outlook 2002. Manila: ADB, 2002. ———. “Foreign Direct Investment in Developing Asia”. In Asian Development Outlook 2004. Manila: ADB, 2004. Austria, M. “The Patterns of Intra-ASEAN trade in the Priority Goods Sectors”. (Unpublished manuscript). REPSF Project no. 03/006e. Regional Economic Policy Support Facility (REPSF). Downloadable from ASEAN-Australia Development Cooperation website . Austria, M. and J. Avila. “Looking Beyond AFTA: Prospects and Challenges for Inter-Regional Trade”. PIDS Discussion Paper Series no. 2001–10. Makati City: Philippine Institute for Development Studies, 2001. Baldwin, R. “Managing the Noodle Bowl: The Fragility of East Asian Regionalism”. Policy Paper. Geneva: Graduate Institute of International Studies, 2006. Banda, O.G.D. and J. Whalley. “Beyond Goods and Services: Competition Policy, Investment, Mutual Recognition, Movement of Natural Persons and Broader Cooperation Provisions of Recent FTAs Involving ASEAN Countries”. NBER Working Paper no. 11232. Cambridge, MA: NBER, 2005. Bhagwati, J. “U.S. Trade Policy: The Infatuation with Free Trade Areas”. In The Dangerous Drift to Preferential Trade Agreements. Washington, D.C.: The AEI Press, 1995.

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East Asia Vision Group. “Toward an East Asian Community: Region of Peace, Prosperity and Progress”. East Asia Vision Group Report, 2001. Feridhanusetyawan, T. “Preferential Trade Agreements in the Asia-Pacific Region”. IMF Working Paper no. 05/149. Washington, D.C.: IMF, July 2005. Freeman, N. and D. Hew. “Introductory Overview: Rethinking the East Asian Development Model”. ASEAN Economic Bulletin 19, no. 1 (April 2002): 1–5. Hew, D. “Southeast Asian Economies: Towards Recovery and Deeper Integration”. In Southeast Asian Affairs 2005, edited by Chin Kin Wah and Daljit Singh. Singapore: Institute of Southeast Asian Studies, 2005. ———. “Towards an ASEAN Charter: Regional Economic Integration”. In Framing the ASEAN Charter: An ISEAS Perspective, compiled by Rodolfo c. Severino. Singapore: Institute of Southeast Asian Studies, 2005. ———, ed. Roadmap to an ASEAN Economic Community. Singapore: Institute of Southeast Asian Studies, 2005. ———, ed. Brick by Brick: The Building of an ASEAN Economic Community. Singapore: Institute of Southeast Asian Studies, 2007. Hew, D. and M. Anthony. “ASEAN and ASEAN+3 in Postcrisis Asia”. NIRA Review 7, no. 4 (Autumn 2000). Hew, D. and R. Sen. “Towards an ASEAN Economics Community: Challenges and Prospects”. ISEAS Working Paper no. 1. Singapore: Institute of Southeast Asian Studies, 2003. Hew, D. and H. Soesastro. “Realizing the ASEAN Economic Community by 2020: ISEAS and ASEAN-ISIS Approaches”. ASEAN Economic Bulletin 20, no. 3 (December 2003). Hsu, L. “ASEAN Economic Integration — A Fillip For The Future”. In Trading Arrangements in the Pacific Rim, compiled by Paul Davision. New York: Oceana Publications Inc, December 2003. Institute of Southeast Asian Studies. “ISEAS Concept Paper on the ASEAN Economic Community”. Unpublished manuscript, 2003. Kawai, M. “East Asian Economic Regionalism: Progress and Challenges”. Journal of Asian Economics 16 (2005): 29–55. Kimura, F. “The Mechanics of Production Networks in Southeast Asia: The Fragmentation Theory Approach”. In Production Networks and Industrial Clusters: Integrating Economies in Southeast Asia, edited by Ikuo Kuroiwa and Toh Mun Heng. Singapore: Institute of Southeast Asian Studies, 2008. ———. “Expansion of the Production Networks into the Less Developed ASEAN Region: Implications for Development Strategy”. In this volume (pp. 15–35), 2009. Krueger, A. “Problems with Overlapping Free Trade Area”. In Regionalism Versus Multilateral Trade Arrangements, edited by T. Ito and A. Krueger. Chicago: University of Chicago Press, 1997.

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Newfarmer, R.S. “Regional Trade Agreements: Designs for Development”. In Trade, Doha, and Development: A Window into the Issues, edited by Richard S. Newfarmer. Washington, D.C.: World Bank, 2005. Nikomborirak, D. and S. Stephenson “Liberalization of Trade in Services: East Asia and the Western Hemisphere”. Paper prepared for the Pacific Economic Cooperation Council (PECC) Trade Policy Forum on Regional Trading Agreements, Bangkok, Thailand, 12–13 June 2002. Plummer, M. “Towards Win-Win Regionalism in Asia: Issues and Challenges in Forming Efficient Trade Agreements in Asia”. Paper presented at the workshop on “Brainstorming on FTAs: Issues and Challenges in Designing Effective Trade Agreements in Asia”, organized by the Asian Development Bank (ADB), Manila, 20 March 2006. Rajan, R. and R. Sen. “The New Wave of FTAs in Asia: Implications for ASEAN, China and India”. In ADB Volume on Asian Economic Cooperation and Integration. Manila: Asian Development Bank, 2005. Salazar, L. and S. B. Das “Bridging the ASEAN Development Divide: Challenges and Prospects”. ASEAN Economic Bulletin 24, no. 1 (April 2007). Sally, R. and R. Sen. “Whither Trade Policies in Southeast Asia? The Wider Asian and Global Context”. ASEAN Economic Bulletin 22, no. 1 (2005): 92–115. Schwartz, A. and R. Villinger. “Integrating Southeast Asian Economies”. The McKinsey Quarterly 1 (2004). Sen, R. “New Regionalism in Asia: A Comparative Analysis of Emerging Regional and Bilateral Trading Agreements involving ASEAN, China, and India”. Journal of World Trade 40, no. 4 (2006): 553–96. ———. “Bilateral Trade and Economic Cooperation Agreements in ASEAN: Evolution, Characteristics, and Implications for Asian Economic Integration”. ISEAS Working Paper in Economics and Finance, no. 1, 2007. Severino, R.C. Southeast Asia in Search of an ASEAN Community: Insights from the former ASEAN Secretary-General. Singapore: Institute of Southeast Asian Studies, 2006. ———. “The ASEAN Developmental Divide and the Initiative for ASEAN Integration”. ASEAN Economic Bulletin 24, no.1 (April 2007): 35–44. Soesastro, H. “Towards an ASEAN Economic Community”. In The 2nd ASEAN Reader, compiled by Sharon Siddique and Sree Kumar. Singapore: Institute of Southeast Asian Studies, 2003. Sussangkarn, Chalongphob. “CLMV and East Asian Integration”. Paper presented at the conference on “Accelerating Development in the Mekong Region: The Role of Economic Integration”, organized by the International Monetary Fund, the ASEAN Secretariat and the Royal Government of Cambodia, Siem Reap, 26–27 June 2006.

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Tongzon, J. “Role of AFTA in an ASEAN Economic Community”. In Roadmap to an ASEAN Economic Community, edited by D. Hew. Singapore: Institute of Southeast Asian Studies, 2005. UNCTAD. World Investment Repor 2005t: Transnational Corporations and the Internationalization of R&D. New York and Geneva: United Nations Conference on Trade and Development (UNCTAD) 2005. World Bank. World Development Indicators. Washington, D.C.: World Bank, April 2007. Yussof Ishak and Rahmah Ismail. “Human Resource Competitiveness and Inflow of Foreign Direct Investment to the ASEAN Region”. Asia-Pacific Development Journal 9, no. 1 (June 2002).

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PART II Case Studies

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5 Industrialization Strategy of Laos: Agglomeration and Fragmentation Motoyoshi Suzuki

I. INTRODUCTION It is not appropriate for national planners to persist in independent and self-satisfactory national development strategies without taking globalization into consideration. It is more rational and time-saving to plan national development strategies in the framework of sub-regions where countries or economies adjoin. Globalization and liberalization are making rapid progress all over the world. Laos should not suppress nor oppose globalization, regional economic integration and liberalization. If Laos can provide more liberal policies than other ASEAN countries, it will succeed in establishing a more attractive investment environment and attract a larger number of overseas investors. This is the most appropriate strategy to develop a land-locked country like Laos with a small population and low income. According to Paul Krugman (1994, p. 90), “A nation is significant if the government policies affect the movements of goods and production elements.” In other words, strategies to be taken in an age when political and economic borders 115

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could be established, and those appropriate for an age when the significance of national borders is becoming increasingly immaterial should be different (Suzuki 2008). The aim of the paper is to indicate that, in formulating its industrialization strategies today, it is more appropriate for Laos, which was far behind in starting economic development, to take advantage of geographical proximity to Thailand and to establish complementary relations with them by deploying international divisions of labour through vertical production networks than to adopt customs and trade policies based upon national borders. The author proposes five kinds of fragmentation in section II. In section III, the author explains the importance of functions which mother factories possess in industrial clusters. In section IV, the significance of fragmentation is emphasized in a global value chain context. Section V argues that the establishment of second factories depends on the size of trade service link costs and cost reduction factors before and after fragmentation. A gravity model is introduced from the viewpoint of trade link costs in section VI. In section VII, the author proposes a fourstage process in the sub-regionally complementary industrialization of Laos. In section VIII, collective efficiency for reducing trade link costs and increasing the benefits of individual firms is discussed.

II. INDUSTRIALIZATION THROUGH SUB-REGIONALLY COMPLEMENTARY FRAGMENTATION Definition Aizenman and Marion (2004) argue that a vertical pattern arises when the multinational firm fragments the production process internationally, locating each stage of production in the country where it can be done at the least cost. A horizontal pattern occurs when the multinational produces the same product or service in multiple countries. According to Hanson, Mataloni, and Slaughter (2003), vertical production networks are defined as a form of “vertical FDI” through which multinationals spread across different locations the different activities that they perform, such as R&D, input production, and input processing. Vertical specialization is defined as production processes that involve a sequential, vertical

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trading chain stretching across many countries, with each country specializing in particular stages of the production process (Hummels, Ishi, and Yi 2001). In common with many other studies, the multinational enterprise is mentioned as a main actor which coordinates international fragmentation and organizes international production networks. The key actors of sub-regionally complementary industrialization, which the author suggests, are the small and medium-sized enterprises, and they supply parts to multinational enterprises. Based on Hiratsuka, Keola and Suzuki (2008), the author defines “industrialization through sub-regional complementary (SRC) production networks” as an industrialization process whereby a well-established industrial cluster in the core is complemented by the periphery in specific product parts or manufacturing processes where the core has lost its advantage, and where the periphery conversely has an advantage, by deploying vertical production networks or vertical product differentiation in the sub-region. To realize this, however, mother factories and their final assemblers operating in the core must capture higher competitiveness and upgrade their value-added activities. Then it requires an upgrading of the skills of unskilled labour, and the number of specific skilled labour, engineers or technical experts needs to be increased at firm level as well as at the national level.

Development of Industrial Clusters in Thailand Laos possesses location advantages over Thailand in terms of plentiful space, abundant water resources, and cheap labour (at no more than a quarter to one-eighth of the cost of labour in Thailand). Mother factories in Thailand foster vertical production networks with Laos through the establishment of second factories there. By so doing, Thai international competitiveness is reinforced. At the same time, Laos is incorporated into the framework of clusters in Thailand and industrialization in Laos is fostered. In addition, diseconomies of agglomeration in the Bangkok area will be relaxed to some extent.1 Japanese-affiliated companies began to make their way into Thailand around 1960, and have increased in number to more than 7,000. The establishment of assembly plants promotes the advancement of partsmanufacturing subcontractor companies into Thailand. Accordingly, parts industries with advanced technology and local human resources

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to support such industries have been cultivated in Thailand through the cycle of this mechanism in industrial clustering (Suzuki 2008).

Diseconomies of Agglomeration The cumulative process of industrial agglomeration tends to bring excessive congestion to the cluster area. Numerous scholars and policymakers in the late 1970s and early 1980s argued that many Third World countries, especially those moving up the hyper-urbanization curve, were afflicted with serious diseconomies of agglomeration (Scott 2002). For instance, chronic and serious traffic congestion, air pollution, the formation of slums, and an increasing crime rate, etc., damaged the quality of amenities in the Bangkok area. Such adverse factor conditions as rising wages and costs of office, factory or land leases induced the diseconomies of agglomeration which offset the economies of agglomeration in Thailand.2

Wage Gap between the Core and Periphery The Thai Government had made efforts to introduce labour-intensive industry FDI into industrial parks with the location advantage of cheap labour. In 1975, the minimum wage in the Bangkok area and surrounding suburbs was 25 baht (eight hours/day). Significant Japanese FDI flowed into Southeast Asian countries following the appreciation of the yen under the Plaza Agreement in 1985. At that time, the minimum wage in Thailand was 70 baht (eight hours/day) and afterwards increased gradually. The proportion of middle-income earners has increased, resulting in increased domestic demand which has also supported the economic growth of the country. An increase in wages brought about an increase in income, which led to increased investment in education. As a result, the quality of the labour force in Thailand has improved, indirectly supporting the development of industrial clusters (Suzuki 2008). Former Prime Minister Thaksin Shinawatra mentioned as one of the key industrial policies a shift from labour-intensive industries with low added-value to industries with higher added-value, which may contribute to future development in Thailand. At the same time, the minimum wage was increased by the Cabinet to win votes from

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the poor in the general election. As a result, the minimum wage in Thailand was raised to 175 baht/day in the Bangkok area in 2005, 184 baht/day in 2006, 191 baht/day in 2007, 194 baht/day in January 2008, and 203 baht/day in July 2008. Table 5.1 shows the wage comparison between factories in Thailand and those in Laos. The monthly minimum wage rate in Thailand is fixed at US$160 (203 baht/day * 26 days, 33 baht = US$1). On the other hand, the monthly minimum wage rate in Laos is fixed at $30 (290,000 kip, 9,500 kip = US$1) by a decree of the Prime Minister of Laos, Decree No. 64/PM (2005). That is to say, the minimum wage level in Laos is at no more than one-fifth of the level in Thailand. Factories in Laos in general pay a diligence allowance, meal subsidy, transportation fee, etc. However, factories in Laos do not pay bonuses to workers and only a few factories subscribe to social insurance. Therefore, they pay an average monthly salary of US$45–62 including the above fringe benefits to workers. On the other hand, factories in Thailand must pay workers direct and indirect labour expenses which include a diligence allowance, meal subsidy, bus service/transportation costs, provident fund, accommodation, bonus, dangerous work allowance, uniform, educational subsidy, travel allowance, new year party subsidy, housing subsidy, medical benefits, welfare facilities (such as library or gym). Factories in Thailand are estimated to pay monthly US$300–360 to freshman labourers. As a result, labour costs in Thailand end up being 4.8 to 8.0 times higher than in Laos (US$45–62 dollars including basic salary and fringe benefits). According to the author’s questionnaire survey of Japanese-affiliated companies in Laos, the average salary including allowances is no more than 50 baht/day. In other words, the average wage level in Laos is no more than one-third to onefifth of the level in Thailand, suggesting that Laos is significantly attractive for labour-intensive industries. In Thailand, it is becoming more difficult for factories to recruit sewing-machine workers at the minimum wage. Car assembly companies like Toyota give an annual eight-month bonus to workers. On the other hand, factories in the garment industry provide at best a one- to two-month bonus. Therefore, labour tends to move from low-tech industries like garments to hightech industries like the automobile industry. In addition, factors such as the ageing of workers, aggressive action by labour unions, and

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Item

Total US$

Total Thai Baht

Bonus Long Service Award Shift Allowance Dangerous Allowance Uniform In-house Training External Training Japan Training Educational Subsidy Life Subsidy Travel Allowance New Year Party Birth Funeral Housing Subsidy Medical Benefit Welfare Facility(Library, Gym)

Sub-total

Basic salary (Operator) OT Diligent Allowance Meal Subsidy Bus Service/Transportation Fee Social Insurance Provident Fund Dormitory

�

�

Total = US$300–360

10,000–12,000 baht/Month

500 baht/baby up to 2 babies 10,000 baht for death

Basic education/Safety seminar

1−8 months

US$207–225

3 per cent of Salary

Total = US$45–62

none

none none none none none none none none none none none none none none none none none

US$45–62

US$5 US$5–0 US$5 5 per cent of Salary

Lao Factory 290,000 kip/Month → US$30

Thai Factory 203 baht/Day → 5,278 baht/Month → US$160 � 400~600 baht/Month → 12~US$20 US$10~US$20 US$20

Source: Suzuki, Yamada, and Phonmathit (2008).

23 24 25

10 11 12 13 14 15 16 17 18 19 20 21 22

1 2 3 4 5 6 7 8

TABLE 5.1 Direct and Indirect Labour Cost Compared between Thailand and Laos

4.8–8.0 times

3.3–5.0 times

5 times

Wage Gap

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well-established social welfare insurance place upward pressure on direct and indirect labour costs.

Five Types of Fragmentation for Sub-regionally Complementary (SRC) Industrialization In Thailand, industrial clusters have developed with changes in their quality and size by “path dependency”, which means that future outcomes might depend on historical contingency, experience, accumulation, etc. (Hiratsuka and Ishido 2006). Suppliers must locate near anchor firms to respond to their requests promptly and precisely (Hiratsuka 2006). This is because the more economic activities agglomerate into the geographical boundary, the more production costs decrease. Or, the nearer the industrial clusters to the location of factories, the more production costs decrease (Kimura 2003, p. 109). In the case of the automobile industry, eight Japanese car assembly companies (Toyota, Honda, Nissan, Matsuda, Mitsubishi, Suzuki, Isuzu, and Hino) have operated in Thailand. Approximately 1,300 supporting firms supply parts to them. Although thousands of super lightweight parts are incorporated into advanced high-tech products such as cars, cameras, cellular phones, DVDs, and computers, some of them are not necessarily produced in the capital-intensive process (Suzuki 2004). Rather, some parts or some production blocks for producing a certain kind of part are suitable for labour-intensive production methods. The author proposes five different types of fragmentation (four vertical fragmentation and one vertical product differentiation) which deepen sub-regional complementary industrialization. The common feature is to shift all or a part of labour-intensive production blocks losing their comparative advantage in industrialized Thailand to Laos.

(1) Vertical Fragmentation between Pre- and FinalAssemblies (Direct Export from Laos to the World through Bonded Transport in Thailand) This is an international vertical production network which allocates the relatively capital-intensive pre-assembly process in Thailand, and the relatively labour-intensive final assembly process in Laos. For example, production blocks for automobile wire harnesses consist of eight blocks

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in total, four for pre-assembly and four for final assembly. The four pre-assembly blocks are: (1) cutting (to cut electric wire), (2) crimping, (3) jointing, and (4) offsetting (completion). The four final blocks consist of (5) sub-assembly, (6) layout/wire routing, (7) assembly taping, and (8) inspection. For the sake of simplicity, the author assumes that the process for producing parts consists of only four production blocks (PB1–PB4). Mother factories located at the core supply all the materials to their second factories at the periphery (Figure 5.1). The Lao government does not impose import tariffs on these materials because they are to be re-exported from Laos after processing. After processing at the second factories parts will be re-exported (Type 1) from Laos to the world through bonded transport in Thailand.

FIGURE 5.1 Vertical Fragmentation between Pre- and Final-Assemblies (Direct Export from Laos to the World through Bonded Transport in Thailand)

Lao Second Factory PB3

Periphery

PB4 (Inspection) Final Assemblies

No tax / No tariff on imported material & parts

National Border Thai Mother Factory

PB1

PB2

Pre-Assemblies

Core

PB3

Bonded transportation Through Thailand

PB4 (Inspection)

Final Assemblies Export to the World [Type 1]

Note: PB Production Block. Source: Author.

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(2) Vertical Fragmentation between Pre- and Final Assemblies (Supply for Assembly Factories in the Core) In this model, parts processed at the second factories in Laos are exported to assemblers located in Thailand (Figure 5.2). Thai assemblers then export their products incorporating those parts to the world (Type 2) or, may sell them at the domestic markets in the core (Type 3). In the former case (Type 2), the Thai Government waives import tariffs for parts imported from Laos or refunds them afterwards. But in the latter case (Type 3), the Thai Government imposes import tariffs on them.

FIGURE 5.2 Vertical Fragmentation between Pre- and Final-Assemblies (Supply for Assembly Factories in the Core)

Periphery

Lao Second Factory PB3

No tax / No tariff on imported material & parts

PB4 (Inspection) Final Assemblies

National Border Thai Mother Factory

PB1

PB2

Pre-Assemblies

Core

PB3

Assembly Makers

PB4 (Inspection)

Final Assemblies

Domestic Market [Type 3]

Export to the World [Type 2]

Note: PB Production Block. Source: Author.

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(3) Boomerang-Type Vertical Fragmentation In the boomerang-type vertical fragmentation, after completion of the final assembly process (PB3) in Laos, these processed parts are transported to the Thai mother factories where inspection (PB4) is undertaken. This is referred to as “boomerang-type” vertical fragmentation because the parts go back and forth between Thai mother factories and Lao second factories (Figure 5.3). After Thai mother factories inspect parts processed at Lao second factories, Thai mother factories export them to markets throughout the world (Type 4). In the case of Type 4, the Thai Government waives import tariffs for parts imported from Laos or refunds them afterwards. Alternatively, Thai mother factories sell the parts to Thai assemblers. Thai assemblers may export their products which incorporate those parts to markets throughout the world FIGURE 5.3 Boomerang-Type Vertical Fragmentation

Periphery

Lao Second Factory PB3

No tax / No tariff on imported material & parts

Final Assembly

National Border Thai Mother Factory

PB1

PB2

Pre-Assemblies

Core

PB3

PB4

Assembly Makers

Domestic Market [Type 6] Export [Type 5]

Inspection Export to the World [Type 4]

Note: PB Production Block. Source: Author.

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(Type 5), or sell them in domestic markets in the core (Type 6). Tokyo Coil (Laos) Co. Ltd and Asahi Maxima (Laos) Co. Ltd come under Type 4. These two companies export their parts to world markets through Thailand. Thailand’s Board of Investment waives import tariffs on them after consultation with these companies. Vientiane Automation Product Co. Ltd, to which Yazaki provides technical assistance, comes under Type 6. After the final assembly process (PB3) in Laos, the Thai mother factory (Yazaki) conducts an inspection of the parts imported from its second factory, and supplies them to final assemblers like Toyota in Thailand. The Thai government imposes import tariff on these parts from Laos.

(4) Vertical Product Differentiation Figure 5.4 shows the mechanics of vertical product differentiation. In this type of division of labour, some items in products such as apparel or hats at the higher end of the product line that need a higher level of production skill, are produced in Thailand. On the other hand, other items requiring a lower level of production skill or more labour-intensive production processes are produced in Laos. Under this arrangement, a whole line of items with highly labour-intensive or a lower level of skill production will be shifted from Thailand to Laos. Then, Lao second factories in the periphery receive only a reward for labour service as “processing on commission”, from Thai mother factories. The Lao government does not impose import tariffs on materials imported from Thailand, because all the processed products are to be exported from Laos. After inspection of the products at the second factories in Laos is completed, they are exported to world markets with bonded transportation through Thailand (Type 7). Many factories such as Lao Yamaki Co. Ltd, Craft Industry Co. Ltd, Universal Hat Co. Ltd, etc. come under Type 7. Lao Shoes Co. Ltd, for example, closed its factory at Chiang Mai because of increased production costs. Its mother factory relocated to China. Then the company imports materials like leather from China and India and exports shoes from Laos to Japan under the General System of Preferences (GSP), which exempts import tariffs. There is no doubt that the experience of factory operations in Chiang Mai promoted its FDI to Laos. Sante Lao Co. Ltd has its mother factory at Huangshi Shi, Hebei Sheng in

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FIGURE 5.4 Vertical Product Differentiation

Periphery

Lao Second Factory

Item 2

PB1

PB2

PB3

PB4

No tax / No tariff on imported material & parts

National Border Thai Mother Factory

Item 1

PB1

PB2

PB3

PB4

Item 2

PB1

PB2

PB3

PB4

Core

Bonded Transportation throughThailand

Export to the World [Type 7]

Note: PB: Production Block. Source: Author.

China, where 7,000 workers are employed. However, it established its second factory at Vientiane because of wage increases and difficulty in recruiting factory workers who operate sewing machines. For apparel (HS Chapter 62), the government of Japan grants GSP privileges only to factories operating in LDCs provided that the garment is sewn from fabric in these countries. The government of Japan does not grant GSP privileges to China in the field of apparel production under HS Chapter 62. Therefore, it is expected that a great number of garment factories in China will shift to Laos.

(5) Vertical Fragmentation among Three Countries In this model, the relatively capital-intensive pre-assembly process is placed in China, and the relatively labour-intensive final assembly

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process is in Laos. Following these processes, parts processed at the second factories in Laos are shipped to parts or to assembly factories located in Thailand (Figure 5.5). Note that this is vertical fragmentation among three countries. Then if Thai parts factories re-process their parts imported from Laos and export them to world markets (Type 8), the Thai Government does not impose import tariffs on them. On the other hand, if Thai assemblers sell their products at the domestic markets, the Thai Government imposes import tariffs on them. Moreover, there are cases where Thai assemblers may export their products in world markets (Type 9), or sell their products in domestic

FIGURE 5.5 Vertical Fragmentation among Three Countries

Chinese Mother Factory

Core: China

PB1

PB2

Pre-Assembly

PB4 (Inspection)

PB3

Final Assembly

National Border Periphery: Laos

No tax / No tariff on imported material & parts

Lao Second Factory PB3

PB4 (Inspection) Final Assembly

National Border Assembly Makers

Parts Factories

Core: Thai Export [Type 8]

Export [Type 9]

Core Market [Type 10]

Note: PB: Production Block. Source: Author.

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markets (Type 10). TSB Laos Co. Ltd comes under Types 9 and 10. It plans to undertake the pre-assembly process in China and the final assembly in Laos. Then, its parts are shipped to Fujikura Thailand Co. Ltd. Finally, Fujikura Thailand Co. Ltd supplies the re-processed parts to Canon Thailand.

III. FUNCTIONS OF THE MOTHER FACTORY IN INDUSTRIAL CLUSTERS Suzuki and Keola (2005) and Suzuki (2008) emphasize that mother factories operating in the industrial clusters would not be closed as long as they enjoyed agglomeration economies. On the other hand, the mother factories have at least the seven functions shown below. The author proposed that second factories be established in Laos and that the production of labour-intensive parts in which Thailand is losing its comparative advantage be shifted there (Suzuki 2004, pp. 25–26). Mother factories have the following functions: 1. Function as strategic headquarters. It is always the mother factory in Thailand that functions as the strategic headquarters. The mother factory allocates each production facility in the region — in view of AFTA (ASEAN Free Trade Area) and other regional frameworks — so that efficient configuration of a global value-chain is achieved. 2. Transaction cost-related governance function. This function can be demonstrated by maintaining mother factories in Thailand where industrial clusters have been relatively developed. If a mother factory in Thailand is located in an industrial cluster and saves on “costs for searching for trading partners as well as those for negotiations and coordination” (Mika Takaoka 1998, p. 111), transaction costs for the second factory in Laos will also be reduced (Suzuki 2008). 3. Supply and demand coordination function. Mother factories in Thailand perform the function of accepting orders from customers, passing them on to second factories in Laos and relaying detailed instructions according to the customers’ requests. Mother factories can achieve an “effective connection” (Weber 1922) by fulfilling both transaction cost-related governance functions and supply and demand coordination functions (Takaoka 1998). If a company establishes a parts manufacturing factory separately in Laos — which

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5.

6.

7.

129

is far from the finished goods market in Thailand — it may lack access to the market information and may have to find customers by itself. Mother factories in Thailand can fill such an information gap, reduce transaction costs and coordinate supply and demand (Suzuki 2008). Selling function. Materials used at second factories in Laos are imported from mother factories in Thailand, and all the parts processed in accordance with the instructions given by mother factories in Thailand are exported to mother factories in Thailand. In other words, mother factories have two functions: one to supply materials to second factories in Laos, and the other to import produced parts from second factories. Moreover, mother factories in Thailand have a “selling function” to deliver their products to companies manufacturing finished goods, after further processing parts imported from second factories in Laos or combining them with other parts produced by themselves. Fund-raising function. Savings rates are low and interest rates are high in Laos, resulting in high fund-raising costs in the country. Mother factories also raise funds for constructing and operating second factories. Technology transfer function. Laos lacks technical and management abilities. These deficiencies need to be compensated for by foreign managers, engineers and trainers sent by mother factories. Foreign companies in Thailand, including Japanese-affiliated companies, have trained Thai managers, engineers and trainers over many years. If these Japanese-affiliated and other foreign companies bring Thai trainers to Laos, communication can be facilitated due to similarity in their languages and it will speed up the transfer of technology (Suzuki and Keola 2005). Training function. Mother factories in Thailand play a significant role in training. Workers who are expected to work at second factories in Laos can be trained in advance at the mother factories in Thailand. Alternatively, intensive training programmes can be offered at mother factories in Thailand to Lao workers in the event that there are model changes, etc. In these aspects, Laos has an advantage over Cambodia, Vietnam or Myanmar as a site for establishing second factories.

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IV. DECISION-MAKING TO IMPLEMENT SUB-REGIONALLY COMPLEMENTARY FRAGMENTATION Our concern lies in the conditions under which mother factories in the core establish their second factories in the neighbouring periphery with a small domestic market through vertical production networks. Krugman and Venables (1995) discussed a core-periphery model with incorporation of the concept3 of transportation costs between the core and periphery. Anderson and Wincoop (2004) and Hiratsuka, Keola, and Suzuki (2008) consider “trade costs” as all costs incurred in getting goods to final users other than the marginal costs of producing the good itself. But the cost of quality control and management coordination, etc., incurred in fragmentation are ignored in these studies. Petersson (2003), Arndt and Kierzkowski (2001), Ando and Kimura (2003, 2005), and Kimura (2007) stress the definite importance of the “service link costs” in the context of fragmentation. The author defines the “trade service link costs” in the context of sub-regionally complementary production networks as follows. (1) Freight costs and accompanying time costs (2) Charges in export and import procedures and accompanying time costs (3) Policy barriers (tariffs and non-tariff barriers) (4) Communication costs (including different language barriers) (5) Different currency barriers (6) Contract enforcement costs (especially important in case of arm’s length transactions) (7) Quality control, management coordination, and the timing and matching of supplies The mother factories decide to establish their second factories in the periphery country, if total production costs with fragmentation are less than the mother factories’ total production costs without fragmentation. Kimura (2007, pp. 20–21) assumes that the cost structure of production is presented as in Figure 5.6. Namely, constant variable costs with and without fixed costs are displayed by two kinds of an upward-sloping line. Production costs saving per se is found in the difference in slope between production with and without fragmentation. The service link

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costs come in only in the case of fragmentation. Consequently, the total cost curve without fragmentation (curve A) crosses that with fragmentation at point T (or point U). In this setting, if mother factories in the core country relocate their machinery and facilities to the second factories in the periphery country, set-up costs of the second factories will decrease by α, because they need not purchase new machinery and facilities to install at second factories. Thus, the total cost curve shifts to C downwards. On this occasion, the timing of fragmentation will take place earlier (T→S). FIGURE 5.6 Total Costs before and after Fragmentation Total Cost

(A) No Fragmentation (B) Fragmentation U α

(C) Fragmentation with Line Facility

V (D) Fixed Costs (E) Fixed Costs of Fragmented Line Facility

α S

T

Output

Source: Author based on Kimura (2006, p. 20).

V. DEPLOYMENT TO THE THIRD FACTORIES Venables (2005) shows how a number of economic interactions decline with distance (Table 5.2). The trade volume is estimated using the gravity model. The numbers in the Table indicate that doubling the distance from 1,000 km to 2,000 km reduces trade flows by more than half; at

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TABLE 5.2 Economic Interactions and Distance Distance

Trade

Equity flows

FDI

1000km 2000km 4000km 8000km

1 0.42 0.18 0.07

1 0.55 0.31 0.17

1 0.75 0.56 0.42

Note: Relative intensity of economic interaction at 1000 km. Source: Venables (2005).

4,000 km, distance trade volumes are down by 82 per cent. In a study on cross-border equity transactions, Portes and Rey (1999) found that equity flows at 8,000 km are less than one-fifth of those at 1,000 km. Foreign direct investment (FDI) flows were studied by Di Mauro (2000) who found a less steep decline, although international flows more than halve as distance goes from 1,000 km to 8,000 km. A gravity model assumes that the volume of trade between two countries increases in proportion to the size of their economies and in inverse proportion to distance. Then trade volume decreases as the geographical distance increases. Therefore, the geographical proximity of the second factories and the mother factories will help to keep transport costs down and thus will increase trade and other linkages. Foreign factories are first established in Bangkok or its suburbs. As production costs including wages increase, companies move and construct their second factories in neighbouring areas like Ayuttaya. Thereafter, some shift to Lamphun, near Chiang Mai or other industrial estates in the northeastern region where wages are cheaper and better incentives are offered by the Thai Government. The following are examples of such firms: • Tokyo Coil (Thai) Co. Ltd has been operating at Lamphun Industrial Park near Chiang Mai with tax incentives. • Since the Thai Yazaki Group established its first factory in 1962, it has grown into a sizeable group enterprise of seven factories employing 11,600 workers. Its headquarters were originally located

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in metropolitan Bangkok, and the company subsequently established factories at Samutptakarn, Chachoengsao near Bangkok, and Phitsanulok in central Thailand. • Thai Yamaki Co. Ltd has a factory at Nakhonpathom 60 km south of Bangkok. It should be noted that trade service link costs fall to a considerable extent when mother factories in Bangkok or its suburbs establish their second factories in provincial areas in Thailand and then establish third factories in Laos. As the geographical distance between the northern region of Thailand and the Mekong River watershed is not significantly great and there are strong similarities in the culture and language of the two regions, communication costs for second factories located in central Thailand inevitably fall considerably. If border-related trade barriers associated both with contractual enforcement problems and corruption were mitigated, sub-regionally complementary trade and investment would definitely increase.

VI. FOUR-STAGE PROCESS IN SUB-REGIONALLY COMPLEMENTARY INDUSTRIALIZATION Sub-regionally complementary industrialization is thought to pass through a four-stage process (Figure 5.7). After promulgation of the Law of Promotion and Management of Foreign Investment in 1988, FDI inflow to Laos has increased gradually. The main investors were Thai companies, accounting for nearly half of total FDI inflow. The first stage of industrialization is processing on a commission based on product differentiation (in the garment sector). The main investors are from the garment sector which exports all garment products to the EU under the General System of Preferences (GSP) scheme. China is becoming a less attractive site for labour-intensive industries due to increases in wages. In addition, the government of Japan does not grant GSP concessions for apparel (HS Chapter 62) made in China. Therefore, some Japanese companies are expected to shift their factories from China to Laos. The main actors of the first stage are approximately eighty Thai and Chinese garment factories as well as Japanese factories such as Craft Industry, Union Yagi, Lao Yamaki, Universal Hat, and Maruhachi.

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FIGURE 5.7 Four Stages Industrialization Processes of Laos

Industrial Clusters in China

1st Stage Core/Periphery Processing on Commission Type (Garment)

Industrial Clusters in Vietnam

2nd Stage Core/Periphery Labour-intensive Fragmentation

3rd Stage Sub-regionally Complementary Labour-intensive Fragmentation

4th Stage Sub-regionally Complementary Intra-Parts Industrial Clusters

Industrial Clusters in Thailand Source: Author based on Kimura (2007, p. 20).

The second stage of industrialization is the core/periphery fragmentation. This is a configuration of an international vertical production network. Parts industries supporting automobiles, electric appliances, and electronics industries retain the relatively capital-intensive preassembly process in Thailand, and shift the relatively labour-intensive final assembly process to Laos. Consequently, the total production costs fall and the industrialization of Laos is promoted. The main actors are Tokyo Coil Laos Co. Ltd, Vientiane Automation Product (Yazaki), Asahi Maxima, etc.

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The third stage of industrialization is sub-regionally complementary labour-intensive fragmentation which covers the border areas. The difference between the second and third stages is that the former is fragmentation covering Thailand and Laos, while the latter is subregionally complementary fragmentation covering a broader area, namely transactions between Thailand and Laos, China and Laos, or Vietnam and Laos. Wage levels in China and Vietnam are also rising, and labour unions are relatively active and radical. The governments in those countries also tend to introduce new taxes or fees without consultation. Therefore, the strong cost push and worsening investment climate in the neighbouring countries compel labour-intensive final assembly to relocate to Laos which has the advantage in cheap labour with passive labour union activity. Sante Lao Co. Ltd, which was established in January 2008, has its mother factory at Huangshi Shi, Hebei Sheng in China. It plans to import materials like fabric from its mother factory in China and to export garments from Laos to Japan with GSP concession granted by the Japanese government. Mani Laos Co. Ltd (medical parts producing company), which registered its investment licence in January 2008, plans to shift 40–55 out of 60 production activities from Vietnam into Laos. It plans to import materials from its mother factory in Vietnam and to export processed parts from its Lao second factory to its Vietnamese mother factory. After final inspection in the Vietnamese mother factory, it will export all parts to the world market. TSB Laos Co. Ltd, which applied for an investment licence in February 2008, has a Chinese mother factory. It keeps the relatively capital-intensive pre-assembly process in China, and shifts the labour-intensive final assembly process to Laos. After processing parts, the Lao second factory will export them to Kurabo Thailand Co. Ltd. The fourth stage of industrialization is sub-regionally complementary industrial clusters where factories supply materials and unfinished parts to one another. At this stage, the number of Lao second factories separated from mother factories in Thailand, China and Vietnam increases considerably, and industrial clusters, mainly consisting of parts-processing second factories, are formed in Laos. In addition, industrial linkages are formed as second factories use raw materials such as copper, bauxite and gold, mined in Laos.

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VII. COLLECTIVE EFFICIENCY AND JOINT FORUM Collective Efficiency Schmitz (1999) discussed why and how the clustering opens up efficiency gains which individual enterprises can rarely attain (Schmitz 1995, Rebelloti 1997, Nadvi 1999a). These gains are captured in the concept of collective efficiency, defined as the competitive advantage derived from local “external economies” and “joint action”. Citing Brusco (1992), Nadvi (1999b) introduces the importance of collective services provided by local business associations in the development of SME-dominated Italian industrial districts. Best (1990) also drew from the Italian experience to highlight the influence of associations such as providing local producers with a wide range of managerial, financial, business and technical services. Nadvi and Schmitz (1994) introduce examples of business associations that undertake significant tasks, both in lobbying government in the interests of their members and in providing a range of producer, technical and advisory services to clustered firms. According to Moore and Hamalai (1993) and Nadvi (1999b), business associations perform a wide range of functions including providing a political voice and a range of concrete business services such as seminars, information and library services, exhibitions and trade fairs, foreign contacts, contract adjudication, specialized legal advice and assistance, and certification of documentation and of product quality. They also provide an arena for social contact between members as well as an arena and “cover” for cartel arrangements, and they participate in the framing and/or implementation of public policy, including the performance of regulatory duties.

Lao National Chamber of Commerce and Industry The Lao National Chamber of Commerce and Industry was established in 1989 with 895 members initially; presently the organization has 11 groups and 14 associations. The organization aims to help promote local businesses and develop better relations and cooperation with its foreign partners in the region. The principal responsibility of the chamber

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board is to maintain the link between local industries and various governments and agencies aimed at expanding trade and investment. The chamber also seeks to eliminate barriers against the competitiveness of Lao enterprises in the international market (LNCCI 2008) There are three foreign chambers of commerce and industry (Thai, Vietnamese and Cambodian) in Laos. However, a Japanese Chamber of Commerce and Industry has not yet been established. The Lao Business Forum and Lao-Japan Public and Private Sectors Joint Dialogues provide valuable opportunities for solving problems which foreign companies encounter in the Lao business environment.

Lao Business Forum The Lao Business Forum was launched in March 2005 by the Mekong Private Sector Development Facility (MPDF) sponsored by the International Finance Corporation (IFC) in collaboration with the government’s Committee for Planning and Investment and the Lao National Chamber of Commerce and Industry. Its main goals are to promote business in the country by establishing a favourable environment conducive to business and by providing a platform for dialogue between business and government, as well as facilitating information-sharing with potential investors (Ann Bishop 2007). The Lao Business Forum has three functions. The first is to identify common problems facing a particular sector and propose possible solutions. This is done by working groups and is open to anyone from the private sector. The second is to identify top priority issues that the working group and related government officials agree to resolve. This is done by a government-appointed inter-ministerial team and representatives from each of the working groups. The third is to show what has been achieved or is under discussion, relevant research, and issues that need consideration by the highest levels of government. This involves formal business forums held twice a year and these are chaired by the country’s Deputy Prime Minister.

Lao-Japan Public and Private Sectors Joint Dialogues On 4 December 2007, the First Meeting of the Lao-Japan Public and Private Sectors Joint Dialogues was held in Vientiane with Laos’ Ministry

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of Planning and Investment and the Embassy of Japan, in collaboration with JETRO Bangkok and JBIC Bangkok and JICA Laos Office. Participants from the public and private sectors of Japan and Laos discussed problems concerning business operations in Laos and exchanged views. On this occasion, the Japanese side recommended 28 sub-items under 11 items to the Government of Laos (Table 5.3). The eleven items are (1) Legal and policy transparency and predictability, (2) Deregulation, (3) Procedures for permission and approvals, (4) Taxation and accounting, (5) Public utility charges, (6) Land use, (7) Labour, (8) Preferential treatment for foreign investment (Special Economic Zone), (9) Logistics, (10) Protection of intellectual property rights, and (11) Relations with the provinces. Regarding item 6 on land use, for example, Prime Minister Bouasone Bouphavanh announced at the National Assembly on 9 May 2007 that the government would stop approving land concession for investors on an indefinite basis, or until a more comprehensive strategy could be devised. Prime Minister Bouasone explained at the national land meeting that the government would stop approving land concessions for both local and foreign investors involving land of 100 hectares or more for industrial, perennial plants and mining. He emphasized that the government would strongly promote the “2+3” policy — i.e. 2 means natural resources and farmers in Laos, and 3 means foreign capital, management, and foreign markets, which determines allocation of benefits between investors and villagers — to ensure that all investment projects have the potential to benefit local people. This 100-hectare policy came out of infinitive provision of land concessions to investors which caused serious deforestration and soil deterioration. According to Japanese agricultural companies who want to invest in Laos, a minimum 2,000-hectare field is needed to make a positive profit in planting vegetables and fruits like okra, asparagus, mango, etc. As Japanese agricultural investors can get only a 100-hectare national land concession under the 100-hectare policy, they must negotiate with 1,900 farmers respectively to make contracts for the remaining 1,900 hectare field (Lao farmers possess on average a 1-hectare field). As a result, this transaction cost is too high for Japanese companies to invest in Laos. Before implementation of the 100-hectare policy, some foreign investors who got over 5,000 hectares concession have in fact utilized

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TABLE 5.3 Action Recommendations Proposed at the First Meeting of the Lao-Japan Public and Private Sectors Joint Dialogues 1. Legal and policy transparency and predictability (1) To clarify and make public the responsible governmental departments in charge of granting the necessary official licences and approvals (2) To make public the laws and regulations as well as measures concerning investment, e.g. favourable treatment for foreign companies, in an easily accessible way. For instance, it will be useful to update the website of the Lao Government in a timely way and to issue an official gazette (3) To give prior notice to the public well in advance when laws and regulations as well as measures concerning investment are newly adopted or modified. For the sake of the directly-affected companies in particular, it will be desirable to give them prior explanations individually and then seek their opinions (4) To apply these laws and regulations as well as measures concerning investment to investors in an impartial and fair fashion at all governmental levels including the implementing bodies (5) To ensure consistency among laws and regulations concerning investment 2. Deregulation (6) To clarify and ease regulations on foreign capital and broaden the sectors which are 100 per cent open to foreign capital participation 3. Procedures for permission and approvals (7) To simplify procedures for visas and work permits (8) To simplify procedures for licences and approvals, such as land use licenses, business licences and import/export licenses, as much as possible at every stage for realizing investment in Laos, and to reduce the number of licences and approvals as well as the time it takes for them to be granted (9) To introduce a one-stop service across the country to facilitate procedures 4. Taxation and accounting (10) To clarify and make fair the tax collection system and to tighten control of double collection and irregularities (11) To exercise no unjustified discrimination among investors from all foreign countries with respect to custom duties and taxation (12) To give a sufficient explanation in advance regarding the transition from the current turnover tax to the future VAT, and to implement VAT in an impartial and consistent way once it comes into force (13) To harmonize the accounting standards with international standards

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TABLE 5.3 (Cont’d) 5. Public utility charges (14) To abolish the dual pricing system for foreign businesses 6. Land use (15) To lift the temporary ban on licences for more than 100ha of land use, still in effect since last May, as early as possible and to clarify procedures for land use licences that are to be newly issued (16) To inspect the ways in which land that was already granted the use license have been used and to confirm that their use is appropriate 7. Labour (17) To further strengthen governmental efforts for developing human resources, including Japanese and English language education, and to make good use of these human resources (18) To ensure reasonable flexible business operations as to employment/ dismissal and working hours 8. Preferential treatment for foreign investment(Special Economic Zone) (19) To make efforts to improve the Savan-Seno Special Economic Zone while making effective use of existing infrastructure for establishing industrial parks (20) In addition to the development of the Savan-Seno Special Economic Zone, to make efforts to improve the systems and infrastructure in the suburbs of the capital Vientiane while maintaining the importance of the establishment of the Special Economic Zones 9. Logistics (21) To simplify systems and procedures concerning custom clearance and immigration control so that investors will be able to conduct business more easily; for example, it is desirable to increase the number of one-stop shops along the borders with Vietnam and Thailand (22) To coordinate logistics with Thailand and Vietnam so that a change of vehicles and reloading of merchandise from one vehicle to another at the borders will be unnecessary, thus facilitating logistics (23) To improve the logistics network and make better related systems and infrastructure in the suburbs of the capital Vientiane (24) To revise existing aviation agreements to ensure the operation of large aircraft capable of transporting large-sized containers (= increase the capacity of aircraft ) in view of the outcome of the ASEAN transport ministers’ meeting on 1 November 2007 concerning the opening of the airways to link capital cities by the end of 2008

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TABLE 5.3 (Cont’d) (25) To try to resolve the issue concerning one-way loading of container trucks by consulting with the neighbouring countries 10. Protection of intellectual property rights (26) To make further endeavours to exercise necessary controls and regulatory measures regarding the infringement of intellectual property rights 11. Relations with the provinces (27) To ensure that the authority to issue licences and approvals, including certificates of origin, is transferred to provincial governments as much as possible and that necessary procedures can be locally processed smoothly by companies doing business out of the capital city to relieve them of the burden of travelling to the capital Vientiane each time they need to clear license- and approval-related procedures at central governmental ministries (28) To improve transportation infrastructure facilities, including airports, outside the capital Vientiane Source: Embassy of Japan in the Lao PDR (2007).

only 20–30 per cent of the total concession land. The government must investigate for what objectives the lands that were already granted the land use licence have been used and then make sure of their proper use (e.g. environmental protection). The government should urge them to return unutilized land, and reallocate land to other potential foreign investors efficiently to promote employment and export. Alternatively, the government is requested to lift the temporary ban of the licence for more than 100-hectare land use, still in effect since last May, as early as possible, and then clarify the procedures for land use licence that are to be elaborated. The Japanese side requested the Lao side to follow up the abovementioned points at the working level of both countries and, in order to respond to them, they drafted and presented the Action Programme at the second meeting of the Lao-Japan Public and Private Sectors Joint Dialogues in 2008 (Embassy of Japan in the Lao PDR 2007). This is a real outcome of joint action. Even though individual firms complain about the problems to the government, such action might be disregarded. Thus, it was an important opportunity for both Japan and Laos.

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VIII. CONCLUSION The author discussed the development strategy of Laos. It is desirable for Laos to industrialize the country through sub-regionally complementary fragmentation. There are mainly two reasons in support of this. First, an import substitution strategy is not suitable for Laos as it has a small population and limited domestic demand. Second, both domestic and foreign factories operating in Thailand are plagued with surges in production costs. If they establish second factories in Laos through fragmentation, unemployment in Laos will be reduced. In 2007, Thaisin Southeast Asia Import Export Co. Ltd closed its factories, and dismissed 5,000 workers in Thailand. Some factories of the Saha Union Group also closed their factories in 2007. According to the Association of the Thai Garment Industry, more than 20 factories among about 500 member companies were forced to shut down operations in 2007. As a result, approximately 300,000 workers would lose jobs. Thailand is rapidly losing its advantage of cheap labour. If an international vertical production network is formed by placing the relatively capital-intensive pre-assembly process in Thailand and relatively labour-intensive final assembly process in Laos, or by vertical product differentiation, industrialization will be promoted and at the same time the unemployment problem in Thailand may be alleviated to some degree. To realize this, however, mother factories and their final assemblers operating in Thai industrial clusters must capture higher competitiveness and upgrade their value-added activities. It requires upgrading of unskilled labour, and the number of specific skilled labour, engineers or technical experts needs to be increased. This subregionally complementary industrialization strategy will then lead to mutual benefits to neighbouring countries.

Notes 1. Lipton (1977) argued urban bias from the critical standpoint. 2. Arthur (1994) discussed lock-in effects which have either a positive or negative impact on economic units operating in the clusters. Positive lock-in effects may restrain divestment of individual companies out of the clusters or promote entry of a larger number of companies into clusters.

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However, once clusters are established, the negative lock-in effects may prevent motivation to reform or to innovate from clusters. 3. Hiratsuka, Keola and Suzuki (2008). Krugman and Venables (1995) claim that when transportation costs (broadly defined) fall to the level where location advantage of low wage rates in the periphery offsets its disadvantages of being remote from market and suppliers, manufacturing in the core will move to the periphery (Hiratsuka, Keola and Suzuki 2008).

References Aizenman, Joshua, and Nancy Marion. “The Merits of Horizontal versus Vertical FDI in the Presence of Uncertainty”. Journal of International Economics 62 (2004): 125–48. Anderson, James E. and Eric van Wincoop. “Trade Costs”. Journal of Economic Literature XLII (2004): 691–751. Arndt, S.W. and H. Kierzkowski. Fragmentation: New Production Patterns in the World Economy. Oxford: Oxford University Press, 2001. Arndt, S.W. and H. Kierzkowski. “Introduction”. In Fragmentation: New Production Patterns in the World Economy, edited by S.W. Arndt and H. Kierzkowski. Oxford: Oxford University Press, 2001. Audretsch, D.B. and M. P. Feldman. “R&D Spillovers and The Geography of Innovation and Production”. American Economic Review 86, no. 3 (1996). Best, M. The New Competition: Institutions of Industrial Restructuring. Cambridge: Polity Press, 1990. Bishop, Ann. “IFC Sponsors Lao PDR’s First Business Forum”. Lao Business Forum 2007, . Brusco, S. “The Emilian Model: Productive Decentralisation and Social Integration”. Cambridge Journal of Economics 6 (1982). Deardorff, Alan V. “Fragmentation in Simple Trade Models”. Presented in a session on Globalization and Regionalism: Conflict or Complements?”. North American Economics and Finance Association, Chicago, 1998. Di Mauro, F. “The Impact of Economic Integration on FDI and Exports: A Gravity Approach”. CEPS Working Document no. 156 (2000). Embassy of Japan in the Lao PDR. Press release “Action Recommendations from the Japanese Side — For Further Enhancing Investment from Japan to Laos”, The Lao-Japan Public and Private Sectors Joint Dialogues: the First Meeting, 4 December 2007. Ernst, D. and L. Kim “Global Production Networks, Knowledge Diffusion, and Local Capability Formation”. Research Policy 31 (2002): 1417–29.

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Fujita, M., P. Krugman and A. Venables. The Spatial Economy: Cities, Regions, and International Trade. Cambridge, MA: MIT Press, 1999. Fujita, Masahisa, P. Krugman and Tomoya Mori. “On the Evolution of Hierarchical Urban Systems”. European Economic Review 32 (1999): 209–51. Giroud, Axele. “Vietnam in the Regional and Global TNC Value Chain”. Paper prepared for the DFID Workshop on Globalisation and Poverty in Hanoi, Vietnam, 23–24 September 2002. Hanson, Gordon H., Raymond J., Mataloni, Jr., and Matthew J. Slaughter. “Vertical Production Networks in Multinational Firms”. NBER Working Paper no. 9723 . Hiratsuka, D., Keola Souknilanh and Motoyoshi Suzuki. “Industrialization Through Vertical Production Networks: Can Laos Participate in Vertical Production Networks?”. In East Asia’s Economic Integration, edited by Daisuke Hiratsuka and Fukunari Kimura. London: Palgrave Macmillan, 2008. Hummels, David, Ishii Jun and Yi Kei-Mu. “The Nature and Growth of Vertical Specialization in World Trade”. Journal of International Economics 54 (2001): 75–96. Kimura, Fukunari. “The Development of Fragmentation in East Asia and Its Implications for FTAs”. In East Asia’s De Facto Economic Integration, edited by Daisuke Hiratsuka. London: Palgrave Macmillan, 2006. Kimura, Fukunari and Mitsuyo Ando. “Fragmentation and Agglomeration Matter: Japanese Multinationals in Latin America and East Asia”. North American Journal of Economics and Finance 14 (2003): 287–317� ———. “Two-dimensional Fragmentation in East Asia: Conceptual Framework and Empirics”. International Review of Economics and Finance 14 (2005): 317–48. Krugman, Paul. Geography and Trade. Cambridge, MA: MIT Press, 1991. ———. Development, Geography and Economic Theory. Cambridge, MA: MIT Press, 1995. Lall, Sanjaya, Manuel Albaladejo, and Jinkang Zhang. “Mapping Fragmentation: Electronics and Automobiles in East Asia and Latin America”. Oxford Development Studies 32, no. 3 (2004): 407–32. Lipton, M. Why Poor People Stay Poor: A Study of Urban Bias in World Development. London: Temple Smith, 1997. LNCCI. Homepage , 2008 Marshall, Alfred. Principles of Economics. London: Macmillan, 1920. Moore, M. and L. Hamalai. “Economic Liberalization, Political Pluralism and Business Associations in Developing Countries”. World Development 21, no. 12: 1895–912. Nadvi, Khalid. “The Cutting Edge: Collective Efficiency and International Competitiveness in Pakistan”. Oxford Development Studies 27, no. 1 (1999a): 81–107.

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———. “Facing the New Competition: Business Associations in Developing Country Industrial Clusters”. Discussion Papers, International Labour Organization, 1999b. Petersson, Lennart. “Production Fragmentation and Specialization, with Special Reference to the SADC Textile and Clothing Industry”. South African Journal of Economics 71, no. 4 (2003): 762–91. Portes, Richard and Helene Rey. “The Determinants of Cross-Border Equity Flows”. NBER Working Paper no. 7336, 1999. Rabellotti, R. External Economies and Cooperation in Industrial Districts: A Comparison of Italy and Mexico. London: Macmillan, 1997. Schmitz, H. “Small Shoemakers and Fordist Giants: Tale of a Supercluster”. World Development 23, no. 1 (1995). ———. “Collective Efficiency and Increasing Returns”. Cambridge Journal of Economics 23, no. 4 (1999): 465–83. Suzuki, Motoyoshi. “Sub-regionally Complementary Industrialization Policy for the Lao P.D.R”. In The Experience and Prospects of Late-Comer ASEAN Countries, edited by Naoko Amakawa. Singapore: National University of Singapore. Forthcoming, 2008. Suzuki, Motoyoshi and Keola Souknilanh. “Sub-regionally Complementary Industrialization Strategy for Laos under Economic Unity”. Macroeconomic Policy Support for Socio-Economic Development in the Lao PDR Phase 2 Main Report, volume 1, (2005): 25–42. Suzuki, Motoyoshi, Kenichiro Yamada, and Vannada Phonmathit. “Research on Investment Climate Under the Study on Japan’s ODA Taskforce in the Lao People’s Democratic Republic”. Japan Bank for International Cooperation (JBIC), 2008. Stewart, F. and Ejar Ghani. “How Significant Are Externalities for Development?”. World Development 19, no. 6 (1991). Venable, Anthony J. “Economic Geography; Spatial Interactions in the World Economy”. In Oxford Handbook of Political Economy, edited by Barry R. Weingast and Donald Wittman. Oxford: Oxford University Press, 2005. Weber, A. Uber den Standort der Industrien. Tubingen: Verlag von J.C.B. Mohr, 1992.

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6 Export-oriented Garment Manufacturing and Its Impact on Employment, Productivity and Wages in Cambodia and Laos Rajah Rasiah

I. INTRODUCTION Export-orientation as the vehicle to initiate manufacturing growth in the developing economies became significant only since Shannon International Airport in Ireland and later Kaohsiung in Taiwan began attracting foreign firms to assemble and process labour-intensive goods in the 1960s. Import-substitution had dominated early industrialization until then, including in India, Thailand, Malaysia, the Philippines and China. Export-processing zones (EPZ) then sprung up rapidly in many developing economies, with Malaysia developing over ten of them by 1990 to become the country with the most number at that time. Cambodia and Laos entered the fray in the 1990s to develop EPZs.

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Cambodia and Laos developed EPZs from the 1990s to provide the basic infrastructure necessary to complement the preferential access provisions offered by the European Union (through the “everything but arms” clause in 2001) and the United States (through a bilateral trading agreement since 1999). The other developed economies such as Japan and Canada have since followed similar practices. These instruments helped attract massive foreign direct investment targeted at specializing in cut, make and trim (CMT) garment manufacturing operations. The evidence of countries pursuing the EPZ approach to economic development is mixed. Singapore and Ireland managed to stimulate sustained upgrading through a combination of incentives and grants, and the expansion of the requisite supply-side resources such as human capital and R&D labs. However, others such as Bangladesh, the Philippines, Thailand and Indonesia have not managed such a transformation thereby failing to offer households sustained improvements in living standards. Hence, this chapter uses the systemic quad to examine the extent of knowledge depth achieved in garment firms and the impact of their expansion on the households located in the Phnom Penh and Vientiane metropolitan locations, which are the key garment manufacturing regions in Cambodia and Laos. Section II provides literature review. Section III discusses the methodology and data used in the chapter. Section IV examines the strength and cohesion of relationships of four systemic pillars considered the key institutional pillars necessary to drive upgrading in firms and sustainable improvements in employment, productivity and wages. Sections V and VI examine the state of technological intensities and the impact on employment, exports, productivity and wages. Section VII concludes.

II. LITERATURE REVIEW This section introduces the systemic quad to emphasize the importance of the global integration pillar in translating export growth into improvements in employment, income and environmental standards in Phnom Penh and Vientiane. A clusters in this chapter is defined as a regionally networked set of economic agents (firms and institutions) that refer to localized systems connecting all critical economic agents necessary to drive learning,

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innovation and competitiveness. Clusters here are considered to produce the most synergies when all requisite institutions to drive learning, innovation and competitiveness and economic agents are horizontally connected (interdependent interface is important). Clusters can generate an egalitarian network if all participants are effectively networked so that all views are equally embodied in policy formulations. Governments in developing economies tend to accept the public-private partnerships over the egalitarian stakeholder framework because of the interest in growth not realizing that the effective pursuance of it taking account of all members of society is pertinent for balanced development. What is important when examining stakeholders (e.g. government, industry, non-governmental organizations) is not a rigid demarcation of their roles in influencing the conduct of firms and other actors in the clusters. Dynamic clusters are often characterized by actors that enjoy overlapping and changing roles. For example, whereas the industrial technical research institutes in Taiwan played a key role in developing and relocating their research output in firms through incubation activities, firms such as Samsung and Hyundai internalized much of these activities in Korea (see Rasiah et al. 2008; Rasiah and Lin 2005). In addition, governments can promote a particular agglomeration of competence to provide a snowballing effect to attract the relocation of firms or the creation of new ones. Such a role will be purely promotional. Governments can also screen particular clusters and identify bottlenecks, holes and weaknesses to ease, and fill and ameliorate these problems. Such problems can take the form of critical basic infrastructure, high-tech infrastructure, or supplier firms. Given the problems of information asymmetries between government and firms, intermediary organizations such as chambers of commerce, parastatal training institutions and R&D labs often help resolve collective action problems. Interdependent relationships that are driven by the discipline of the market, the participation of government when public goods are involved, and complementation through trust-loyalty to extract social commitment from the humans directing all of them is vital for the development of competitive clusters. Industry-governmentconsumer/labour coordination councils often help form and expand social capital. A combination of lack of firm-level drive, and lack of the requisite human capital and high-tech institutions necessary to stimulate

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innovation and with it competitiveness have often undermined the capacity of such clusters to enjoy sustainable differentiation and division of labour. These are also the prime reasons for the stagnation that has characterized export-processing zones and industrial estates in developing economies. Central to any effort to revive fading industrial concentrations must be a focus on planting the right pillars to stimulate upgrading, innovate, industrial differentiation and new firms. The strategy must be one of mapping regions in terms of firms, institutions, policy framework and their integration with markets (global and local), and to identify the drivers or the lack of drivers that explain the vibrancy of the region. Regions endowed with a dynamic set of economic agents effectively connected and coordinated — firms and institutions with provision of utilities such as power, water, telecommunications, education and training institutions, for example — and R&D labs drive innovation and competitiveness through flows of circular and cumulative causation. What Young (1928), Kaldor (1957, 1977) and Cripps and Tarling (1974) argued at a structural level can be presented in networks terms through the concept of clusters. Frontier clusters (high-tech clusters in Porter’s notion and any dynamic cluster in Best’s definition) are characterized by innovation. The focal point of innovation in a dynamic cluster is essentially the interdependent and interactive flow of knowledge and information among people, enterprises and institutions. It must obviously include coordination between the critical economic and technological agents across value chains who are needed in order to turn an idea into a process, product or service on the market. In dynamic clusters such as the Silicon Valley and Route 128, innovations evolve from a complex set of inter-relationships among actors located in a range of enterprises, universities and research institutes. The execution and appropriation of these innovations inter alia expand further actors in dynamic clusters to intermediary organizations such as suppliers, venture capitalists, property rights lawyers and marketing specialists. The government is a major player providing a significant share of the funding public goods, though, the National Science Foundation (NSF 2003) has warned about a decline in it over the last decade. Government funding comes in the form of research supported in the military, support of research undertaken in firms and other laboratories.

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In the past most efficiently governed industrial estates and EPZs generally only focused on the elements that are listed in the basic infrastructure rectangle (see Figure 6.1). The long-term objective of government policy in these economies has been to ensure sustained increase in labour force participation and wages so that the broader objectives of poverty alleviation and human development are met. The original exponents’ calls to limit the role of government to the provision of excellent basic infrastructure proved to be the shortcoming of the EPZ strategy. Without a policy to ensure learning and innovation, increased integration in the global economy undermined the capacity of these regions to compete against rising wages, the emergence of new sites such as China, and to meet the rising technological deepening requirements in them (e.g. electronics) with deleterious consequences to underemployment, poverty and human development. Lall (2001) was to assert that economies that failed to develop their technological capabilities became losers in the globalization process. Central to the failure of EPZs and industrial estates in developing economies has been the lack of development of an effective enabling environment for technological upgrading, differentiation and division of labour, and new firm and industry creation. Figure 6.1 identifies the critical pillars that drive dynamic clustering. The first central pillar of a dynamic cluster is a strong role by governments (federal or local) to provide stability (macroeconomic, political and security) and efficient basic infrastructure. The second pillar refers to high-tech infrastructure and the institutions coordinating learning and innovation to stimulate technology acquisition and development through learning by doing, licensing, adaptation, training, standards appraisal mechanisms, a strong intellectual property right framework to prevent moral hazard problems facing innovators, and R&D. The second pillar is vital for the continuous upgrading of technological capabilities in the cluster. The third pillar requires that the cluster is globally connected — markets and value chains. Global markets provide the economies of scale and scope and the competitive pressure to innovate. Global value chains assist economic agents in the cluster to orientate their strategies to the critical dynamics that determine upgrading and value addition (see Gerrefi 2002; Gerrefi, Humphrey, and Sturgeon 2005). Examples of such changes include the introduction of cutting edge just-in-time and flexible specialization techniques in electronics, and the proliferation of software

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technology in the use of cad-cam machines, and the interface between firms, assembly activities and the major markets abroad. In Indonesia for example, Texmaco, which is located on an EPZ in the outskirts of Jakarta, responded to the changing nature of global value chains in the garment industry by integration assembly, fashion design, packaging, and logistics to supply brand-name holders. Lacking in institutional support — both basic and high-tech infrastructure — Texmaco has managed to compete globally despite facing tremendous transactions costs in Indonesia. The fourth pillar differentiates a cohesively networked cluster from others defined by truncated operations. Lundvall (1988) expanded the elements of interdependence and interactiveness by articulating the role of producer-user relations in innovation. The nature of interface and coordination between vertically connected economic agents is vital in the horizontal evolution of innovation activities. Connectivity and coordination is critical for knowledge flows — beyond simply codified information that markets can coordinate. Intermediary organizations FIGURE 6.1 Systemic Quad

HIGH-TECH INFRASTRUCTURE Institutions to drive learning and innovation, technology diffusion, licensing, training and R&D

BASIC INFRASTRUCTURE Electricity and water, transport, health care, telecommunications, schools, stability, security, and bureaucratic and customsefficiency

Critical stakeholders

Dynamic Cluster Differentiation and division of labour Upgrading and value addition New firm creation New processes and products

Underdeveloped cluster

INTEGRATION IN GLOBAL MARKETS AND VALUE CHAINS Scope, scale, competition and value chains

NETWORK COHESION Connectivity and coordination — interactive and interdependent social capital

Source: Rasiah (2007a Figure 1).

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such as industry-government coordination councils and chambers of commerce play an important role to increase connectivity and coordination in dynamic clusters. In emerging regions, governments have initiated such platforms (e.g. Penang in Malaysia) (see Rasiah 2002). The appropriation of knowledge through the rubbing-off effect as humans employed by the critical economic agents in the cluster meet and interact, and the movement of tacit knowledge embodied in humans to start new firms rises as trust-loyalty (social capital) becomes a critical coordination mode. Economies that managed to strengthen the four pillars of the systemic quad have managed to sustain several decades of rapid growth in exports, value addition and employment absorption (e.g. Singapore, China and Ireland). Economies that only focused on providing basic infrastructure, political stability and security in EPZs and industrial estates have failed to enjoy sustained growth in exports, value addition and employment (e.g. Bangladesh and the Philippines). Whereas sustained value addition, differentiation and division of labour, and wage increases have helped to sharply raise standards of living in the successful economies noted, the failure to strengthen the four pillars has prevented the latter economies from translating export participation into improvements in living standards.

III. METHODOLOGY AND DATA This chapter uses comparisons of simple means to examine differences in firms’ assessments of the institutional and systemic instruments facing them, as well as the technology of foreign and local firms in Cambodia and Laos. Likert scale scores ranging from 0–5 were used to score firms’ rating of connections and coordination quality with critical institutions. The estimation of the technological intensity variables is shown in Table 6.1. Taxonomies and trajectories were used to differentiate technology, and technological intensities were captured by normalizing related proxies (see Table 6.2). Two sets of surveys were conducted using national consultants, one targeted at firms, and the other at households.1 Only two of the three technology variables were examined in the firms, viz. human resource (HR) and process technology (PT) (see Table 6.1). Since none of the firms studied in Cambodia and Laos had

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TABLE 6.1 Variables, Proxies and Measurement Formulas, Automotive Firms Variable

Proxies

Specification

HR

Training expenditure in payroll, HR practices and skill-intensity

Normalized using formula: (xi–xmin)/(xmax–xmin)

Process Technology

Normalized using formula: Age of machinery and equipment, (xi–xmin)/(xmax–xmin) inventory and quality control systems, expenditure on inventory and quality control systems, process patent

TABLE 6.2 Taxonomy and Trajectory of Garment Firms Knowledge depth

HR

Process

Product

Simple activities (1)

On the job and in-house training

Dated machinery with simple inventory control techniques

Simple CMT operations and knitting through foreign supervision

Minor improvements (2)

In-house training and performance rewards

Advanced machinery, Localized supervision of layouts and problem garment manufacturing solving

Major improvements (3)

Extensive focus on training and retraining; staff with training responsibility

Cutting edge inventory control techniques, SPC, TQM, TPM

Mastery of CMT operations by local personnel using foreign technology

Source: Developed from Rasiah (1992, 2007a).

R&D activities in place, and were not engaged in product adaptation or design, no attempt was made to estimate R&D here.2 Nevertheless, incidence of participation in levels 1, 2 and 3 of product technology — the stages before R&D begins — is examined in this chapter (see Table 6.2). In the first stage, employees in Laos and Cambodia simply carried out CMT operations under the supervision foreign employees. In stage two, local employees participated in the supervision of CMT

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operations with foreign technology transferred from abroad. In stage three, local personnel enjoy mastery of CMT operations. The data used in this chapter is drawn from surveys conducted by the author in 2007. The national consultants engaged in the survey used a sampling frame supplied by their national statistics department to select firms and households for the study. The data obtained is shown in Table 6.3. Unless otherwise stated, all information presented is for the year 2006. TABLE 6.3 Breakdown of Sampled Data, Garment Firms, 2006 Phnom Penh

Mailed Responses Interviewed

Vientiane

CMT

Knitting

CMT

Knitting

118 101 1

2 2 0

100 87 5

0 0 0

Source: Compiled from IDE (2007).

Basic Infrastructure The infrastructure in both Phnom Penh and Vientiane is poor by most standards, but focused development in the specially classified EPZs has helped offer reasonable support for fairly good roads, utilities and telecommunication connections (see Table 6.4). With large endowments of power-generating capabilities and water, firms in Vientiane rated the supply of electricity and water significantly higher than firms in Phnom Penh. Indeed the mean rating of electricity and water were the only basic infrastructure proxies to be rated higher than average (see Table 6.4). In Phnom Penh, firms rated electricity supply alone higher than the average. Although fast deliveries as demanded by high-tech firms in electronics manufacturing is not yet critical in garment manufacturing, it will help for the governments in the two countries to improve basic infrastructure further to raise delivery times by the firms. The garment lead times (between order and delivery) in Laos and Cambodia were the longest

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TABLE 6.4 Basic Infrastructure, Garments, Phnom Penh and Vientiane, 2006 Phnom Penh

SD

Vientiane

SD

Water Electricity Primary and secondary schools Health care Customs Security Transport Telecommunications

2.4* 2.7* 2.1* 2.2** 2.5* 2.4* 2.4** 2.3*

1.6 1.3 1.2 1.6 1.1 1.9 1.1 1.3

2.7* 3.0* 2.1* 2.0* 2.8** 2.6* 2.2* 2.3**

1.0 0.3 1.1 1.3 2.2 1.3 1.0 1.0

N

101

87

Note: Likert scale score of firms (0–5 with none highest possible rating); * and ** - statistically significant at 1 per cent and 5 per cent respectively. Source: IDE Survey (2007).

among selected economies in 2004 shown in Table 6.5 (see Rasiah 2007b; reproduced in UNCTAD 2007, p. 17). Although a number of firms complained of security, theft, corruption and other unnecessary transactions costs, they were considered less serious than those they believed existed in Africa. TABLE 6.5 Garment Lead Times, 2004 (Days)

Bangladesh Cambodia China India Indonesia Laos Malaysia Sri Lanka Thailand Vietnam

Woven

Circular Knit

90–120 90–120 40–60 50–70 60–90 90–120 60–90 60–90 60–90 60–90

60–80 90–120 50–60 60–70 60–70 90–120 50–60 60–70 50–60 60–70

Source: ADB (2004); Rasiah (2007b).

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High-Tech Infrastructure Given the poor infrastructure and low educational levels of the labour force none of the garment firms had in place any significant R&D activities. At most, firms were engaged in adaptation activities. The only high-tech institutions of significance that firms reported being interested in Cambodia and Laos are training institutions, technical institutes, universities and standards organizations. Both Cambodia and Laos rely extensively on foreign official development aid to develop their infrastructure, including the construction of technical schools and universities. At the time of the fieldwork, there were no clearly designated standards organizations in both locations. Agents appointed by buyers largely handle quality inspections at manufacturing sites. Two critical institutions that the firms sought in Phnom Penh and Vientiane are examined here (see Table 6.6). Since government technical training institutes were rated poorly, a few private initiatives have emerged in Phnom Penh. The lack of such initiatives was reported as a serious drawback in Vientiane. Although Chinese firms are regarded as largely disinterested in providing off-firm training, other firms reported that the presence of such organizations will help them reduce defects and upgrade their operations.3

TABLE 6.6 High-Tech Infrastructure, Garment Firms in Phnom Penh and Vientiane, 2006 Phnom Penh

SD

Vientiane

SD

University

1.7*

0.5

1.5*

0.5

Technical Schools

1.9**

0.5

1.3*

0.9

Training Institutions

1.5*

0.7

1.4*

0.3

N

101

87

Note: Likert scale score of firms (0–5 with none highest possible rating); * and ** - statistically significant at 1 per cent and 5 per cent respectively. Source: Computed from from IDE Survey (2007).

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Network Cohesion Being relatively new to capitalist integration following stagnation under isolationist regimes, the level of coordination in both locations can be expected to be low. Unlike the experience of Emilia Romagna in Italy, where a communist-style egalitarian framework attracted small-scale artisanal operations and drove them to globally competitive enterprises, the garments firms in Cambodia and Laos are largely foreign-owned enterprises with few bonds with the local residents. The firms were asked to rate the degree of connectivity and coordination with critical basic and high-tech institutions. The empirical evidence shows that firms in Phnom Penh and Vientiane enjoy low levels of connectivity and coordination with critical basic and hightech institutions. Although the results were mixed, there were no big differences between Phnom Penh and Vientiane (see Table 6.7). Perhaps the agglomeration of garment firms around the smaller Vientiane and less congestion compared to Phnom Penh led to firms in Vientiane rating better cohesion with the embedding basic infrastructure of licensing, customs and security than firms in Phnom Penh. Firms

TABLE 6.7 Network Cohesion, Garment Firms, Phnom Penh and Vientiane, 2006 Phnom Penh

SD

Vientiane

SD

Ministries Utilities Licensing Authorities Security Authorities Customs Industry Associations Training institutions Technical institutes Universities Development Organizations

2.0* 1.8* 2.1* 1.9* 1.5* 2.3* 1.7* 1.5** 1.9* 1.7*

1.2 0.9 0.7 1.8 1.2 1.1 0.6 1.3 0.4 0.8

2.3* 2.5* 2.7* 2.3* 2.1* 1.9* 1.1* 1.2* 1.4* 1.8*

0.5 0.3 0.5 0.7 0.5 1.3 1.0 0.9 0.7 0.7

N

101

87

Source: Compiled from UNU-MERIT, World Bank and DFID Survey (2004). Note: Likert scale score of firms (0–5 with none highest possible rating); * and ** - statistically significant at 1 per cent and 5 per cent respectively.

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in Phnom Penh rated connectivity and coordination with the hightech establishments of technical institutes, training organizations and universities higher than Vientiane firms. Phnom Penh (2.3) was also rated better on connectivity and coordination between firms and the industry association than Vientiane (1.9).

Integration in Global Markets and Value Chains All surveyed garment firms in Phnom Penh and Vientiane are directly integrated in global markets and most of them are either owned or controlled by foreign investors. Phnom Penh is slightly better connected to global markets only because of its much larger production base and sea frontage through Sihanoukville. Both countries attracted garment firms from abroad largely because of preferential agreements they entered with the United States in 1999 (bilateral), the European Union in 2001, and with Japan and Canada to import clothing manufactured under preferential terms accorded to the least developed countries. All surveyed exporters use brand names from foreign firms and specialize largely in cut, make and trim (CMT) operations (see Figure 6.2). Most investment came from East Asian economies with FIGURE 6.2 Main Markets and Investment Source of Garment Firms in Phnom Penh and Vientiane, 2006 Vientiane Developed Economies East Asian Economies Phnom Penh FDI Export using brand names from developed economies Source: Established from IDE Survey (2007).

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Chinese (61 per cent) investment dominating in Phnom Penh and Thai investment (45 per cent) in Vientiane. There were some foreign direct investment from the developed economies but it was tiny in comparison to the inflows from the East Asian economies. Among the surveyed firms, the breakdown in ownership by totally foreign, totally local and joint ventures in Phnom Penh was 81, 9 and 13 and in Vientiane was 61, 15 and 11 in 2006. In both countries, foreign firms enjoyed production technology from their operations at parent sites — using their owner-specific know-how (Dunning 1978) while local firms enjoyed access to know-how supplied from buyers. None participated in R&D — including product adaptation. All firms relied on brand names that were accessed from independent brand-holders in developed markets. Machinery suppliers from abroad were also a major source of training in both locations.

IV. TECHNOLOGICAL INTENSITIES This section seeks to discuss the depth of technological intensities experienced by garment firms facing the institutional environment discussed in section III. Given that all four systemic pillars in Phnom Penh and Vientiane are still evolving and weak, garment firms are not expected to demonstrate high technological intensities.

Knowledge Depth This sub-section examines technological capabilities acquired or developed using the framework of knowledge depth in the garment firms in Phnom Penh and Vientiane. Only embodied technology — in humans, processes and equipment, and product — is examined here (see Table 6.8). Each of the three technology components are differentiated by knowledge depth (see also Table 6.2). The scores show incidence of participation of firms in the respective knowledge categories. The weak high-tech infrastructure pillar explains why no firm reported participation in levels 4, 5 and 6 knowledge activities in both locations. The overall incidence of participation of firms in high-technology activities is low in both Phnom Penh and Vientiane (see Table 6.8). Firms in Phnom Penh enjoyed a higher incidence of participation in level 2 and level 3 segments of technology than firms in Vientiane.

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TABLE 6.8 Technological Capabilities of Garment Firms in Phnom Penh and Vientiane, 2006 (Incidence) HR Process Product Knowledge Depth Phnom Penh Vientiane Phnom Penh Vientiane Phnom Penh Vientiane (1) (2) (3)

101 77 39

87 59 23

101 77 39

87 59 23

101 65 29

87 55 5

Total

101

87

101

87

101

87

Source: Compiled from IDE Survey (2007).

Participation in product technology was extremely low in both Phnom Penh and Vientiane. None of the firms in Phnom Penh and Vientiane were engaged in levels 4, 5 and 6 knowledge activities from where product adaptation, design and R&D activities are carried out. Typical with underdeveloped economies starting at the lower end of the “S” curve, learning and innovation in the garment industry appears to be low in Cambodia and Laos. The lack of human capital, poor infrastructure and the uncertainty associated with the preferential access opportunities in the developed markets were cited as the main reasons as to why firms in Phnom Penh and Vientiane are engaged only in levels 1, 2 and 3 knowledge intensities.

Employment, Export, Productivity and Wages Whereas learning and innovation has been low, employment and exports has grown more significantly in Phnom Penh than Vientiane. Employment in the surveyed garment firms in Phnom Penh grew phenomenally, by 11.6 per cent per annum over the period 2000–06 (see Table 6.9). The smaller labour force and Laos’s land-locked status meant that employment in the country only grew by 2.7 per cent per annum over the same period. Real exports grew significantly in both locations: 24.1 per cent and 13.0 per cent per annum in Phnom Penh and Vientiane respectively (see Table 6.9). The expansion in Cambodia in general and Phnom Penh

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TABLE 6.9 Employment, Export, Productivity and Wages, Garments, Phnom Penh and Vientiane, 2006 Phnom Penh

Employment (‘000) Export (US$mn) VA/L (US$) W (US$)

2000

2006

Annual Average Growth

35.7 93.3 40.3 66

69.1 341.4 45.7 77

11.6 24.1 2.1 2.6

Vientiane 2000

2006

Annual Average Growth

30.3 57.2 31.2 45

35.6 119.2 32.9 53

2.7 13.0 0.9 2.5

Note: VA/L are in annual figures while W are in monthly figures. All figures except for employment are in constant 2000 prices. Source: Computed from IDE Survey (2007).

in particular has been impressive as garments accounted for almost 50 per cent of manufacturing employment in Cambodia in 2006 (see Rasiah 2007b). Due to specialization in low-technology activities — which is understandable given the emerging status of both locations — labour productivity grew slowly in Phnom Penh (2.1 per cent) and Vientiane (0.9 per cent). Low productivity growth in the face of high unemployment rates also had an impact on wage growth rates, as over the period 2000–06, real wages only grew by 2.6 per cent and 2.5 per cent respectively in Phnom Penh and Vientiane. The employment elasticity of exports for both locations was fairly impressive. For every 1 per cent of export growth, employment grew by 0.4 and 0.3 per cent respectively in the locations of Phnom Penh and Vientiane (see Table 6.10). The positive relationship between exports and job creation has been the strongest benefit enjoyed by Cambodia and Laos from the expansion in garment manufacturing. The high export intensity of employment helped raise the wage elasticity of exports. The wage elasticity of exports was 0.13 in Phnom Penh and 0.10 in Vientiane (see Table 6.10). For every 1 per cent growth in garment exports, wages grew by 0.13 and 0.10 per cent respectively in Phnom Penh and Vientiane. The much lower wage elasticity of exports — explained partly by high unemployment and underemployment levels

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TABLE 6.10 Employment and Wage Elasticity of Exports of Garment Firms, Phnom Penh and Vientiane, 2000–2006

Employment N Wages N

Phnom Penh

Vientiane

Pooled

0.42* (0.00)

0.32* (0.00)

0.40* (0.00)

83

69

152

0.13*** (0.06)

0.10*** (0.09)

0.11** (0.05)

68

55

123

Note: Figures in parentheses refer to statistical significance at 1 per cent (*), 5 per cent (**) and 10 per cent (***) levels. Source: Computed from IDE Survey (2007).

— is the reason why technological capabilities have remained low in those locations. High unemployment and underemployment rates have capped wage increments, which in turn has reduced the pressure on firms to upgrade. Taken together, the results show that garment manufacturing has driven strong employment creation. However, the weak wage elasticity of exports — which appears to be a consequence of high unemployment and underemployment rates and low productivity growth — explains the low accumulation of technological capabilities in garment firms in both Phnom Penh and Vientiane. These results appear to typify catch-up at the lower end of the “S” curve, which is slow in least developed countries because of a combination of surplus labour pulling wages down and the lack of infrastructure development to quicken technological learning and innovation.

V. CONCLUSIONS This chapter examined the impact of Phnom Penh and Vientiane’s incorporation in global garment value chains using the systemic quad. Since both locations are still faced with weakly developed systemic

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pillars even foreign firms enjoying considerable technological capabilities in their parent locations have only redeployed low-technology low value-added activities in these countries. Indeed, lead times reported by garment firms in Cambodia and Laos were much longer than garment firms in competitor countries. Both Phnom Penh and Vientiane enjoyed double digit annual average growth in employment and exports over the period 2000–06. The surge in employment in low value-added activities and low levels of technological capabilities held productivity growth and wage elasticity of exports low. Given the high unemployment and underemployment rates faced by Cambodia and Laos, the growth in jobs is a good thing for these countries. However, the slow development of basic and hightech infrastructure, and the high unemployment (and underemployment) rates has combined to restrict technological upgrading in the garment firms in both countries. Two obvious reasons call for a focus by the governments in the two countries to stimulate technological upgrading and productivity by improving the four systemic pillars. Firstly, the preferential access to markets offered by the developed economies cannot be taken for granted as they can be withdrawn at any time. Secondly, technological deepening must take place to sustain firm-level competitiveness. Otherwise the garment firms will lack the requisite technologies to compete in international markets. It is therefore important that governments in both countries initiate these developments before it is too late.

Notes 1. Sitthiroth Rashpone and Kum Kim led a small survey team each to collect the data from Laos and Cambodia respectively. 2. See Rasiah (2008) for a broader explication of taxonomies and trajectories involving more advanced economies. 3. Interview by author on 10 December 2007.

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7 FDI and Economic Integration in Vietnam1 Tuan Bui

I. INTRODUCTION Since 1986, economic reform (Doi Moi) in Vietnam has made significant strides towards transition to a market-oriented economy and improvement in the living standards of the people. Vietnam’s economic growth rates have been high for nearly twenty years. Many of the Millennium Goals have also been achieved before the target dates. One of the important driving forces of this achievement is Vietnam’s open policy and integration into the global economy. During this process, FDI has played a very important role. The flow of FDI into Vietnam has brought with it many benefits in the development of Vietnam. FDI assists in enhancing the competitiveness of industries by bringing in financial resources, know-how, and management skills for the economy. This flow of capital helps develop many supporting industries and, via these industries, creates a lot of opportunities for jobs creation in the domestic market. At the same time, 168

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there are a number of challenges related to FDI flows that require the attention of the government. Thus, identifying the challenges and issues related to FDI flows is important in formulating appropriate policies. This chapter aims to review the integration processes and developments of FDI in Vietnam. It also discusses the impact of FDI on economic development. The relationship of FDI and development of production networks and supporting industries are also within the scope of the research. The chapter also intends to point out challenges and issues related to the attraction of FDI, which require attention at both central and local government level. The results of the research are based on the analysis of secondary data obtained from different sources. The sources include the General Statistical Office (GSO), Ministry of Planning and Investment (MPI), Ministry of Industry and Trade (MOIT), Ministry of Labour, Invalids, Social Affairs (MOLISA), and various publications in Vietnam. The timeframe of consideration is the last two decades, since FDI attraction has accelerated the progress of Vietnam’s integration into the international market. The chapter has the following structure: section II discusses industrial policies and FDI policies in Vietnam; section III reviews the development and recent changes in FDI in Vietnam; section IV analyses the impact of FDI; section V discusses the production networks and development of supporting industries in Vietnam; section VI points out the challenges and existing issues related to FDI, and section VII provides some policy recommendations.

II. INTEGRATION AND FDI POLICIES IN VIETNAM Integration of Vietnam One of the most important aspects of the renovation policy has been the promotion of economic integration. In the official documents of the Communist Party of Vietnam and the government on socioeconomic strategies,2 economic integration into the world and the region was identified as a key orientation and an important driving force for economic development. Vietnam has actively participated in economic and trade institutions in the region and in the world. The

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first important step in Vietnam’s integration in the renovation period was its membership in the Association of Southeast Asian Nations (ASEAN) in 1995, and the implementation of the Common Effective Preferential Tariff (CEPT) and ASEAN Free Trade Area (AFTA).3 In 2006, Vietnam became a member of the Asia-Europe Meeting (ASEM), an informal dialogue process initiated in 1996 with twenty five European Union (EU) member states, the European Commission and thirteen Asian countries (Brunei, Myanmar, China, Cambodia, Indonesia, Japan, South Korea, Malaysia, Laos, the Philippines, Singapore, Thailand, and Vietnam). The ASEM4 aims to strengthen the relationship and improve mutual understanding between the two regions, in a spirit of mutual respect and equal partnership. In 1998, Vietnam joined the Asia-Pacific Economic Cooperation (APEC), an economic forum for a group of Pacific Rim countries to deal with matters on regional economy, cooperation, trade and investment. In 2000, Vietnam also signed a historic Bilateral Trade Agreement with the United States (USBTA), its first comprehensive trade agreement, to completely normalize the economic relationship between the two countries. The latest important event and the most significant achievement of the integration process is membership of the WTO in November 2006. Access to the WTO has guaranteed Vietnam an equal position in trade relationships with other partners in the world. It helps Vietnam have a voice in dealing with trade disputes and access to the markets of all the members of the WTO. Vietnam’s WTO commitments consist of two types: general commitments and concrete commitments on trade in goods and services. The general commitments are the ones that comply with principles of the WTO such as commitments on WTO agreement and on regulatory adjustment and revision to suit WTO regulations and others such as a commitment to allow foreigners and enterprises with foreign investment to operate in the export and import of goods (except some goods such as tobacco, oil and gas, rice and pharmaceutical products). The other type of commitment is the commitment to reduce tariffs on goods and open the market for services. The average tariff on all (tariff 10,600 lines) is to be reduced from 17.4 per cent to 13.4 per cent in a period of five to seven years. The average tariffs for agricultural products are to decrease from a current level of 23.5 per cent to 21 per cent, manufacturing products — from 16.6 per cent down to 12.6 per cent

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also in a period of five to seven years. In terms of opening the market for services, the WTO commitments for Vietnam have been liberalized even further than those of the USBTA. In the USBTA, Vietnam has made commitments to open the market in eight service sectors, while under WTO commitments Vietnam will open the market for eleven service sectors with about 110 sub-service sectors. Thus, the WTO commitments have helped Vietnam further open its economy, and hence become further integrated into the world economy. Apart from multilateral and regional agreements, Vietnam also actively negotiates bilateral trade and investment agreements with other countries in the region. Up until now, Vietnam has had trade relations with 224 countries and territories, has signed more than 350 development cooperation agreements, 87 bilateral trade agreements, and 51 investment promotion and protection agreements. Along with the new wave of preferential trade agreements (PTAs) and free trade agreements (FTAs) in the world due to the deadlock of the Doha Round Talks, a series of bilateral agreements between Vietnam as a member of ASEAN and other countries has been signed and more are being negotiated. They include FTAs between Vietnam as a member of ASEAN with China, South Korea, Japan, India, Australia, and New Zealand. ASEAN and China reached an agreement in 2002 to establish a free trade area between China and ASEAN (referred to as ACFTA) within ten years. The early harvest programme implemented under the ACFTA framework started even earlier in 2004. Under this programme, tariffs on almost all agricultural products are to be reduced to zero per cent by 2006 for the ASEAN-6 and China, and 2008 for Vietnam. An ASEAN-Korea agreement on FTA has recently been reached. Other agreements such as FTAs with Japan, India, Australia and New Zealand are currently being negotiated and are likely to come to completion soon. Integration essentially means opening the domestic market and linking it with the world market. In terms of opening its market, Vietnam has gone a long way in the twenty years since renovation. Using the ratio of exports and imports to GDP as a measure of openness, Vietnam’s progress has been clear; it soared from around 50 per cent in 1993 to 120 per cent in 2005. Opening the market means more FDI entering the economy. The renovation period witnessed robust development in the foreign investment sector. In 2007, foreign investment accounted for about 17.7 per cent of GDP, up from 6 per cent in 1995.

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Deeper integration with the world has provided an important driving force for Vietnam to develop trade and economy. Development of trade, exports and imports in the last decade can be seen in Figure 7.1. Along with the acceleration of the integration process, both exports and imports have followed a clear, increasing trend. In the period between 1995 and 2005, while GDP grew by 7.2 per cent a year on average, exports soared at an average rate of 21.3 per cent a year. In addition, this period experienced a constant deficit in the balance of trade. Comparing the average export values of different five-year periods since 1986 up to now, the export value of the 2001–05 period increased rapidly, almost sixteen times that of the 1986–90 period (Table 7.1). The ratio of exports to GDP also increased significantly, from 20.5 per cent in the 1986–90 period to 54 per cent in the 2001–05 period. This ratio is also on an increasing trend.

FIGURE 7.1 Trade Values of Vietnam, 1996–2005 (US$ million) 80000 70000 60000 50000 40000 30000 20000

Total trade

Imports

Exports

Balance of trade (deficit)

2005

2004

2003

2002

2001

2000

1999

1998

1997

0

1996

10000

Source: GSO (2006).

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TABLE 7.1 Export Value and GDP: A Comparison across 5-year Periods

Average export value (US$ million) Export value in comparison with GDP (percentage of GDP) Export value per capita (US$)

1986–90

1991–95

1996–2000

2001–05

1406 20.5

3431 25.2

10365 37.4

22166 54.0

18.1

43.6

129.9

274.0

Source: GSO (2006).

The market structure in terms of total merchandise value can be seen in Table 7.2, where Asia accounted for a major part of the total value — 71.4 per cent and 66.3 per cent respectively in the periods 1996–2000 and 2001–05. The Southeast Asian countries alone already accounted for about 25 per cent and 20.5 per cent respectively in the two periods. Europe remained in second place on the list of most important trade partners with Vietnam. In terms of regional cooperation, Vietnam also actively participates in regional economic cooperation programmes such as the Greater Mekong Subregion (GMS) which was an initiative of the Asian Development Bank (ADB), Ayeyawady–Chao Phraya–Mekong Economic Cooperation Strategy (ACMECS)5 proposed by Thailand, and the ASEAN-Mekong Basin Development Cooperation (AMBDC)6 which was the idea of Malaysia. This brings the number of such economic cooperation

TABLE 7.2 Market Structure in Total Merchandise Value (US$ million)

Total Asia Europe America Africa Oceania

1996–2000

Percentage of total

2001–05

Percentage of total

113,438.8 80,985 20,683.6 4,952.2 551.1 4,266.7

71.4 18.2 4.4 0.5 3.8

240,981.8 159,808.9 40,274.9 26,844.1 2,264 10,763.3

66.3 16.7 11.1 0.9 4.5

Source: GSO (2006).

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arrangements in the GMS to twelve. Among them, some initiatives to strengthen economic cooperation at the regional level are by Vietnam itself. These initiatives include the Triangle Development Programme that involves three of the least developed countries: Laos, Cambodia, and Vietnam, and the cooperation of poor provinces along economic corridors. Some of the regional programmes have progressed very well, with some programmes achieving success that was considered exemplary as models of regional cooperation and integration from which developing countries and transitional countries in other regions of the world could learn. The active participation of Vietnam in regional cooperation programmes reconfirmed the political will of Vietnamese policymakers to accelerate integration into the international market to promote the economic development of the country. Thus, Vietnam has currently been quite active in accelerating integration on all fronts: multilateral, regional, and bilateral.

Industrial Policies under Renovation (a) The Renovation The renovation (Doi Moi) in 1986 marked a turning point from a period of economic crisis to a period of rapid economic growth in Vietnam. The key direction of the renovation policy was a comprehensive restructuring of the economy from a centrally-planned economy to a market-oriented one. Under Doi Moi, private and foreign ownership as well as rights to conduct business were recognized. Foreign investment, trade, and financial sectors were also liberalized. State-owned enterprises (SOEs), which operated quite inefficiently in the past were reformed and restructured, including being equitized or sold. The differentiation between SOEs and non-state enterprises was justified by regulations in different types of enterprises. Because of this liberalization, the market has responded positively. Around 161,000 private enterprises were registered during the 2000–05 period. This is 3.2 times more than the total number of private enterprises registered during 1991–99. Accumulated capital registered by new enterprises amounts to around US$26.3 billion, including additional capital registered by existing enterprises due to business expansion. As of 2007, around 320,000 private enterprises were registered.

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Under the Soviet-style central planning model heavy industry and the collectivization of agriculture were the important features of the development strategy. In the period of renovation, they were replaced by the development of manufacturing and industries in which Vietnam had many comparative advantages (see Box 7.1). To accelerate progress in industrialization and modernization, particular attention was given to policies promoting certain important industries such as telecommunications, electronics, information technology, and shipbuilding. They also included the textile and garment, footwear, and other manufacturing sectors such as food processing of agricultural products, which were considered important industries in terms of generating significant revenues from exports. The liberalization measures have led to high growth rates in exports of the products of many industries over a long period since Doi Moi. The annual export growth rates have been more than 20 per cent for many years. Some service sectors, including telecommunications and tourism, have experienced booming growth due to the advantage of abundant cheap labour in the BOX 7.1 Some Important Steps in Recognizing Private Ownership and Rights of Doing Business Under Doi Moi •

• •

• •

•

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The contract system in agriculture introduced in 1981 (regulated by Party Resolution No. 10 in 1988) recognized the household as an economic unit entitled to own the surplus it produced after fulfilling its obligations to the state. The Council of Ministers issued a series of decrees clarifying the rights of the nonstate sector to engage in industrial production in March 1988. The Land Law was passed by December 1987 and enacted in 1988, followed by the Amended Law in 1993, which was reinforced in 1999. These were important steps towards the introduction of property rights, recognizing private land-use rights. The Constitution of 1992 acknowledges private ownership and provides guarantees against nationalization (Article 23). Property rights and private ownership were further detailed in the first Civil Code 1995 (and modified in 2005). The Code not only confirms the protection of lawful property rights and private ownership, but also covers provisions for the establishment of property rights and provisions for transactions and the transfer of these rights and property. The Law on Enterprises 2005 came into effect on 1 July 2006, replacing the 1999 Law on Enterprises which acknowledges people’s right to engage in business: “Citizens are free to do business in all business areas not prohibited by Law.”

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market and the smooth dissemination of final products of information technology. The reform measures and the sound industrial policies brought about positive results. The procedures for market entry for all business entities were simplified. The cumbersome administrative procedures for business registration and operation were gradually removed. The time required for registering a business was also shortened and limitations on an owner’s capital were removed. The state-owned enterprises were also restructured. From 1990 to 1994, the number of SOEs fell from 12,000 to 6,300. In the period 2001–05, Vietnam restructured 3,572 out of 5,355 SOEs, of which, 2,378 SOEs were restructured through equitization. In 2005, 47 major state-owned enterprises were allowed to change over to a parent and subsidy company model and this continued in 2006. Vietnam has had a high economic growth rate for more than twenty years. In fact, Vietnam is currently enjoying the second highest economic growth rate in the region, after just China. Despite the period when the Asian economic crisis of 1997–98 hit the economy, the GDP of Vietnam grew on average by around 7.5 per cent during the entire period of renovation. The structure of the economy has been reorganized for industrialization and modernization. The contribution of the industrial and service sectors to GDP has been following a rising trend, while the ratio of agriculture in the GDP has been declining. These three sectors account for 42 per cent, 38 per cent and 20 per cent of the GDP respectively (based on 2006 figures). General living standards have also improved significantly, thus creating a good environment for significantly lowering the poverty rate which was around 22 per cent in 2006. (b) The Establishment of Market Institutions In the transition towards a market-oriented economy many measures were taken by the Vietnamese government. To establish market institutions, the following important steps were taken: • The Land Law was approved in 1987, and then amended in 1993 and 1999. • The Bankruptcy Law was approved in 1993, and the revised Bankruptcy Law was passed in 2004. • The Labour Code was approved in 1994.

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• The Commercial Code was approved in May 1997 and later amended in November 2005. • Legislation concerning competition was approved in 2004 and enacted in July 2005. • The Unified Investment Law (2006 Common Law of Investment), which has been in force since 1 July 2006, regulates both domestic and foreign investment in Vietnam and provides for a more level playing field in investment. • Decree No. 108/2006/ND-CP of the Government, issued on 22 September 2006, stipulates details and gives guidance on the implementation of selected articles of the 2006 Unified Investment Laws. This document reflects the strong orientation toward deregulation of the state control of investment. • The Unified Enterprise Law (UEL) was approved in December 2005 and was enacted in July 2006. This Law unified the Law on Private Enterprises (enacted in 1990 and later amended in 1994 and in 2000), the Company Law (enacted in 1990 and twice amended in 1994 and in 2000), and State Enterprise Law (enacted in 1995). • Law on Intellectual Property Rights, approved in December 2005 and enacted in July 2006. • Law on Environmental Protection was approved in 1993 and amended in December 2005. Institutional changes under Doi Moi also included new banking and financial institutions. To promote the establishment of the monetary market, the following measures were implemented: • The inter-bank market for domestic currency was established in 1993 the inter-bank market for foreign currencies was introduced in 1994, and a bidding market for treasury bills was recognized in 1995. • The bond market for short-term loans was established in 1995. • The stock market began operating in 2000. • Since 1997, foreign banks, stockholding banks, and many financial institutions have obtained approval to operate. (c) Policies Promoting FDI The enactment of the Law on Foreign Investment (LFI) in 1987 provided a legal framework for foreign investors to enter Vietnam’s market.

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This law marked the first step towards investment liberalization. Since then, the law has been revised and supplemented on four occasions: in 1990, 1992, 1996, and 2000. These regulatory frameworks were further measures aimed at liberalizing FDI in Vietnam and making practices in Vietnam consistent with international rules and attractive to foreign investors. The most important measure for improving business and the investment environment was the adoption of the new Investment Law (IL) by the National Assembly in November 2005. This law (enacted on 1 July 2006) applies to investment from all sectors and replaced the foreign investment and domestic investment laws that were implemented separately in the past. The 2005 Investment Law and the attendant decrees of the Vietnamese Government (in particular, Decree No. 108 in 2006 and Decree No. 139 in 2007) have been regarded as significant progress and as laws that reflect the determination to proceed with economic integration, removing all discrimination between foreign and domestic investments that are contrary to international practices. The new law aims to create a unified legal investment framework and a level playing field for all investors, irrespective of their origin. The spirit of the new law is to devolve the process of investment project approval to local authorities and management boards of industrial zones and economic zones, and to ease the tasks of consideration and approval of investment projects by the central government. The prime minister just considers and approves in principle the important projects that are not in plan. This move helps the central government departments concentrate on the functions of forecasting, monitoring, assessing, and making policies. The following are some important aspects of the changes of the new law. First, the IL provides for a broader range of methods of investment than the LFI. It groups these methods into the two broad categories of “direct investment” and “indirect investment”. Direct investment is defined as “a form of investment whereby the investor invests its investment capital and participates in the management of the investment activity”. Direct investment can be made in the following forms:7 (1) establishment of wholly foreign- or domestic-owned companies; (2) establishment of joint venture companies between foreign and domestic investors; (3) investment in contractual forms, including business

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cooperation contracts, build-operate-transfer (BOT) contracts, buildtransfer-operate contracts and build-transfer contracts; (4) investment in business development; (5) purchase of shares or capital contributions to participate in the management of investment activities; (6) mergers and acquisitions; and (7) other (unspecified) forms of direct investment. It is important to note that only the first three categories were directly regulated under the LFI. Article 3.3 defines indirect investment as “a form of investment by way of the purchase of shares, share certificates, bonds, other valuable papers or a securities investment fund and by way of intermediary financial institutions and whereby the investor does not participate directly in the management of the investment activity”. Article 26 provides that indirect investment can be made in the following forms: (1) purchase of shares, bonds and other valuable papers; (2) investment through securities investment funds; and (3) investment through other intermediary financial institutions. Such indirect investment is not governed by the Investment Law but by securities laws. Second, the IL regulates that: “Investors shall be permitted to invest in all sectors and in all industries and trades which are not prohibited by law.”8 This aspect was a significant change in comparison with previous investment laws that allowed investments only in areas specified by law. Third, the IL has introduced a system of registration and licensing for investment enterprises. Investors must comply with licensing and registration procedures in accordance with the size and the sector of investment. The various levels of investment and procedures are as follows: • Business Registration: For small domestic enterprises with investment capital less than VND15 billion or US$940,000 and not falling under the conditional list of sectors,9 the investment projects are subject to business registration only. • Investment Registration: The projects with investment capital from VND15 billion to VND300 billion (US$19 million) and not falling under the conditional list of sectors, are subject to investment registration procedures.10 Such projects are granted an investment certificate which serves as business registration of the corporate entity. Investors may set up their corporate entity separately and then

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file for registration of any project without receiving an investment certificate. • Investment Evaluation: Any project with investment capital over VND300 billion (US$19 million) or projects in conditional sectors (even if they are less than VND300 billion) must undergo an investment evaluation by the Licensing Authority and other relevant authorities.11 For evaluation of investment projects greater than VND300 billion (US$19 million), together with the application documents, the applicant must also submit an “economicaltechnical explanation” of the investment project.12 When assessing the certificate application, the Licensing Authority cooperates with other ministries and authorities to evaluate the proposed investment project. For investment projects in conditional sectors, the investor must also demonstrate compliance with requirements specific to that conditional sector. The licensing of certain investment projects in sensitive sectors such as air and seaports, mining, broadcasting, casinos and cigarette manufacturing, must be approved by the Prime Minister. Also subject to Prime Ministerial approval are foreign investment projects with an investment capital greater than VND1,500 billion (US$94 million) including industries such as electricity generation, mineral processing, road and railway construction, alcohol production, trade, postal and delivery services, telecommunications networks and publishing. Fourth, disputes between domestic investors or between domestic investors and state authorities may be resolved not only through Vietnamese arbitration or a Vietnamese court but also by an international arbitration body in some cases. Provisions for international arbitration must be written into a contract or stipulated in an applicable trade treaty with Vietnam. These provisions give investors greater confidence when doing business with Vietnamese partners. Fifth, for the first time, the IL covers offshore investment by Vietnamese companies outside Vietnam. Investors may make direct investments overseas if they satisfy certain conditions. Offshore indirect investments must comply with relevant banking and securities legislation.13 Apart from the above, the IL no longer regulates corporate governance but regulates access and entrance to the market through licensing and

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registration requirements. Also, under its WTO commitments, Vietnam is developing rules to prohibit the government from forcing the purchase or use of domestic goods and services; forcing the export of a certain percentage of goods and services; requiring a certain ratio of local content in manufacturing; requiring certain levels of domestic research and development; and forcing the supply and location of goods and services or a head office in a certain location. However, the licensing of the IL still has problems. While projects over VND300 billion or in conditional sectors must undergo an investment evaluation, the evaluation criteria are rather vague. It is thus necessary to have clarification of unclear provisions to provide more guidance on the criteria an investor must meet to pass the evaluation. In terms of restrictions on the level of capital contribution and purchase of shares by foreign investors under the LFI, the legal capital of an enterprise with foreign-owned capital had to comprise at least 30 per cent of its invested capital. The new Investment Law imposes no required debt to equity ratio. Under the LFI, reduction of the legal capital of a foreign invested enterprise was prohibited. Under the IL, no such restriction is stipulated. Apart from the IL, the other measures to encourage FDI include regulations to allow foreign investors to acquire equity capital of stateowned and domestic firms through the stock exchange (opened in July 2000). Foreign investors are allowed to acquire shares in domestic companies without limitation, subject to the following exceptions: (1) the 49 per cent capital for listed companies remains, according to the Law on Securities; (2) general foreign ownership restrictions according to sectoral laws and regulations; and (3) maximum ownership ratios in the services sector will follow the WTO schedule of specific commitments on trade in services. Vietnam has concluded more than seventy-five bilateral investment treaties and treaties for the avoidance of double taxation on income and capital, which provide additional guarantees for foreign investments. Under the 1998 Framework Agreement on the ASEAN Investment Area, Vietnam — a member of the Multilateral Investment Guarantee Agency (MIGA) and the World Intellectual Property Organization (WIPO) — is committed to granting national (preferential) treatment to foreign investors from that area by 2010.

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Other main management and legal measurements to improve the investment environment in recent years include: • Abolishing discrimination towards various investors; • Improving state management by minimizing administrative intervention and providing further support and guidance on national and MFN principles; • Clearly defining the rights and obligations of investors; • Approval of the Anti-Corruption Law, essentially aimed at increasing the transparency of the state apparatus while making state officials fully accountable for any wrongdoing; • Enactment of the Procurement Law that is expected to overcome the complexity and numerous shortcomings involved in procurement; • Approval of the Copyright Law to meet with international requirements for copyrights. Since WTO accession in 2006, Vietnam has abandoned almost all regulations that were used to encourage investment projects in import substitution industries, export-oriented production, projects that use domestic materials, and projects that have a high local content ratio. These changes are consistent with WTO regulations, and in the direction of liberalization of investment.14 Under increasing competition to attract foreign investment in Southeast Asia, the Vietnamese government has put in place many investment incentives. Corporate income tax is 28 per cent and preferential rates range from 10 to 20 per cent, which is quite attractive. Foreign investors can be exempted from import duties to create fixed assets, such as machinery, means of transportation, and construction materials that are not produced locally. Further exemptions are also available for raw materials, spare parts, and parts and materials imported for the production of goods for export. Moreover, foreign investors may carry their losses forward for up to five years. In the past, the legal framework provided for different treatment of enterprises, giving more favourable conditions to domestic rather than foreign-owned firms. This was recognized as an obstacle to business development and to attracting further FDI. Thus, initiatives and institutional changes were established to address these issues for harmonizing the legal framework. In this way, the company laws for foreign and domestic firms coincided and land rental fees were levelled. A new competition

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law will also remove distinctions between types of firms, while new laws on technology transfer and intellectual property will provide better protection of the interests of foreign investors. These legal changes can make a significant contribution to creating a more level playing field for foreign investors.

III. FDI IN VIETNAM: TRENDS AND CHANGES After the Law on FDI was passed in 1987, FDI started to pour into Vietnam. It has followed a rapidly increasing trend in the period up to 1996 and slowed in the period of 1998–2000, due to the consequences of the Asian financial crisis. In the subsequent period, the flow of FDI has been rising again, especially in the years 2006–07 (Figure 7.2). Recently, there is a new wave of FDI in Vietnam. The newly registered and supplementary FDI capital reached over US$31 billion just after the first six months of 2008. Furthermore, the registered capital in FDI projects reached US$20.3 billion in 2007 and realized capital also experienced an increasing trend (Figure 7.2).

FIGURE 7.2 FDI in Vietnam, 1988–2007 (US$ million) 25000 20000 15000 10000

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

1989

0

1988

5000

Years Registered

Implemented capital

Source: GSO (2008).

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As of the end of 2007, there were more than 9,500 FDI projects with a total registered capital of about US$98 billion (including increased capital). Apart from the projects already completed, 8,590 projects were underway with capital stock of US$83.1 billion. Many approved projects that proceeded according to plan increased investment capital and started expanding production in Vietnam’s market. The total increase in capital from these projects was more than US$18.9 billion, accounting for 23.8 per cent of the approved capital of newly registered projects. This situation shows that more FDI projects have been profitable in Vietnam and many investors have made positive assessments of the investment and business environment. Projects in sectors where investment capital has risen are for the most part in construction and industrial production. However, while the registered capital of FDI projects has been increasing over the years, the pace of the realization of capital has been slow. In the period 1991–95 the realized capital was US$7.1 billion, and in the period 2001–05, the realized capital reached US$14.3 billion, accounting for 64.8 per cent of the total registered capital. The realized capital of just two years, 2006 and 2007, was about US$8.7 billion, The speed of capital realization depends both on the financial capacity of the foreign companies and the performance of the invested projects. The situation of slow capital realization in fact has been among the important issues the Vietnamese Government needs to address to ensure a favourable investment and business environment in Vietnam. Despite the increasing investment capital of FDI, the share of FDI in the total investment of Vietnam has been quite stable since 2002 at around 15–17 per cent. This is because investment in other sectors such as state investment and private investment has also increased significantly. A clear increasing trend has been observed in the non-state sector, 33.6 per cent in 2006, up from 26.2 per cent in 2002 (Table 7.3). At the same time, the share of state investment has been declining gradually. Table 7.4 shows the main FDI sources in Vietnam. Singapore has the biggest registered capital of FDI in Vietnam, while in second place in terms of registered capital, Taiwan has the largest number of FDI projects in Vietnam. Ranking the partners by registered capital shows that the top five countries are Singapore, Taiwan, South Korea, Japan, and Hong Kong. However, a look at trends in FDI figures in 2007

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TABLE 7.3 Structure of Investment by Ownership, 2002–2006 (percentage)

Total State investment State budget State credit Owned equity of SOEs Other mobilized funds Non-state investment FDI

2002

2003

2004

2005

2006

100.0 56.3 25.0 17.6 8.0 5.7 26.2 17.5

100.0 54.0 24.0 16.9 9.3 3.8 29.7 16.3

100.0 53.6 25.1 16.5 9.1 2.9 30.9 15.5

100.0 52.2 24.3 16.1 9.0 2.8 32.1 15.7

100.0 50.1 21.5 8.9 14.7 5.0 33.6 16.3

Sources: GSO (2006) and CIEM (2007).

TABLE 7.4 The Top 20 FDI Counterpart-Countries during 1988–2006 Country having FDI in Vietnam 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Singapore Taiwan South Korea Japan Hong Kong British Virgin Islands Netherlands USA France Cayman Islands Malaysia Thailand Britain China Samoa Luxembourg Switzerland Australia British West Indies Germany

Number of projects

Total investment (US$ million)

Realized capital (US$ million)

460 1,564 1,310 764 379 282 73 318 177 23 203 144 81 424 34 15 42 127 5 83

8,480.0 8,289.0 8,285.8 7,746.4 5,308.8 3,388.4 2,365.8 2,280.8 2,202.9 1,680.4 1,627.1 1,605.3 1,353.4 1,151.9 986.2 803.8 744.6 673.2 511.1 377.4

3,784.8 3,041.1 2,662.4 4,947.0 2,152.9 1,374.7 2,031.7 683.0 1,136.9 595.0 1,079.8 830.4 648.7 239.0 13.4 12.1 530.6 393.8 117.2 160.4

Source: MPI (2007).

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shows that this order is changing. FDI flow from the United States and the West has increased markedly, especially after proactive diplomatic initiatives (such as the visit by the President of Vietnam, Nguyen Minh Triet to the United States in 2007). The fact that Vietnam became a WTO member at the end of 2006 also strengthened the flow of investment into Vietnam. In addition, a significant amount of investment capital from the United States has been realized via third countries such as Singapore, Hong Kong, and the British Virgin Islands; the study showed that if the indirect flow of FDI from the United States is taken into account, the United States would be in the top five countries in the table of ranking (STAR 2007). The same could be said of Taiwan. More than half of the FDI from the Virgin Islands is actually from Taiwan. FDI in Vietnam is concentrated in manufacturing industries, hotels, tourism, real estate, and office and apartment development. Table 7.5 shows that the ratios of these sectors to the total realized capital are substantial, especially that of manufacturing industries (68.55 per cent), while the share of the agricultural sector is just 6.93 per cent as shown in Figure 7.3. The reason for the high concentration in the manufacturing sector is that foreign investment is more interested in taking advantage of cheap labour in the domestic market and making this market its base for producing products for exports. Another reason is Vietnam’s past investment policies to attract investment in the manufacturing industries. Projects in this sector also enjoyed many forms of preferential treatment, including tax holidays. In addition, the share of approved FDI in manufacturing industries during 2001–06 was greater than that of the 1995–2000 period (Appendix 7.1). The approved investment in these industries accounted for about 69.5 per cent of the total approved investment in the 2001–06 period. The shares of real estate, construction, hotels, and transportation in the total approved investment in the 2001–06 period were quite small at 9 per cent, 3.7 per cent, 3.5 per cent, and 3.4 per cent respectively. FDI flowed more in the high-tech industries than the garment, textile, and footwear industries. The recent decision of Intel to invest (about US$1 billion) in an assembly and high-tech production project in Ho Chi Minh City, Canon’s decision to invest (US$300 million) in a camera production project in Hanoi, and many other projects (including projects initiated by Panasonic, Foxcon, Technology Group and Robotech) are among the many indicators of this change in the pattern of FDI. This

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TABLE 7.5 FDI Realized during 1988–2007 by Economic Activity Project Realized investment Share of the total number (US$ million) (percentage) Industries and construction Oil and gas Light industries Heavy industries Food industries Construction

5,745 38 2,542 2,404 310 451

20,043 5,148 3,639 7,049 2,058 2,147

68.55 17.61 12.45 24.11 7.04 7.34

Agriculture, forestry, fishery Agriculture, forestry Fishery

933 803 130

2,027 1,857 170

6.93 6.35 0.58

Service Service Transportation-post Hotel-tourism Finance-banking Culture-Health-Education New urban area development Office and apartment development Industrial zone development

1,912 954 208 223 66 271 9 153 28

7,167 383 722 2,401 715 367 111 1,892 576

24.51 1.31 2.47 8.21 2.45 1.26 0.38 6.47 1.97

Total

8,590

29,237

100.00

Source: GSO (2008).

pattern shows that foreign investors have begun to consider Vietnam as a base for high-tech production. This trend will bring even more benefits to Vietnam, since high-tech products create more added value than industrial products that are labour intensive. FDI flows have been weak in the service sector. The service sector attracted US$7.2 billion, accounting for 24.5 per cent of the total FDI realized capital (Figure 7.3). The ratios of FDI in hotel-tourism, transportation-post, and finance are just 8.21 per cent, 2.47 per cent, and 2.45 per cent respectively (Table 7.5). The development of offices and apartments in the last few years has attracted more FDI due to the shortage of supply. The share of this sector is 6.47 per cent. The

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FIGURE 7.3 FDI Realized in Vietnam during 1988–2007 by Economic Sector

Service 24.50%

Agriculture, forestry, fishery 6.90%

Industries and construction 68.60%

Source: GSO (2008).

pattern of FDI in the service sector in Vietnam somehow contradicts the common pattern of FDI in other countries where the service sector accounts for about two-thirds of the total FDI (UNCTAD 2004). The reason for this situation is that this sector had not been liberalized in the past. However, when Vietnam became a WTO member in December 2006, the service sector had to be liberalized due to WTO commitments. In the first quarter of 2008 alone the approved FDI in the service sector reached US$4.6 billion, accounting for 89.9 per cent of the total approved FDI.15 A number of global retailers and banks from France, Germany and the United States already have undertaken studies of Vietnam’s market and are planning entry into this market. FDI will become more prominent in this sector, especially after 2011, when almost all services will be fully open to foreign investment. After the service sector is liberalized, the pattern of FDI may shift toward the more stereotypical pattern of FDI in developing countries. Another change in the pattern of FDI in Vietnam in recent years is that FDI in the service sector flows more into real estate. Increasing integration of Vietnam into regional and world markets and more foreign investors coming into Vietnam are placing significant pressure on the office rental market. The shortage of office space, especially in the big cities, and the high demand in this market have driven up prices. In addition, the real estate market has been gradually liberalized. For

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example, Vietnamese expatriates (Viet kieu) are now allowed to buy houses and apartments in Vietnam. Providing a good opportunity to make profits, the real estate and office and apartment development sectors are attracting more FDI. By the end of 2007, this sector was the second highest among the service sectors in terms of realized capital (6.47 per cent). While covering all provinces, FDI is concentrated in the important regions in Vietnam (Table 7.6). Among these, Ho Chi Minh City and Hanoi are the two most attractive destinations for FDI. For the entire period 1987–2007, the two cities accounted for 20 per cent and 15 per cent of the total registered capital respectively. The Southeast and Red River Delta are the two most attractive regions for FDI in Vietnam. These two regions in fact are the two most important regions in terms

TABLE 7.6 FDI Approved during 1988–2007 by Region

Province/region

Project number

Share of the total project number (percentage)

Registered capital (US$ million)

Share of the total registered capital (percentage)

Red River Delta Ha noi Hai phong Others North East North West North Central Coast South Central Coast Da nang Central Highlands South East Ho Chi Minh City Binh duong Others Mekong River Delta Oil and Gas

2,261 1,183 321 757 409 38 145 414 148 128 5,931 2,816 1,607 1,508 425 59

23 12 3 8 4 0.4 1 4 2 1 60 29 16 15 4 1

26,728 15,085.6 3,188.1 8,454.3 3,014.9 154.1 2,084.6 8,349.3 2,478 1,183.8 50,837.9 20,174.2 8,958.1 21,705.6 4,057.9 3,185.7

27 15 3 8 3 0.15 2 8 2 1 51 20 9 22 4 3

Total

9,810

99,596.2

Source: GSO (2008).

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of production and exports because of their more developed infrastructure and favourable geographic location. Many important transportation links connect these two regions. In the southeast region, Ho Chi Minh City alone contributes about one-third of the country’s GDP. Binh Duong also is a good place to attract many FDI projects, accounting for 16 per cent of all projects and 9 per cent of the total registered capital for projects. On the other hand, the Northwest, North Central Coast and the Highlands have attracted little FDI. This is because of the difficult conditions of doing business and less developed infrastructure in those regions. They are also the poorest regions of Vietnam and the legal framework of Vietnam has preferential policies to attract FDI in these regions. For example, since 1996 FDI projects in the mountainous and remote areas in Vietnam can enjoy very low or no land tax and tax holidays of up to eight years if businesses show profits. The revised FDI Law in 2000 also stated that materials and spare parts for projects in the preferential sectors or in the mountainous and remote areas in Vietnam can be exempted from import tax for the first five years of operation. However, FDI projects in these areas are still limited. The issues of attracting more FDI into these regions and establishing more balanced FDI in terms of geographical regions are still among the most challenging issues. Before the FDI Law in 2005, there were three forms of FDI (modes of entry), namely, wholly-owned foreign enterprises, joint ventures, and business contractual cooperation. The 2005 law clearly stipulates the forms of FDI such as establishing economic organizations with 100 per cent capital from domestic investors or 100 per cent capital from foreign investors; establishing joint venture economic organizations between domestic investors and foreign investors; investment under a BBC contract, BOT contract, BTO contract, BT contract, business development investment, the purchase of shares, the contribution of capital for participation in investment management, and investment in mergers and acquisitions. Table 7.7 shows the structure of FDI in Vietnam by form of investment. Wholly-owned foreign enterprises are the most popular form. The share of joint ventures is almost the same, accounting for 38.1 per cent of the total number of FDI projects. The other new forms account for only a small share because the new FDI laws have been in effect for just over a year. It is interesting to note that initially the joint venture was the most popular form of

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TABLE 7.7 FDI Approved during 1988–2007 by Form of Investment Project number

Realized investment (US$ million)

Percentage

100 per cent foreign-owned enterprises Joint venture Business contractual cooperation BOT, BT, BTO Joinstock company Parent-children company

6685 1619 221 7 57 1

11,319.0 11,155.6 5,661.1 727.0 359.4 14.4

38.7 38.1 19.4 2.5 1.2 0.05

Total

8590

29,236.6

100.0

Form of investment

Source: MPI (2008).

investment because foreign investors were not familiar with the new investment environment. After a period of investigation of the new market, they tend to feel more confident about independent operation in Vietnam. Vietnam also develops industrial zones (IZs) and export processing zones (EPZs) as strategies for attracting FDI. As of the end of 2007, there were 154 IZs and EPZs occupying a total area of 32,808 ha in 55 provinces.16 In addition, Vietnam has ten economic zones with about 550,000 ha and two high-tech zones (in Hoa Lac (Hanoi) and Ho Chi Minh City). These zones have attracted nearly 2,600 FDI projects with about US$25.3 billion (around 34 per cent of all projects and 37 per cent of the total registered FDI capital for the whole country), and 2,800 projects of domestic investors amounting to VND137 trillion. The ratio of occupation of these zones has been quite high, about 70.4 per cent in 2007. The developed IZs and EPzs cover more than approximately 13,500 hectare and employ more than 872,000 workers.17 An interesting recent trend is the rapid rise in the number of domestic investment projects in the IZs, surpassing FDI projects in number. This indicates that domestic investors are also attracted to the IZs because of the favourable conditions including infrastructure, linkages, networks, and environmental aspects. Among the FDI projects in the IZs, wholly-owned foreign enterprises are the most popular form

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of investment, accounting for 85 per cent of the number of projects and 80 per cent of registered capital. The IZs contributed a significant share to economic growth and development of the country. The share of total industrial outputs of the IZs out of the total industrial outputs of the country increased rapidly, from 8 per cent in 1996 to 17 per cent in 2001, and about 30 per cent in 2007. The share of exports of the IZs out of the total exports of the country in 2007 was also quite high at about 23 per cent. Most of the IZs and EPZs are concentrated in the southeastern and northern regions (for example, Ho Chi Minh City, Dong Nai, Binh Duong, Ba Ria Vung Tau, Hanoi, BacNinh, Vinh Phuc) that are economically important. IZs in other areas of the country are not yet attractive to investors. There are still very few IZs that have attracted large-scale investment projects in the field of high technology. There have been only eleven projects in the field of high technology in the IZs (among them are Canon Vietnam, Mabuchi Motor and Orion Hanel). This is still somewhat below the target expectations in the industrialization and modernization process.18

IV. IMPACT OF FDI FDI has played an important role in Vietnam’s economic development since the implementation of the renovation policy.19 The role of the FDI inflows can be seen in many aspects of its contribution to the economy.

Contribution to Investment Capital and GDP FDI makes an important contribution to the investment capital of Vietnam. Figure 7.4 compares the ratios of investment of three sectors in the economy in the period 1995–2007. On average, FDI in this period accounted for 20.12 per cent of the total investment of the country. The foreign investment sector had the largest share in 1995 at 30.4 per cent. This share showed a gradual contraction relative to other sectors until 2006. In 2007, however, it increased to 24.8 per cent (estimated), marking a new wave of investment. Figure 7.4 shows that the state sector increased its investment share during the second half of the 1990s and gradually reduced it to 39.9 per cent (estimated) in 2007.

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FIGURE 7.4 Investment by Type of Ownership (at current prices, percentage) 70 60 50 40 30 20 10 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Years State

Non-state

Foreign invested sector

Note: * Figure for 2007 is estimated. Source: GSO (2008).

The non-state sector grew strongly, reaching 38.1 per cent in 2006 and 35.3 per cent (estimated) in 2007. The contribution of FDI to Vietnam’s GDP has also been important. Figure 7.5 shows an increasing FDI contribution to GDP during the period 2000–07, although the increase is not strong. FDI made a contribution of 13.28 per cent to GDP in 2000 and this increased to 17.66 per cent in 2007. The reason for the moderate increase is that the non-state sectors (including the collective, private, and household segments) have been growing significantly stronger in the course of the liberalization process of the economy and the positive progress of the integration of Vietnam. The contribution of FDI was still less than the state sector which showed a decreasing trend in terms of GDP contribution. The contribution of the state sector was about 36.43 per cent of GDP in 2007. A noteworthy point is that while investment of the state sector has always been the largest of the three sectors in the 1995–2007 period, its contribution to GDP has been only in second place, after the non-state sector (Figures 7.4 and 7.5).

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FIGURE 7.5 FDI Contribution to GDP (percentage) 60 50 40 30 20 10 0

2000

2003

2004

2005

2006

2007

Years State

Non-state

Foreign invested sector

Note: * Figure for 2007 is estimated. Source: GSO (2008).

Contribution to Industrialization and Structural Change The contribution of FDI to gross output of industry increased during the 2000–06 period. Foreign investment contributed about 43.8 per cent of the industrial gross output in 2007, an increase of 3.9 percentage points compared to that of 2000 (GSO 2008 and MOIT 2008). This contribution is overwhelming when compared to those of the state sector and the non-state sector, which were about 22.5 per cent and 33.3 per cent, respectively. The increasing trend of the contribution of foreign investment was steady over the 2000–07 period. In absolute terms, the industrial output of the foreign investment sector reached VND221,972.5 billion (or about US$13.7 billion) in 2007. The important contribution of this sector has been a driving force in the process of economic structural change towards industrialization and modernization, which are the aims of Vietnam’s development strategy.

Contribution to Access to and Expansion of Markets Under the policy to encourage export-oriented foreign investment, foreign investors have paid a lot of attention to export-oriented

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industries. The foreign investment sector has played an important role in increasing exports from Vietnam since the renovation. The export value of this sector (excluding oil and gas) has been rapidly increasing, going from US$1.12 billion in the 1991–95 period to US$10.6 billion in the 1996–2000 period, an eight-fold increase. The export value of the foreign investment sector reached a peak of US$ 27.8 billion in 2007 (US$ 9.7 billion excluding oil and gas), accounting for about 57 per cent of the country’s total export value. The role of foreign investment in exports is especially crucial in some key industries. For example, it accounted for 42 per cent of footwear exports, 35 per cent of garments and textiles, 60 per cent of laminated steel output, 84 per cent of electronics, computers and computer supplies, and 100 per cent of the output of crude oil, automobiles, and air conditioners. Figure 7.6 shows that the share of foreign investment in total exports increased significantly over time. The increase in exports was robust even during the Asian financial crisis. While foreign investment accounted for about 5 per cent of exports in early 1990, its share grew solidly, reaching 47 per cent in 2000 and 57.2 per cent in 2007 (estimated figure). Through the “market arms” of multinational enterprises that are parent companies of many foreign enterprises in Vietnam, foreign

FIGURE 7.6 Export Share by Sector 70 60 50 40 30 20 10 0

53

50.4

47

49.6

2000

2003

54.7

57.2

57.9

45.3

42.8

42.1

2005

2006

2004

57.2 42.8

2007

Years Share of domestic sector

Share of foreign invested sector

Source: GSO (2008).

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investment played an important role in expanding the export market for Vietnam. At the same time, the foreign investment sector also assists in augmenting the capacity of the services sector, especially in tourism and hotels and the banking and financial sectors.

Contribution to Absorbing Advanced Technologies, Improving R&D, and Enhancing the Technological Capacity As FDI brings technology and management to the host countries, the contribution of the FDI sector in raising the country’s capability in technology is very important. Many new and modern technologies have been imported into Vietnam through FDI projects, especially in the areas of telecommunications, oil and gas, chemicals, electronics, computers, automobiles and motorbikes. The FDI sector helps develop cutting-edge areas that can compete in the world market in areas such as electronic parts and software, for example. Investment projects by companies such as Intel, Canon, Matsushita and Fujitsu in Vietnam have assisted significantly in the development of these industries. In general, technologies used in FDI projects are of a similar or a higher technological level than technologies existing in Vietnam. There is also a spillover effect from the more advanced technologies introduced in the FDI sector, resulting in the introduction of new technologies in other economic sectors. To survive in a competitive market, it is essential that SOEs and private enterprises upgrade their technology to produce products of quality that can compete with products of foreign enterprises. In addition, technological research and development and the localization of imported technologies (adapting technologies to local conditions) require more attention. Thus R&D activities can be improved due to the presence of the foreign investment sector. Using new technology also helps, to some extent, in better dealing with environmental protection issues in both foreign and domestic enterprises.

Contribution to Job Creation FDI inflows contribute to generating jobs, although the contribution is often fairly small. The FDI sector created over 1.5 million jobs in 2007, accounting for 3.49 per cent of the total workforce (Table 7.8). Since FDI helps develop production networks both domestically and

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TABLE 7.8 Employed Population by Ownership Sector (thousand persons)

State sector Non-state sector Foreign-invested sector Share of total (percentage) Total

2000

2003

2004

2005

2006

2007

3501 33735 373.7 0.99

4035 35763 775.7 1.91

4108 36526 952.6 2.29

4039 37355 1132.8 2.66

3949 38057 1333 3.08

3975 38658 1539.6 3.49

37609.7 40573.7 41586.6 42526.8

43339 44172.6

Source: GSO (2008).

internationally (which will be discussed in the next section), millions of indirect jobs are also created by FDI. The supporting industries are often labour-intensive, and, therefore, the indirect jobs created by the FDI sector can be considerable.20 Table 7.8 also shows that while the employment share of the FDI sector is still small, it increased over the 2000–07 period, indicating the increasingly prominent role of FDI in creating jobs. Reports by MPI and MOLISA show that among the jobs created by the FDI sector, jobs in industry and construction account for the largest share. This situation is consistent with the reality that FDI has focused more on industries than on agriculture and the service sectors. It also confirms the apparent objective of FDI inflow, that is to take advantage of cheap labour in Vietnam. The growth rate of job creation by the FDI sector was considerable: 10–15 per cent over the last fifteen years. This sector has very much helped in training workers, contributing to the establishment of a core of skilled workers in Vietnam. Many foreign enterprises have their own training centres in IZs or have cooperative arrangements with local training centres and vocational schools. These centres target areas where there is a shortage of skilled workers in the market. The FDI sector has educated about 1.5 million Vietnamese people. Among these, 65 per cent have been trained at job sites, and 35 per cent have been trained in separate training centres (MOLISA 2008). The FDI sector has been attractive to the labour market. One of the important reasons is that the average salary of the FDI sector is higher

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than other sectors in the economy.21 The average salary of the FDI sector was about VND2.2 million per month. The salary of skilled workers and managers may even be up to 20 to 30 times higher. It is worthy to note that the FDI sector still enjoys cheap labour costs in Vietnam. The average salary of a worker in Vietnam is about 30–40 per cent lower than salaries in other countries in the region (Nguyen Thi Kim Ngan 2008).

V. DEVELOPMENT OF PRODUCTION NETWORKS AND SUPPORTING INDUSTRIES While motivated by the desire to find new markets, resources, efficiency, and strategic assets (Dunning 1993, 2000), FDI creates linkages both locally and internationally. These linkages also contribute to the benefits of foreign investors in the host country. At the same time, the local linkages create benefits that the host country can derive from FDI. The more linkages that a foreign firm is willing to build up with local firms, the greater the benefits that are generated in the local economy. As a result of local linkages, the local production network has opportunities to develop. In the process of economic integration and the opening of the local market, the local production networks then help to strengthen the competitiveness of foreign investors, leading to further development of international production networks. Thus, the production networks at the international level are shaped and developed accordingly. A number of studies have examined this phenomenon and explained this trend.22 Examples in support of their arguments are many, and the current development of production networks in East Asia is one such example. As FDI played an important role in developing local linkages and a production network, supporting industries also developed in Vietnam. The development of supporting industries occurs through the network of suppliers, outsourcing, and competition. The development of the supporting industry is often reflected in the local content ratio or localization ratio, that is, the percentage of product components that are made or assembled in Vietnam. Typical examples in the development of production networks and supporting industries in Vietnam are the motorbike and electronics industries.

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The motorbike is a common mode of transportation used by the Vietnamese people. The demand for this product is high, especially as living standards begin to improve. Therefore, the entry of foreign investors into the motorbike industry occurred quite early after the announcement of the liberalization of investment in 1987. The main players came from Taiwan (such as Chinfong) and Japan (such as Suzuki, and Honda in a joint venture with a Thai partner) in the first half of the 1990s. Initially these companies had to import most of the components to assemble the final products because local suppliers were weak and small. Their technological capability was not up to the required technical standards. Due to the import of components, the cost of the products was high in comparison with the relatively low income level of the majority of the population at the time. Motorbikes (especially ones with 100cc or 110cc engines) were luxury goods at that time. However, the situation changed substantially when other manufacturers such as Yamaha (Japan), Lifan (China), and even local Vietnamese manufacturers entered the market in the early 2000s. In addition, Vietnam implemented local content requirement policies that used tariffs as a tool for assisting in the development of supporting industries.23 The severe competition in reducing costs made companies and manufacturers seek components and spare parts from local suppliers or foreign suppliers. As a consequence, local suppliers developed rapidly. The local content ratio, which indicates the proportion of a product that is made locally, increased considerably for the final motorbike product. For example, in the case of Honda, the local content ratio increased from around 20–25 per cent in the mid 1990s to around 90 per cent in 2007. This figure was high in comparison with 80 per cent for the average content level of the motorbike industry in the country24 in general. Apart from the most important parts of the motorbike such as the engine, most of the components are now locally produced. Motorbike assemblers in Vietnam are now able to source many metal and plastic parts from both FDI and local suppliers. The foreign companies send their experts to local suppliers to assist them in setting up production and ensuring technical standards. Outsourcing has become more and more popular, and local suppliers have good opportunities to develop their businesses. Honda also has partners in Thailand to provide engines and important components that are not produced in the local market. Thus, the production network has developed at the regional level as

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well. This supported the arguments of production fragmentation and networks. According to Mishima (2005),25 domestic demand in the motorbike market in Vietnam was about 2.02 million units in 2004, ranking third within ASEAN after Indonesia (3.08 million in 2003) and Thailand (2.11 million in 2005). Interviews conducted by the author with many Japanese managers in the motorbike industry indicated that market size and scale of production are very important. Interviews with many other managers and investors also indicated that foreign motorbike parts suppliers enter the market when the minimum order exceeds 200,000 to 300,000 units. Domestic demand of 2 million units per year is sufficient to lure a number of FDI parts makers to Vietnam to compete with each other. In the electrical and electronics industry too, local content ratio has increased in foreign firms. In 2002, most consumer electronics assemblers were unable to buy even relatively simple plastic and metal parts from domestic sources. But after five years, one TV assembler reports that it was able to buy almost all plastic parts from (mainly FDI) suppliers in Vietnam.26 By 2005–06 the local content ratio for TVs has been in a range of 20 to 40 per cent, depending on the producer.27 A computer device producer said that it had increased the number of domestic suppliers from 7 in 2002 to 45 in 2006. As a result, the local content ratio of this firm rose from 5 per cent in 2004 to 30–40 per cent in 2006. However, the picture of supporting industries is not so bright. There are other firms which continue to have low local content ratio due to the weak development of supporting industries in Vietnam. Many TV assemblers said that they still prefer complete knock-down (CKD) production because imported parts are cheaper than parts domestically produced. This situation can further worsen when tariff exemptions are implemented by 2010 under Vietnam’s commitments to the WTO. The current local content ratio is far below the desired level of the foreign firms. According to the Vietnam Development Forum (2006), an assembler of home appliances reported that it could not find any high value-added components in the domestic market. And although this firm has achieved a local content ratio of 70 per cent in terms of number of parts, localization accounts for only 30 per cent of the product’s overall value. This study also concluded that the current localization has been concentrated in low-value parts only.

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Due to the dearth and weakness of supporting industries, in 2008 the electronics giant Sony announced that it would terminate all production in Vietnam.28 Toyota Vietnam, the largest automobile manufacturer in Vietnam also has serious concerns about this situation. The company reports that its current Vietnamese producer-partners can supply only a few automobile components for Toyota Vietnam, while their peers in Thailand and Indonesia have been able to provide up to 90 per cent of components for orders.29 The local content ratio in the automobile industry has been the lowest at about 5–12 per cent. Trucks and buses have higher local content ratios than cars because their upper structure can be built by Vietnamese companies. Toyota currently has the highest local content at about 12–14 per cent. However, the company indicates that when Vietnam opens its automobile market completely in 2018, it will be hard for Toyota to stay in Vietnam if supporting industries are not developed. Textile-garment and leather footwear producers are currently importing 80 per cent of their materials. Some materials are being made in Vietnam as a substitute for imported materials, but because the quality is inferior, foreign manufacturers continue to prefer to import in spite of the lower price of the materials locally made. There are more than 200 companies in the plastics industry in Vietnam and, for the most part, they are making very simple consumer goods as well as some plastic parts used by auto, motorcycle and electronics assemblers. The capacity of the supporting industries is still far below the expectation of the foreign investors. This situation is indicative of the urgent attention required from policymakers to address development issues in production networks and supporting industries in Vietnam.

VI. REMAINING ISSUES IN FDI Despite the significant contribution of the FDI sector to the economy, there have been some issues related to FDI in Vietnam that are of concern. These issues are also the challenges for policymakers to address and can be summarized as follows: • Investment has been unbalanced in terms of geographical location. Under the driving force of maximization of profits, foreign investors tend to invest in industries and areas where the rate of return is

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high and production conditions are favourable. Therefore, it is difficult to have balanced investment for all regions. The areas and regions that have developed infrastructure often have advantages in attracting FDI. Some provinces and cities have attracted a lot of foreign investors, such as Ho Chi Minh City, Dong Nai, Ba Ria-Vung Tau and Binh Duong, while many other provinces and cities have failed to do so. The unbalanced investment of FDI further skews the existing imbalance in development in Vietnam. This situation does not support the strategy to develop the less developed regions of the country. • The linkage between the FDI sector and the domestic sector has been poor. Different surveys conducted in manufacturing industries in Vietnam showed that the spillover effect caused by FDI in Vietnam’s market was weak.30 This result, together with the weak development of production networks and supporting industries as discussed above shows that Vietnam is losing its potential. The weakness of supporting industries drives up input costs since companies have to import inputs at higher costs. This results in reduced competitiveness of their products in the market. When foreign investors enter the domestic market, they expect supporting industries to be able to supply parts and materials/inputs of good quality at a low cost, in a timely manner. Therefore, it is very important to develop supporting industries that fulfil these requirements to meet the expectations of foreign investors. • Logistics are important but they have not been adequately developed in Vietnam. Quality, costs, and delivery of inputs and products depend largely on the conditions of the system of transport, storage, and other logistics services. It was found that the costs of transportation of a container by sea from Hanoi to Tokyo were higher than costs for any other city in the region to Tokyo.31 Ho Chi Minh City had the third highest costs in this comparison. This situation seriously influences the competitiveness of companies operating in Vietnam and their participation in the production network in the region. • The labour market needs to develop in accordance with the needs of FDI investors. A shortage of skilled workers in a market with an abundance of workers such as Vietnam shows inadequate development of the local training system. The current training and vocational training schools seem to be somewhat disconnected from the needs

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of the market. Labour market conditions also suggest that foreign investors play quite an important role in training skilled workers and this role needs to be taken into account when making policy regarding human resource development. • There are still problems associated with the transfer of technology and equipment through FDI. The technical level of the FDI sector in Vietnam in general is higher than that of the domestic sector. However, it is not always the case that foreign investors bring in new and more advanced technology. In some cases, they have actually brought in obsolete technology and equipment, even to the point of not utilizing existing machines and technology, resulting in low productivity, environmentally harmful waste, and destruction of the environment. This situation not only reduces competitiveness of companies and enterprises but also creates unwanted serious environmental problems.32 Thus, behind the statistical figures of FDI capital inflows, it is important to take into account the issue of quality in FDI when aiming for sustainable development. In investment projects there is often a trade-off between short-term growth and the objectives of long-term development. • Although the introduction of capital into the domestic market through FDI is the norm, there are FDI projects that borrowed from the domestic banks to finance their investment capital and increased their capital from this source during their operation. Since 1992, when the second revised Law on FDI allowed FDI projects to open foreign and domestic currency accounts in any bank in the domestic market, many FDI projects increased their capital by borrowing from these institutions. Therefore, not all FDI capital is of foreign origin and real foreign investment capital flows in fact may be less than the published statistics. This situation cannot be ruled out when assessing the impact of FDI in terms of capital formation. • Due to the strong decentralization of the FDI project approval process, the FDI incentive policies used in different local provinces are sometimes different and in competition with each other. These incentives may differ in terms of financial measures or rent reduction for foreign-invested enterprises. This situation may result in harming the unified, common strategy and master plan of socio-economic development at the national level.

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VII. SOME POLICY RECOMMENDATIONS The policy recommendations that can be made for FDI and the development of production networks relies on solutions targeting the existing issues and problems of FDI. These recommendations can be divided into the following: • Laws and regulations for the necessary revision of investment preferential policies to conform to Vietnam’s WTO commitments need to be reviewed. Based on the revised laws and regulations, and the liberalizing road map of investment, the government should promulgate necessary guidelines for provincial governments to approve investment certificates and monitor operation of investment projects. It is necessary to stop the investment preferential policies at the local level that are not in line with the laws, and Vietnam’s international commitments. • Conditions of the infrastructure system and logistics for FDI need further improvement. This includes development of transport, electricity, telecommunications, and storage systems necessary for investment projects to operate, since the development of these systems is the primary concern of foreign investors when deciding to invest in a market. The government should pay attention to allocating adequate resources to improve infrastructure. A mechanism to attract the non-state sector in the development of infrastructure should be taken into account. In addition, adequate attention should be given to the development of logistics services. This includes adequate research into the causes of the weak development of logistics and appropriate measures to overcome these problems. • It is necessary to enhance the clarity, transparency, consistency and predictability of laws, regulations and policies to improve the attractiveness of the investment environment. The list of restrictions for FDI entry should be well clarified. The government should continue to improve a fair competitive environment for enterprises and players of all sectors. A unified strategy and master plan for industrial development needs to be worked out, and investment policies need to be placed in this unified strategy and master plan to ensure the consistency and predictability of the policies.

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• More attention needs to be paid to the development of a training system as well as development of the labour market to ensure the supply of a trainable workforce with low skills as well as high skills for FDI. It is necessary to enhance the quality of training centres and vocational schools and make them more market-oriented. New training centres that are of international standard need to be established. An efficient working mechanism of cooperation in training and education between foreign enterprises and universities and training centres needs to be created.33 Necessary institutional factors for labour market development including new regulations on mobility of labour and migration at the international level (allowing foreign workers in the domestic market) need to be established. • It is important to continue to accelerate administrative reform so as to have an adequate and capable apparatus to effectively implement the role of assessing proposals, monitoring and managing projects, and providing public services for investors and business sectors to operate. Simplifying and making transparent administrative procedures for FDI projects is extremely important for foreign investors. The model of a “one-stop service” should be followed. Attention should also be paid to the improvement in cooperation among central and local departments as well as among departments and ministries.

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APPENDIX 7.1 FDI Registered (Approved) during 1988–2006 by Economic Activity (US$ million) Registered capital percentage

Share of total

1995–2000

2001–06

1995–2000

2001–06

Industrial production

1,487

2,281

44.8

69.5

Construction

4,152

1,215

12.5

3.7

Office and apartment development

3,477

2,953

10.5

9

Transportation and post

2,706

1,136

8.2

3.5

Hotel and restaurant

2,524

1,122

7.6

3.4

Agriculture, forestry, fishery

1,852

588

5.6

1.8

Mining

1,541

453

4.6

1.4

Others

1,341

1,550

4

4.7

716

985

2.2

3

Electricity, gas and water

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Notes 1. I would like to express sincere thanks to all those who gave me the opportunity to complete this study. Special thanks go to Dr Ikuo Kuroiwa (IDE) for his ideas and great support and patience up until the completion of this study. I would also like to thank IDE for financial support for this study. I am deeply indebted to Dr Pham Lan Huong (CIEM) who provided me with necessary data and materials, and also valuable suggestions in the course of our discussions. I would like to thank all anonymous institutions and people who helped me in accessing and collecting materials and data for implementing this study. 2. For example, there was a special document of the Vietnamese Communist Party on promoting economic integration in 2001 (IXth Congress of CPV). Integration continued to be one of the key directions in socio-economic development strategies of Vietnam in the period 2006–10. 3. The CEPT is a mechanism by which tariffs on goods traded within the ASEAN region, which meet a 40 per cent ASEAN content requirement, are to be reduced to 0–5 per cent by the year 2002–03 (2006 for Vietnam, 2008 for Laos and Myanmar, and 2010 for Cambodia). Tariffs on goods in the fast track were largely reduced to 0–5 per cent by 2000. Tariffs on goods in the normal track were reduced to this level by 2003. 4. ASEM provides an open forum for policymakers and officials to discuss any political, economic and social issues of common interest. It complements work carried out in bilateral and multilateral fora, such as the United Nations (UN) and World Trade Organization (WTO). It covers the full spectrum of relations between the two regions, and places equal importance on political, economic and cultural issues. It emphasizes equal partnership through a process of dialogue and cooperation based on mutual respect and mutual benefit. It provides a platform for meetings at a high level (heads of state or government, ministers and senior officials), and has been increasing its focus on fostering people-to-people contacts in all sectors of society. 5. The Ayeyawady–Chao Phraya–Mekong Economic Cooperation Strategy (ACMECS) is a cooperation framework among Cambodia, Laos, Myanmar, Thailand and Vietnam to utilize member countries’ diverse strengths and to promote balanced development in the sub-region. Prime Minister Thaksin Shinawatra of Thailand initiated the establishment of this cooperation framework in April 2003. 6. AMBDC was established on 17 June 1996. The members are Brunei, Cambodia, People’s Republic of China, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand and Vietnam. The objectives are (1) strengthening

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7. 8.

9.

10.

11.

12.

13. 14.

Tuan Bui

sustainable economic development in the Mekong Basin; (2) encouraging the dialogue process and identifying common beneficial projects; and (3) promoting economic linkages between ASEAN countries and member countries of AMBDC. Article 21 of the Investment Law. Sectors prohibited by law include: projects detrimental to national defence, security, and the public interest; projects detrimental to historical and cultural traditions, and the ethics and customs of Vietnam; projects harmful to people’s health, natural resources, and the environment; and projects treating toxic waste imported to Vietnam and projects manufacturing toxic chemicals banned by international law. Conditional sectors include sectors impacting on social order, safety, and national security; banking and finance; public health; culture, information, the press and publishing; entertainment services; real estate business; prospecting, exploration and mining of natural resources; the ecological environment; development of education and training; and some other sectors in accordance with law. Decree No. 108/2006/ND-CP enacted on 22 September 2006 stipulates that the investor must submit an application for investment registration to the licensing authority together with a “report on the financial capacity of the investor” and the proposed constitutive documents for the enterprise. The licensing authority is to consider, approve and issue the investment certificate within 15 working days of receiving the entire application. Furthermore, the licensing authority has 25 days to issue the investment certificate (20 days in industrial zones), or 40 days if the prime minister’s approval is required. These include management boards of industrial zones, export-processing zones, high-technology zones and economic zones that are responsible for licensing foreign investments within their zones, as well as the Provincial People’s Committee which is the responsible authority for all other foreign investments. Licensing applications are to be made to the bodies which consult with the relevant governmental authorities (if required) before issuing final approval. This covers the investor’s objectives, size, investment location, investment capital, investment project implementation schedule, land use needs, and technological and environmental solutions. Article 76.2 of the IL. As part of its accession to the WTO, Vietnam ratified the Agreement on Trade-Related Investment Measures (TRIMS). To comply with TRIMS requirements, the 2005 law and its decrees specify that the State will not impose any of the following requirements on foreign investors: (1) priority

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15. 16. 17. 18.

19.

20.

21.

22.

209

purchase of domestic goods or services; (2) export requirements or export limitations; (3) foreign exchange balancing; (4) localization ratios; (5) minimum level of R&D; or (6) obligation to supply goods or services in a particular location. MPI, Quarterly Outlook on Vietnam Socio-economy, (2008). Among them, 92 IZs have been in operation and the other 62 IZs are still in the process of construction. These figures are for 2007 and were provided by the Department of Industrial Zones and Export Processing Zones Management, MPI. The objective of the socio-economic development strategy set by the Vietnamese Communist Party and the government is for Vietnam to become an industrialized country by 2020. UNCTAD (2007) points to two main conclusions when assessing the role of FDI in Vietnam: (1) FDI has played an important role in driving economic activity — more than that in other countries in the region; and (2) FDI has significant growth potential in Vietnam. FDI inflows as a proportion of GDP were particularly high in the 1990s, averaging US$70 per US$1,000 of GDP, higher than in most other countries in the region, including China. As the economy developed, the ratio has come more in line with the ASEAN average in the period 2001–06. According to an unofficial report of MOLISA (cited in the Vietnam Investment Review, 2008), one person directly employed in the FDI sector can result in a further two to three persons indirectly employed in other sectors. Currently, there are two minimum wage scales: one that applies to employees working in foreign companies which are VND710,000 (US$44), VND790,000 (US$49) or VND 870,000 (US$54) per month depending on where the company is established, and one that applies to employees working in Vietnamese companies which is VND450,000 (US$28) in 2006. The majority of foreign companies offer wages above the minimum level. It is expected that an adjustment of these wage scales will take place in January 2009, according to which the minimum wages of employees working in foreign companies will be VND920,000 (US$56), VND950,000 (US$58), VND1,080,000 (US$65), and VND 1,200,000 (US$73) per month depending on four geographic areas. The minimum wages of employees working in domestic companies will be VND650,000 (US$39), VND690,000 (US$42), VND740,000 (US$45), and VND800,000 (US$48), respectively Jones and Kierzkowski (1990) discussed how increasing returns and the advantages of specialization of factors within the firm encourage a switch to a production process with fragmented production blocks connected by service links. Deardroff (2000) argued that the incentive of fragmentation

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210

23. 24. 25.

26. 27.

28.

29. 30.

31.

32.

Tuan Bui

can be larger across countries and within countries due to differences in factor prices and technology that are available, and that the service costs of international fragmentation are larger if regulations and restrictions impede the international provision of services. Yi (2003) verifies that if tariffs continue to fall, vertical specialization becomes more of a possibility, meaning that reduction of service link costs is essential to further production fragmentation. This policy was subsequently phased out due to the rules of national treatment under the WTO commitments. Vietnam Economic News, 27 December 2007. Kohei Mishima, “The Supplier System of Motorcycle Industry in Vietnam, Thailand, and Indonesia: Localization, Procurement and Cost Reduction Processes”, in Improving Industrial Policy Formulation, edited by Kenichi Ohno and Nguyen Van Thuong (Vietnam Development Forum, 2005), p. 215. Vietnam Development Forum (2006). Junichi Mori, “Development of Supporting Industries for Vietnam’s Industrialization: Increasing Positive Vertical Externalities through Collabourative Training”, (Master Thesis, Fletcher School, Tufts University, 2005) . In a subsequent meeting with the Vietnam Chamber of Commerce and Industry (VCCI) that aimed to seek ways to prevent Japanese investors from following Sony, the Japanese Business Association (JBA) has called on Vietnam to develop supporting industries in order to keep investors in the country for the long term. VietNamNet Bridge News, 8 August 2008. For example, see the surveys done by the Institute of World Economics and Politics in 2003 and Central Institute of Economic Management in 2005 on manufacturing industries in Vietnam. A survey by JETRO on cost comparison related to investment in some cities and main regions in Asia in 2005, cited in Vietnam Development Forum (2008). Other cities included in the survey are Bangkok, Jakarta, Shanghai, Singapore, Taipei, Seoul, Beijing, New Delhi, Kuala Lampur. A typical example is the case of the company Vedan owned by a Taiwanese investor in 2008. This company uses technology that seriously harms the Thi Vai River in Long Thanh, Dong Nai province. The investigation results showed that the waste from the business activities of the company into this river were 1,000 times higher than the regulated standards. In addition, the company has used measures to avoid necessary steps to process waste before discharging it into the river.

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33. The model of business linkages programme and cooperation in training between foreign invested enterprises and training centres that has been implemented by multinational company Unilever may be a good example.

References Ando, Mitsuyo and Fukunari Kimura. “The Formation of International Production and Distribution Networks in East Asia”. NBER Working Paper, no. 10167, 2003. Benassy-Quere, A., M. Couper and T. Mayer. “Institutional Determinants of Foreign Direct Investment”. World Economics 10 (2007). Bui Tuan. “FDI in Vietnam”. In Managing FDI in Asia: Experiences and Lessons, edited by Hal Hill and B. Douglas. London: Palgrave, 2004. CIEM (Central Institute for Economic Management). Vietnam Economy in 2006. Hanoi: Education Publishing House, 2007. Deardorff, Alan V. “Fragmentation in Simple Trade Models”. Presented in a session on “Globalization and Regionalism: Conflict or Complements?”. North American Economics and Finance Association, Chicago, 1998. Ecochard, Pierre, Lionel Fontagné, Guillaume Gauthier, and Soledad Zignago. “Intra-Industry Trade and Economic Integration”. In East Asia’s De Facto Economic Integration, edited by Daisuke Hiratsuka, Chapter 2. London: Palgrave Macmillan, 2006. General Statistical Office. Statistical Data of Vietnam Socio-economy 1975–2000. Hanoi GSO 2001. ———. Statistical Yearbook. Hanoi: GSO, various years. Hillberry, Russell and David Hummels. “Trade Responses to Geographic Frictions: A Decomposition Using Micro-Data”. Working paper, 2005. Hiratsuka, Daisuke. “Vertical Intra-Regional Production Networks in East Asia: Case of the Hard Disc Drive Industry in East Asia”. In East Asia’s De Facto Economic Integration, edited by Daisuke Hiratsuka, Chapter 6. London: Palgrave Macmillan, 2006. Institute of World Economics and Politics. “Foreign Direct Investment and Development of Vietnam’s Industry”. Project Report, Hanoi, 2004. Jenkins, Rhys. “Globalization, FDI and Employment in Viet Nam”. Transnational Corporations 15, no. 1 (2006). Jones, Ronald W. and Henry Kierzkowski. “The Role of Services in Production and International Trade: A Theoretical Framework”. In The Political Economy of International Trade: Essays in Honor of Robert E. Baldwin, edited by Ronald W. Jones and Anne O. Krueger. Cambridge, MA: Blackwell, 1990.

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Junichi Mori. “Development of Supporting Industries for Vietnam’s Industrialization: Increasing Positive Vertical Externalities through Collabourative Training”. Master Thesis, Fletcher School, Tufts University, 2005, . Klaus E. Meyer. “FDI Spillovers in Emerging Markets: A Literature Review and New Perspectives”. Copenhagen Business School, DRC Working Paper no 15, 2003. Kneller, Richard and Mauro Pisu. “Industrial Linkages and Export Spillovers from FDI”. The World Economy 30, no. 10 (2007). Le Linh, Bui Tuan, and Dao Hung. Foreign Direct Investment in Hanoi and Ho Chi Minh City. Social Sciences Publishing House, 2003. Leproux, Vittorio and Douglas H. Brooks. “Viet Nam: Foreign Direct Investment and Postcrisis Regional Integration”. Asian Development Bank ERD Working Paper no. 56, 2004. MOLISA. “Training and Using Skilled Workers as Requirements of Development in the New Stage Achievement in Attracting Foreign Investment into Vietnam”. Workshop paper, Hanoi, 2008. MPI. Various unpublished reports, 2006, 2007. ———. “The Vietnam 20-year Foreign Investment Outlook”. Hanoi: MPI, 2008. Nguyen Thi Kim Ngan. “Training and Using Skilled Labours for the Needs of Development in the New Period — Achievements of attracting FDI and Future Directions”. In The Vietnam 20-year Foreign Investment Outlook. Hanoi: MPI, 2008. Nguyen, Kim Bao. FDI of China since 1979. Hanoi: Social Sciences, 2000. Nguyen, Ngoc Anh and Nguyen Thang, “Foreign Direct Investment in Vietnam: An Overview and Analysis, the Determinants of Spatial Distribution Across Provinces”. Workshop paper, Hanoi, 2007. Ong Keng Yong. “ERIA Symposium on Opportunities and Challenges towards Regional Integration in East Asia”. Opening Remarks at the ERIA Symposium in Singapore, 2007. STAR (2007). “Assessment of the Five-Year Impact of the U.S.–Vietnam Bilateral Trade Agreement on Vietnam’s Trade, Investment, and Economic Structure”. Report, Hanoi, 2007. UNCTAD. World Investment Report: The Shift Towards Services. Geneva: UNCTAD, 2004. ———. World Investment Report: TNCs and the Internationalization of R&D. Geneva: UNCTAD, 2005. ———. World Investment Report: FDI from Developing and Transition Economies: Implications for Development. Geneva: UNCTAD, 2006. ———. Investment Policy Review Vietnam. Workshop paper, Hanoi, 2007.

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Vietnam Development Forum. “Supporting Industries in Vietnam from the Perspective of Japanese Manufacturing firms”. Policy note, Hanoi, 2006. ———. “Industrialisation Strategy of Vietnam towards 2020”. Symposium with the National Economics University, Hanoi, 2008. Vietnam Investment Review. “20 Years of Foreign Investment in Vietnam”. Special issue, Hanoi, 2008. World Bank. “Moving Toward cCompetitiveness: A Value Chain Approach”. Technical report, Washington. D.C., 2007. Yi, Kei-Mu. “Can Vertical Specialization Explain the Growth of World Trade?”. Journal of Political Economy 111, no. 1 (2003).

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8 Border Industry in Myanmar: Plugging into Production Networks through Border Industry1 Toshihiro Kudo and Ikuo Kuroiwa

I. INTRODUCTION The chairman of the Myanmar Garment Manufacturers Association (MGMA) deplores the fact that the garment industry in Yangon and its suburbs has been losing workers, in particular experienced workers, to Mae Sot, a Thai border town opposite Myawaddy on the Myanmar side. His own factory employed 150 workers but has recently lost 10 sewing-machine-operators to Mae Sot.2 The question is why Myanmar workers have left Yangon, the former capital and business centre of the country, for a small border town on the Thai side. The garment industry in Yangon was severely damaged by the United States’ sanctions of July 2003, which banned all imports from Myanmar. The industry exported nearly half of its products to the United States, and more than 80 per cent of U.S. imports from 214

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Myanmar were clothes. Myanmar’s garment exports declined sharply from US$829 million in 2001 to US$312.4 million in 2005, a 62.3 per cent decline.3 Many factories were closed and many workers lost their jobs.4 Some garment workers who were made redundant went to Mae Sot to seek employment. Such a migration reflects the poor business conditions and serious unemployment problem in Myanmar, as well as the significant wage gap between the two countries. It is therefore only natural that Myanmar workers migrate to Thailand, attracted by abundant job opportunities and higher wages. However, there are two important questions that must be answered: the first is why so many garment factories are concentrated in a small Myanmar-Thai border town. This question raises issues unique to Cambodia, Laos, and Myanmar, as shown below. The other question is why the industry is located on the Thai side, not the Myanmar side. Mae Sot and Myawaddy are separated by a small river called the Moei. The friendship bridge that was constructed by the Thai government in 1997 connects the two towns. The Thai garment industry could easily cross the bridge and relocate to Myawaddy, where it could probably employ more Myanmar workers at lower wages. However, this did not happen. The absence of a border industry in Myawaddy indicates that there exists some hindrance or impediment which prevents the Thai garment industry from operating on Myanmar soil. Nevertheless, the flourishing border industry in Mae Sot indicates the possibility of a border industry thriving on Myanmar soil, once such hindrance has been removed and a favourable business environment created. This chapter examines factors that promoted industrial clustering in the Myanmar-Thai border area, and identifies factors that pushed factories to the Thai side. It also examines the garment industry in Mae Sot as a case study. Such analysis could lead to important policy measures for promoting border industry on Myanmar soil. The first section reviews the historical, political and economic relationship between Myanmar and neighbouring countries. This section also provides background knowledge on how a border industry has become possible along Myanmar’s border areas, especially the MyanmarThai border area. The second section examines factors that promoted a border industry which is expected to grow for some time. What, then, is the rationale behind this and what is the source of competitiveness of a border industry? This section addresses these questions. The third

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section focuses on the garment industry in Mae Sot. Relying on firsthand information from a questionnaire survey, the study discusses the competitiveness of the garment industry in Mae Sot in terms of labour costs, logistics, and infrastructure services. In conclusion, this section also explores the possibility of relocating the border industry to Myanmar soil and presents some policy measures.

II. MYANMAR’S OPEN-DOOR POLICY AND NEIGHBOURS Myanmar shares long borders with five neighbouring countries, namely China (a border of 1,357 miles), Thailand (1,314 miles), India (857 miles), Bangladesh (152 miles) and Laos (128 miles), as well as sharing coastal waters with Malaysia and Singapore. In view of its geographical location, it seems only natural that Myanmar would have strong economic ties with its neighbouring countries. In fact, however, Myanmar’s borders have long been closed for all practical purposes throughout the country’s socialist period (1962–88).5 Myanmar pursued a strict non-aligned foreign policy and operated on an economic strategy of self-reliance and self-sufficiency. It was after the military government (SLORC/SPDC)6 came into power in 1988 that its policy orientation changed drastically, and an open-door policy was introduced in areas such as the liberalization of external trade, the legalization of cross-border trade with neighbouring countries and the acceptance of foreign investment by the enactment of the Foreign Investment Law (FIL). The open-door policy adopted by Myanmar’s newly-established military government was welcomed by neighbouring countries, especially China and Thailand. Following the end of the Cold War, China ceased its dual-track foreign policy toward Myanmar, in which it endorsed party-to-party relations between the China Communist Party (CCP) and the Burma Communist Party (BCP), in addition to state-to-state relations (Tin Maung Maung Than 2003, p. 194). Thailand abandoned its secret strategy of using the Karen and other ethnic insurgents deployed alongside the border area as a buffer against the Myanmar army and the BCP.7 Chatichai Choonhavan, Thai Prime Minister from 1988 to 1991, coined the famous phrase: “Change Indochina from a battlefield to a commercial field.” The newly-established military government in

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Myanmar also initiated a ceasefire policy with ethnic insurgents, most of whom occupied the border areas as of 1989.8 Thus, peace was realized in these areas for the first time. Moreover, Myanmar joined the Greater Mekong Subregion (GMS) Economic Cooperation in 1992, which was a significant departure from its traditional neutralist foreign policy. Subsequently Myanmar joined the Association of Southeast Asian Nations (ASEAN) and the Bay of Bengal Initiative for Multi-Sectoral Technical and Economic Cooperation (BIMSTEC) in 1997, the Mekong-Ganga Cooperation in 2000 and the Ayeyawady–Chao Phraya–Mekong Economic Cooperation Strategy (ACMECS) in 2003. Myanmar’s open-door policy was well received by East Asian regionalism throughout the 1990s, a situation that prevails today. At the same time, Myanmar has strengthened its trade relations with neighbouring countries. The trade shares of its five neighbouring countries, China, India, Malaysia, Singapore, and Thailand, accounted for 70.4 per cent of Myanmar’s exports and 79.5 per cent of its imports in 2006 (Table 8.1). The five countries are also leading investors in Myanmar, accounting for 70.2 per cent of the total amount of approved foreign investment, as of March 2006. Myanmar’s economy, however, has been sluggish for some time, although the official GDP has indicated eight consecutive years of double-digit growth since fiscal year 1999. The per capita monthly household expenditure in U.S. dollar terms has also been extremely low at US$10.9 in 1997 and US$9.9 in 2001.9 Engel’s coefficient was 71 per cent in 1997 and 72 per cent in 2001, suggesting no significant improvement in living conditions. The industrial structure has also been slow to change. The manufacturing share of Myanmar’s GDP increased from 7.8 per cent in 1990 to 11.6 per cent in 2004, while that of Cambodia increased from 5.2 per cent to 18.8 per cent during the same period (ADB KI 2008). Worse still, Myanmar has been subjected to various economic sanctions by the United States, the European Union (EU) and other Western countries. The hostile international environment surrounding the military government and poor infrastructure conditions prevented the Myanmar economy from participating in regional production networks. Due to the hostile attitude of Western countries toward the military regime, as well as its geographical location and cultural affinity, Myanmar’s

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TABLE 8.1 Myanmar’s Trade with Neighbouring Countries, 1980–2006 Exports

(%) 1980

1985

1990

1995

2000

2006

Thailand India China Malaysia Singapore

0.8 1.4 1.2 2.8 14.3

0.8 2.3 1.2 2.2 9.7

12.0 10.8 8.1 2.1 11.3

3.0 12.2 11.3 3.1 16.0

11.8 8.2 5.7 3.2 5.0

49.0 12.1 5.3 2.6 1.4

Five Neighbours

20.4

16.2

44.3

45.7

34.0

70.4

European Union Africa Japan Germany South Korea Others

12.8 10.6 9.9 2.6 0.2 43.5

8.9 19.7 8.4 3.7 6.3 37.7

7.9 14.3 6.9 2.1 2.2 23.2

6.1 9.3 7.1 2.0 1.0 28.7

16.7 8.6 5.5 3.9 1.0 30.3

7.5 5.8 5.1 2.6 1.4 7.2

415.0

302.7

408.7

1,197.9

1,979.3

4,316.0

1980

1985

1990

1995

2000

2006

Total (US$ Million) Imports

China Thailand Singapore Malaysia India

3.7 0.2 6.1 1.9 0.6

3.2 0.5 5.8 2.6 0.5

20.6 3.0 17.9 4.7 0.2

29.0 0.0 29.9 10.8 1.0

18.0 18.3 15.8 8.4 1.7

34.0 21.4 15.8 4.6 3.7

Five Neighbours

12.5

12.6

46.4

70.7

62.1

79.5

South Korea European Union Indonesia Japan Hong Kong Others

1.3 21.4 0.0 43.7 0.5 20.6

0.1 25.4 0. 39.0 0.6 22.3

3.5 16.0 0.5 16.6 1.3 15.8

4.1 8.4 2.8 7.4 3.0 3.6

10.5 4.0 2.3 7.1 3.2 10.8

4.0 2.9 2.8 2.7 1.1 7.1

785.5

282.6

667.7

2,341.6

3,039.2

3,909.6

Total (US$ million)

Source: IMF: Direction of Trade.

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open-door policy has gradually strengthened its economic ties in trade, investment and regional cooperation with neighbouring countries. The opening of the Myanmar border to neighbouring countries has also made the border industry possible.

III. FACTORS PROMOTING A BORDER INDUSTRY Complementary Factor Endowment There are several factors that enhance the competitiveness of a border industry. From an economic point of view, a border restrains the mobility of productive inputs, such as labour, capital, technology and information. As a result, a border creates differences in input prices across the border, and complementary inputs become available alongside each other in border areas. Such complementary inputs can be easily transported across the border and combined for production on either side of the border. A border industry can grow by exploiting the differences in the endowment of productive inputs across the border. In the GMS, Thailand and China are relatively advanced economies, while Myanmar, Cambodia and Laos (CLM) are still in their rudimentary development stage. On the other hand, Vietnam is apparently entering a more advanced stage of economic development. Border areas between relatively advanced and less developed economies offer their respective complementary location advantages. For example, CLM economies provide a labour force, while Thailand offers major inputs (materials, parts, and components), technology, and capital. In border areas, those complementary resources, which exist side by side across borders, are combined to produce cost-competitive products. Of course, some of these resources must be transported across the border to be utilized for production in a border town. Thus, a certain degree of cross-border mobility of productive inputs is required for the birth and growth of a border industry.

Utilization of Cross-border Infrastructure In East Asia, service link costs — costs for connecting remotely located production blocks — have been reduced substantially (Kimura 2006).

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The multinational corporations (MNCs) have aggressively exploited wage differences between developed and less developed economies in East Asia and developed extensive production and distribution networks in the region. However, Myanmar and other less developed Southeast Asian economies have yet to be integrated into such networks in spite of their abundant, reasonably well-educated and low-waged labour force. Underdeveloped infrastructure, notably in transportation and communication, hinders them from participating in production and distribution networks and, unless good infrastructure is developed, the savings in labour costs by relocating labour-intensive activities to less developed economies are more than offset by increases in service link costs and other costs (fixed costs of setting up new factories, high utility service costs, etc.). A border industry could therefore offer a solution for overcoming such a problem. Namely, a less developed economy in Southeast Asia can participate in the production network via border areas. The required infrastructure investment to connect its border areas with the existing infrastructure in neighbouring countries may be far smaller than that for developing a nationwide infrastructure system. For example, it would be very costly to construct a deep-sea port somewhere on the Myanmar coast. Furthermore, the new port may not be fully utilized because of the weak agglomeration of industries, and it may lead to a shortage of cargoes and expensive shipping costs. Firms in MyanmarThai border areas, on the other hand, can gain access to the welldeveloped Bangkok Port and Laem Chabang Port via well-connected road networks in Thailand. In border areas, firms would also have better access to utility services such as electricity, water, and telecommunications that are provided by more advanced neighbouring countries. Thus firms located in border areas can enjoy all the benefits of lower service link costs (i.e. lower transport and communication costs) and more reliable and cheaper utility services (especially electricity) as well as lower labour costs.

Dynamics of a Border Industry The above two factors — lower service link costs and more reliable and cheaper utility services — provide location advantages of the

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border area over other regions, including metropolitan areas such as Yangon and Mandalay. Figure 8.1 shows the relationship between the service link costs and the growth of border industry. Initially, the Myanmar borders were closed during the socialist period, and thus border industry could not emerge (the first stage). In this stage, only illegal, irregular and small-scale cross-border smuggling was conducted, mainly by ethnic minority insurgents. The open-door policy and the ceasefire agreements between the Myanmar military and ethnic insurgents improved security and lowered border barriers, allowing a border industry to emerge and develop (the second stage). A border industry grows rapidly due to the location advantages mentioned above, i.e. lower service link costs, more reliable and cheaper utility services, and an abundant and cheap labour force.

FIGURE 8.1 A Relationship between Service Link Costs and Border Industry

High Service Link Costs

Growth Border Industry

No Border Industry with Closed-door Policy Growth of Border Industry with Open-door Policy Decline

Low Prohibitively High Service Link Costs

Underdeveloped Infrastructure and High Service Link Costs

Developed Infrastructure and Low Service Link Costs

Source: The authors.

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However, as the infrastructure develops in a less developed economy, the location potential of border areas (or the competitiveness of the border industry) diminishes. This is because, on the one hand, the development of infrastructure, especially in transportation, telecommunications, electricity, and water, reduces the service link costs and utility service costs within the territory and therefore diminishes the cost advantages of border areas. At the same time, the advantages of other areas, especially metropolitan areas, may become more important at this stage. Metropolitan areas, for example, can provide a highly qualified labour force and specialized parts and service suppliers as well as lucrative local markets. At the same time, the metropolitan area can also furnish more frequent and cheaper transport services. Such agglomeration effects will become crucially important as the industrial activities in the area are upgraded, shifting from labour-intensive to more capital- (or knowledge-) intensive activities. As a result of lower service link and utility service costs, the economies of agglomeration in the metropolitan area will finally eclipse the initial advantages of the border industry and retard the growth of the border industry (the third stage). Poor infrastructure in less developed economies, which raises service link costs and reduces the quality of utility services, allows the birth and growth of the border industry. Thus, border industries can be seen not only at Mae Sot but also in other less developed economies. For example, eighteen special economic zones (SEZs) have been approved by the Cambodian government as of January 2008, and many of these SEZs are located in border areas, with notable exceptions of Phnom Penh SEZ at the capital city, and Sihanoukville SEZ at the international port (Figure 8.2).10 The Manhattan SEZ is located in Bavet, a small town bordering with Moc Bai in Vietnam and situated on the GMS Southern Economic Corridor that connects Bangkok and Ho Chi Minh City via Phnom Penh. In the Manhattan SEZ, where two Taiwanese firms producing bicycles and screws have already started operation, Cambodian workers are employed at the minimum monthly wage of US$50, electricity is provided from the Vietnam grid, and the products are exported via Ho Chi Minh Port, only 60 kilometers from the border through the Southern Economic Corridor. In this manner, the Manhattan SEZ can enjoy the benefits of better utility services, low service link costs in Vietnam, and lower labour costs in Cambodia.

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FIGURE 8.2 SEZs in Cambodia

Note: This map indicates only sixteen SEZs. Source: Document obtained by the authors from CSEZB on 16 November 2007.

Business Environment and Location of the Border Industry Theoretically, the border industry is expected to be geographically located in the less developed economy. In terms of physical service link costs that are largely determined by geographical distance, it makes no difference on which side of the border firms are located. However, the border industry could enjoy the benefits of lower labour costs if it is situated in the less developed country. In the case of Myanmar, for example, firms in border areas could employ more workers at lower wages on the Myanmar side of the border than on the Thai side, as they do not need to follow the minimum wage regulations and restrictive

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migrant worker policies established by the Thai government. In fact, SEZs in the border areas of Cambodia are located on the Cambodian side of the border rather than on the Thai or Vietnamese side, as shown in Figure 8.2. Moreover, regional economic cooperation schemes, such as the GMS, contribute to the development of the cross-border infrastructure, cross-border institutional frameworks such as the crossborder transport agreement (CBTA), single-window and single-stop services, and truck passports. These efforts will reduce the transport costs across the border and strengthen the location advantages of less developed economies in a border industry. On the other hand, it is particularly surprising that no border industry is located on the Myanmar side. In the case of the Myanmar-Thailand border area, all factories are located on Thai soil, and Myanmar migrant labourers move to Thailand and work there. This is obviously due to an inferior business environment in Myanmar where many restrictive regulations, both explicit and implicit, are imposed on foreign firms by the host government. For example, Myanmar’s government sets the minimum capital investment at US$500,000 for manufacturing firms, and such an amount is often more than Thai small and medium-size enterprises (SMEs) can afford. In addition to such an explicit regulation, lack of policy consistency and unpredictability of policy implementation and sporadic closure of border gates seriously impede Thai firms from crossing the Moei River. The Myanmar government also strictly controls external trade, particularly cross-border trade, by means of export and import licences, an export-first policy and trade bans on certain items. It also restricts foreign currency transactions, which then create significant disparities in exchange rates from the official rate of about 6 kyat to US$1 to the market rate of about 1,350 kyat as of mid-September 2007. Moreover, the Myanmar government frequently changes rules and regulations without prior consultation with the business sector or even without prior notice, and this attitude seriously undermines the stability and predictability of the business environment in Myanmar. Such unfavourable government policies increase the institution-wise service link costs across the Myanmar-Thailand border. If enterprises were to move to the Myanmar side, Thai investors would face an extremely uncertain business environment. Thus, Thai firms in the border area would not choose to move to Myanmar soil.

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IV. GARMENT INDUSTRY IN MAE SOT As a case study, this section examines the garment industry in Mae Sot, which is an emerging border industry on the Thailand-Myanmar border. Based upon the analytical framework mentioned above, this paper will now examine how this border industry exploits the location advantages found in border areas.

Outline Mae Sot is a small town in Tak Province in the north of Thailand (Figure 8.3).11 A small river called the Moei separates Mae Sot and FIGURE 8.3 Tak Province and Mae Sot

Source: Wikipedia .

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Myawaddy, a small town in Karen State in Myanmar. The two towns are also situated on the GMS’s East-West Economic Corridor (EWEC) that connects Danang in Vietnam and Mawlamyine in Myanmar via Laos and Thailand. For nearly ten years, many factories have been established or relocated there. There were 464 factories with 36,821 workers in Tak Province in 2005 (Table 8.2).12 Among them, 235 factories or 51 per cent of the total were located in Mae Sot and employed 31,876 workers or 87 per cent of the total workforce in Tak Province; these figures indicate that TABLE 8.2 Number of Factories by Sector in Tak Province, 2005

Sector of Industry

Number of Factories

Number of Employees Male

Female

Total

per Factory

CapitalLabour Ratio

Agricultural

78

231

85

316

4

354

Food Beverage Textile Garment Leather Wood Furniture Paper Printing Chemical Petrochemical Robber Plastic Non-Metal Products Metal Metal Products Machinery Electrical Transportation Others

37 4 58 55 7 17 7 1 2 2 5 4 4 63 1 13 11 2 40 53

357 24 5,940 1,046 159 553 287 29 8 10 69 7 42 1,640 397 132 47 18 285 1,200

382 15 11,330 8,573 651 280 35 13 1 10 13 0 31 1,483 33 66 2 135 30 1,172

739 39 17,270 9,619 810 833 322 42 9 20 82 7 73 3,123 430 198 49 153 315 2,372

20 10 298 175 116 49 46 42 5 10 16 2 18 50 430 15 4 77 8 45

89 144 15 13 17 31 33 1,414 159 11 217 109 232 145 2,589 48 97 12 242 549

464

12,481

24,340

36,821

79

100

Total

Source: The Tak Chapter of the Federation of Thai Industries.

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many labour-intensive industries, including the textile and garment industry13 (hereafter called “garment industry”), were concentrated in Mae Sot. There were 113 garment factories in Tak Province in 2005, and most of them were located in Mae Sot. These factories employed 26,889 workers or 73 per cent of the total workforce in Tak Province, so that the capital-labour ratio of the garment industry was among the lowest.

Questionnaire Survey The Institute of Developing Economies (IDE-JETRO) conducted a joint study with the Economic Research and Training Centre (ERTC) of Thammasat University on the economic and social aspects of migrant workers in the garment industry in the Myanmar-Thai border areas in August and September 2006.14 The study included a questionnaire survey covering 10 garment factories and 100 Myanmar migrant workers.15 The survey indicated that the garment industry in Mae Sot is still quite young. Six out of ten garment firms were established after 2001, while two were set up in 1998, and one firm in 1990 and 1995 respectively (Table 8.3). Seven garment firms were under sole Thai TABLE 8.3 Year of Establishment 1990 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 (up to Aug)

1 1 0 0 2 0 0 2 1 1 1 1 0

Total

10

Source: The Survey.

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ownership and the remaining three were joint ventures with Chinese investors. Nine firms were sub-contractors that produced garments to order for exporters in Bangkok. Only one firm in this survey exported its products directly overseas. The average number of employees was 423, which is greater than the official statistics show in Table 8.2 (i.e. 298 for the textile industry and 175 for the garment industry). Workers from Myanmar comprised 86 per cent of the total number of employees, with workers from Myanmar in each firm comprising from 83 per cent to 97 per cent of the workers, except for one firm that had no workers from Myanmar.16 The firms operated for 296 days in 2005, or 25 days per month on average. Asked to cite reasons for relocating to Mae Sot, only two firms out of eight explicitly stated that they did so because of the abundance of Myanmar labour. Four firms answered that they just followed their headquarters’ policy, and the remaining two firms stated that they built factories there because the owners were Mae Sot residents. Therefore, the headquarters’ policy of firms must have taken into account the availability of workers from Myanmar in Mae Sot. Entrepreneurs in Mae Sot started garment factories because of the availability of Myanmar workers, and the garment industry there is totally dependent on Myanmar workers. Therefore, the availability of Myanmar migrant workers is obviously the main reason why the garment industry has clustered in this small border town.

Labour The Thai government has responded to requests from employers to allow them to hire foreign workers to fill labour shortages in the industry in particular job areas commonly referred to as the “Three Ds”, which stand for “difficult, dirty, and dangerous”. Following a Thai Cabinet Decision in April 2004, the most comprehensive registration until then took place in that year when the Thai Ministry of the Interior registered 1,280,000 foreigners during the month of July. Of these, 814,000 had applied for work permits by mid-December (Huguet and Punpuing 2005, pp. 30–34). Of the 814,000 applicants, 610,000 or three-quarters were from Myanmar. In terms of the number of work permits issued to Myanmar nationals, Tak Province with 50,932 permits ranked third, surpassed by Bangkok with 98,308 and Samut Sakhon with 67,799.

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Tak Province is one of the places where abundant Myanmar labour is available and employable. The survey also examined the workers’ profiles. Out of the 100 Myanmar workers interviewed, 61 were female; the female ratio of the sample is lower than the textile and garment industry average in Tak Province at 74 per cent (Table 8.2). The average age of the workers was 27 years old, ranging from the youngest at 18 to the oldest at 36 years old. Out of 61 females and 39 males, 44 and 20 respectively were single. In terms of their hometowns, 23 were from Myawaddy; 20 were from Pa-an, the capital of Karen State; 11 were from Mawlamyaing, the capital of Mon State; 9 were from Yangon, the former national capital; 6 were from Thaton, the former centre of the ancient Mon Kingdom; 4 were from Bago, the capital of Bago Division (Figure 8.4).17 Many of the workers were understandably from nearby towns like Myawaddy and Pa-an. It is however notable that quite a few were from rather distant places like Yangon and Bago and, in terms of ethnicity, 96 FIGURE 8.4 Yangon and Myawaddy Route

Source: MEMI (2007), p. 57.

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workers were Burmese and the rest were Karen, Kachin and Akha. These facts imply that the labour market for the garment industry in Mae Sot encompasses quite a large geographical area along the main road that connects Myawaddy and Yangon. Seventy-four out of 100 Myanmar workers migrated to Thailand after 2002 (Table 8.4). In the years 2004 and 2005 in particular, the entry of 25 and 27 persons respectively was recorded. Rapid increases in these two years may be related to the relaxation of the Thai government’s policy on migrant workers. It may also be related to the collapse of Yangon’s garment industry after the United States’ sanctions of July 2003. The garment factories in Yangon may have actually lost their workers to factories in Mae Sot, as the MGMA chairman stated. It was surprising to note that 43 workers had received no formal education; 36 workers had received an elementary and/or junior-high school education (4 to 8 years); 18 workers had a high school education (10 to 11 years); and only four workers had obtained a college and/or university-level education (12 years or more). A survey of the garment

TABLE 8.4 Year of Entry to Thailand 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 (up to Aug) Total

1 0 0 3 5 6 6 5 9 10 25 27 3 100

Source: The Survey.

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industry in Yangon in 2005 shows that only 0.8 per cent of workers had not received formal education, while 50.5 per cent had been educated for up to 8 years, 26.7 per cent for 10 to 11 years, and 21 per cent had a college/university education (Kudo 2006, p. 113). In view of the fact that Myanmar’s total net enrollment in primary education was 99.6 per cent in 2006 (ADB 2008), the education level of workers from Myanmar in Mae Sot was extraordinarily low. The reasons for this gap are unknown. Their work experience in the garment industry was also quite limited. Fifty-seven workers had no experience in the garment industry, 13 had worked in garment factories for one year or less, 18 had worked in factories for three years or less, and only 12 had more than four years’ work experience. Most of those without work experience were probably recent entries into Thailand. Employees worked for eight hours a day, six days a week. Ninetytwo workers earned only the minimum wage of 143 baht (equivalent to US$3.80 at the exchange rate of September 2006) a day, six workers earned 150 baht per day and two workers earned 160 baht or more per day. Their basic monthly wage amounted to 3,575 baht (143 baht/day × 25 days) or US$94, while garment workers in Yangon earned, on average, 17,800 kyat per month, equivalent to about US$20 per month in 2004 (Kudo 2008, p. 1014). Most workers in Mae Sot also received overtime pay with the higher rates being 23–27 baht per hour (equivalent to 184–216 baht per day). Nominal wage differences between the garment industry in Yangon and in Mae Sot were almost fivefold, and this wage gap attracted workers from Myanmar even from distant places.18 This indicates that as long as there is a significant difference in wages, border areas will be able to attract workers from other areas and make up for the shortage of the labour force in the remote area. Seventy-nine workers had remitted money to their hometown. According to the 30 respondents, the average remittance was 2,393 baht or US$63 per month, representing 67 per cent of the minimum wage. Fifty-four respondents answered that their remittances were on average 16,407 baht, equivalent to nearly seven months’ wages, during the past few years. All workers lived in Thailand and no one commuted between Myawaddy and Mae Sot. Ninety-one workers lived in company dormitories and 71 workers did not pay for accommodation, while 29 workers paid 645 baht per month on average. Ninety workers were also provided with meals at subsidized prices by their employers. Such

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an inexpensive way of living for Myanmar migrant workers in Mae Sot made it possible for them to remit a substantial share of their wages home. Thus, 72 workers had no intention of returning to Myanmar permanently.

Logistics The garment industry in Mae Sot has an advantage in logistics over Yangon. Now consider the case where a garment manufacturer in Mae Sot exports to Tokyo. The 490-kilometer road connecting Mae Sot and Bangkok is paved well, and vehicles can cover the distance in twelve hours at a cost of about US$290 (Table 8.5). In Bangkok, there are two major ports: one is Bangkok Port or Klong Toey Port and the other is Laem Chabang Port, the latter of which is one of Asia’s leading ports and the most important commercial deep-sea port in Thailand. It takes eight to nine days from Laem Chabang Port to Tokyo/Yokohama Port and costs US$1,340 to ship a 40-foot container.19 Products made in Mae Sot arrive in Tokyo in about ten days at an approximate cost of US$1,630.

TABLE 8.5 Comparison between Road and Marine Transport

Route Road

1. Bangkok-Mae Sot 2. Mae Sot-Kawkareik 3. Kawkareik-Yangon Total

Marine

1. Bangkok-Bangkok Port 2. Bangkok Port-Yangon Port 3. Yangon Port-Yangon Total

Distance (km)

Time (Hour)

490 75 380

12 Hrs (1st Day) 4 Hrs (2nd Day) 15 Hrs (3rd Day)

945

3 Days

20–30 approx. 4,000

1–2 Hrs 20 Days

20–30

1–2 Hrs

—

Cost (US$) Conditions 290 Very Good Very Bad 440 Good 730 80 Very Good 1,000 — 50

Good

approx. 1 Month 1,130

Source: JETRO Censor in Japanese, February 2006, p. 19.

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Alternatively, consider the case where a garment manufacturer in Yangon exports to Tokyo. Most factories in Yangon have good access to Yangon Port, taking one or two hours, at an approximate cost of US$50. However, no vessels sail directly to Japan and cargoes have to be trans-shipped at Singapore Port. It costs US$650 to ship a 40-foot container from Yangon Port to Singapore Port.20 Moreover, only two vessels are available every three days, and trans-shipment in Singapore takes at least one day. Shipment from Singapore to Tokyo/Yokohama Port costs US$940. In total, it takes twenty days from Yangon to Tokyo via Singapore and costs US$1,740, plus trans-shipment charges in Singapore Port. It is obvious that the latter route takes more time and expense by a significant margin. Moreover, garment firms in Yangon need to apply for export and import licences for each transaction and it requires them to travel all the way to Naypyidaw, the new capital of Myanmar, located about 300 kilometers north of Yangon. It usually takes about two weeks to obtain one export and/or import licence, as the Trade Policy Council chaired by General Maung Aye, Vice-Chairman of the SPDC, approves each licence individually. At the same time, cargoes are often kept in port for a considerable time for inspection and customs clearance. On the other hand, Bangkok Port and Laem Chabang Port are said to provide much more efficient services. The garment industry in Mae Sot has an advantage in the procurement of raw materials. The survey shows that four out of the eight respondent firms used only Thai domestic raw materials. For one respondent, domestic materials accounted for 73 per cent of materials with the remaining 27 per cent imported, and three used imported materials only. Conversely, the garment industry in Yangon has been completely dependent on imported raw materials. Firms in the garment industry actually needed to import all materials — fabrics, accessories, thread, and even plastic bags, with the exception, perhaps, of cardboard boxes. Furthermore, it takes a lengthy period of time in Myanmar to import materials. Thus garment firms in Yangon need a longer lead time for production and the delivery of products. The longer lead time required hinders Myanmar’s garment industry from sewing seasonal and/or fashion apparel items, which require quick responses. On the other hand, it is a strong advantage for garment factories in Mae Sot to be able to use both domestic and foreign raw materials.

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Road transport has recently become the focus of attention in efforts to reduce transportation time and costs in Myanmar. Table 8.5 compares road and marine transport from Bangkok and Yangon (Figure 8.5).21 Road

FIGURE 8.5 Road and Marine Routes for Transport between Bangkok and Yangon

Source: JETRO (2007) ASEAN Logistics Network Map.

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transport logistics could offer an advantageous alternative to the marine route in terms of both time and cost. However, the road route is not yet available for commercial transportation of cargo. Road conditions on some parts of the route are too dangerous for large vehicles. The 38-kilometer road between Kawkareik and Thingannyinaung crosses the Dawna Range and a hilly part of it is restricted to one-way traffic — odd days for ascending vehicles and even days for descending vehicles. At the same time, the procedure for crossing the border through Myawaddy requires tedious and time-consuming prior negotiations with the Myanmar authorities. At present, the cut, make and pack (CMP), a type of production on consignment, is not allowed for cross-border transactions by the government.22 This route constitutes a part of the EWEC, and road construction is scheduled to be completed with Thai assistance. A memorandum of understanding (MOU) for the CBTA between Myawaddy and Mae Sot is being finalized, and this will simplify procedures for crossing the border in the near future. Reduced transportation costs resulting from the completion of the EWEC and the CBTA will also benefit Yangon. However, there are still many obstacles in Myanmar to overcome before the entire service link cost is reduced. Consequently, the border area in Myawaddy-Mae Sot will continue to have advantages over Yangon for a while.

Electricity Myanmar has experienced a long-standing national power shortage since the late 1990s. A shortage of electricity is one of the most serious problems in the garment industry as well as in other manufacturing sectors in Myanmar. In a survey of the garment industry in Yangon conducted by one of the authors in 2005, firms were asked to rate how severely the poor infrastructure services in telecommunications, transportation, and electricity affected their operations (Kudo 2006, p. 113). Table 8.6 shows that electricity is regarded as a very severe problem in garment production. In the same survey, 69 firms among the 139 respondents answered that they had experienced power interruptions more than three times a day and that these had often lasted for more than three hours. Therefore, most manufacturers (134 out of 141 factories) had to use their own generators or share generators with other factories.

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TABLE 8.6 Garment Factories’ Ratings on Infrastructure Services in Yangon, 2005 Very Severe Obstacle

Major Obstacle

Moderate Obstacle

Minor Obstacle

No Problem

3 53 0

18 55 2

30 17 20

34 8 35

56 8 84

Telecommunications Electricity Transportations Source: Kudo (2006) p. 113.

The State-owned Economic Enterprises (SEEs) Law, promulgated in 1989, stipulates that SEEs should continue to monopolize twelve economic enterprises. In electricity, Myanmar Electric and Power Enterprise (MEPE), a SEE that falls under the jurisdiction of the Ministry of Electric Power, was designated as the sole legal provider in Myanmar, and this monopolistic system has retarded the improvement of efficiency in the provision of utility services. On the other hand, firms in Mae Sot are provided with power from a Thai company and therefore have a reliable electricity supply. Moreover, many households in Myanmar are buying electricity from a Thai company in Mae Sot, which is deemed illegal by the SEE law. The Myanmar consumers pay electricity charges in baht, the use of which is also illegal, as possession of foreign currency by Myanmar citizens is prohibited by law. The provision of electricity to households in Myawaddy through the power grid in Mae Sot seems to be based on a mutual understanding between the regional authorities in both countries, although the precise arrangements remain unclear. This arrangement suggests that the cross-border transmission of electricity may be possible between the two border towns. Once legal and institutional arrangements have been concluded between the two governments, factories located in Myawaddy could be officially and regularly provided with electricity from the Thai side.

Comparison of Location Advantages The authors have thus far examined several factors that promote or retard the growth of border industries. Table 8.7 compares location

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237

TABLE 8.7 Comparison of Location Advantages in Myanmar and Thailand Myanmar Yangon Labour Costs Service Link Costs Utility Services Institutions and Regulations Agglomeration Economy Note: O Location Advantage; Source: The authors

Thailand

Myawaddy

Mae Sot

Bangkok x

x x x

x x

Weaker Locational Advantage; x Locational Disadvantage.

advantages of border towns and capital cities in Myanmar and Thailand. Location advantages of four sites are evaluated from five aspects: labour costs, service link costs, utility services, institutions and regulations, and agglomeration economy. First, in terms of labour costs, Yangon and Myawaddy have advantages over the other two cities in Thailand. In Thailand, Mae Sot has advantages over Bangkok, where wages have soared due to industrial agglomeration. Second, in terms of service link costs, Bangkok and Mae Sot have advantages over the two cities in Myanmar. In Myanmar, Myawaddy has advantages over Yangon, since the former is physically adjacent to Thailand, where transportation and communication infrastructure is well developed. Third, in terms of utility services Thai cities have advantages over the Myanmar cities. In Myanmar, Myawaddy has advantages over Yangon, since in the former, utility services such as electricity are provided by Thai companies. Fourth, in terms of institutions and regulations, the Thai cities have advantages over Myanmar cities where cumbersome and restrictive rules and regulations are imposed by the Myanmar government. Fifth, in terms of agglomeration economy, metropolitan areas have advantages over border towns, although each Thai city has advantages over each Myanmar city respectively. Now let us examine which city is the most suitable for such a labour-intensive industry as garment. To begin with, Bangkok will be excluded as a competitive location due to its high labour costs. Among

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TABLE 8.8 Household Expenditure per Capita by Region (kyat)

Rank

Region

1989

1997

2001

Difference Growth (Union = 1) (1989–2001)

1

Shan (East)

355.8

2,855.9

10,095.2

1.8

28.4

2

Tanintharyi

377.6

3,408.9

6,999.4

1.3

18.5

3

Kayin (Karen)

319.6

2,788.2

6,966.1

1.3

21.8

4

Rakhine

314.2

2,421.3

6,894.5

1.3

21.9

5

Yangon

380.5

3,033.2

6,564.7

1.2

17.3

6

Shan (North)

355.8

2,855.9

5,749.0

1.1

16.2

7

Bago (East)

333.4

2,942.7

5,554.2

1.0

16.7

8

Kachin

304.4

2,468.9

5,358.5

1.0

17.6

Mon

304.2

2,581.5

5,340.1

1.0

17.6

10

Bago (West)

333.4

2,942.7

5,313.0

1.0

15.9

11

Sagain

307.2

2,466.4

5,264.2

1.0

17.1

12

Ayeyarwaddy

351.4

2,310.4

5,175.6

0.9

14.7

13

Mandalay

357.0

2,630.1

5,121.2

0.9

14.3

14

Shan (South)

355.8

2,855.9

5,032.0

0.9

14.1

15

Chin

275.7

1,657.0

4,659.9

0.9

16.9

16

Kayah

345.6

1,992.3

4,130.2

0.8

12.0

17

Magway

333.3

2,144.5

4,005.6

0.7

12.0

Union

340.7

2,625.6

5,458.1

1.0

16.0

9

Source: CSO, Statistical Yearbook, 2006.

the remaining three cities, Mae Sot apparently has location advantages over Yangon and Myawaddy, and it has actually attracted many garment firms as described in this chapter. Myawaddy can possibly attract labour-intensive activities because of low labour costs. Nevertheless, Myawaddy has not yet successfully attracted investors due to its poor institutional and regulatory environment. Once Myawaddy overcomes these problems, it will have the potential to combine an abundant and cheap labour force in Myanmar with well-developed infrastructure (road networks, port facilities, electricity, etc.) in Thailand. It may then become the most attractive location.

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239

V. CONCLUSION AND POLICY RECOMMENDATIONS In this chapter, the authors examined the prospects of the border industry along the Thailand-Myanmar border. This border industry has growth potential, as it can exploit the location advantages of the abundant and cheap labour force in Myanmar, while avoiding high service link costs and unreliable utility services that accrue from underdeveloped infrastructure there. It also can avoid the cumbersome and restrictive red tape imposed on business activities in Myanmar. As a result, contrary to the general notion that border areas are remote and backward, they are actually better off because of their location. It is somewhat astonishing to find that the four regions, i.e. Shan (East), Tanintharyi, Karen, and Rakhine, with the highest per capita household expenditures, share borders with Thailand, China and Bangladesh (Table 8.8). Futhermore, these regions are growing more rapidly, thus widening the gap in household expenditures between border areas and other regions. The Myanmar economy is thus characterized as a “poor centre and rich periphery”.23 The periphery in Myanmar is no longer a periphery in the conventional sense of the word. Myanmar’s border area is closer to more dynamic economies like those of Thailand and China. The Myanmar industry can participate in regional production networks via border areas and thus provide an impetus for industrial development in the central part of Myanmar as well, where the economic situation has long been depressed. Human resources are the most important location advantage in Myanmar. The Thai prime labour force population aged 15-39 is no longer growing but the Myanmar population is still increasing by 1.3 per cent per annum (Huguet and Punpuing 2005, p. 5). The wage difference between Mae Sot and Yangon is as much as fivefold. Unemployment and underemployment are widespread in Myanmar, while the “3D” jobs are no longer attracting Thai workers. Thus, creating jobs for the young population is an urgent issue for Myanmar, while filling the labour shortage is a crucial issue for Thailand. Therefore, giving Myanmar migrant workers in Thailand formal legal status is essential. The Thai government signed an MOU on Cooperation in the Employment of Workers with the Myanmar government on 21 June 2003. As a part of programmes implemented

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under this MOU, the Myanmar government opened border passport centres in Myawaddy, Tachileik and Kawthoung in November 2006 for the issue of temporary passports to Myanmar workers who have Thai work permits.24 As stated above, the Thai government has also tried to control and regulate migrant workers through registration, issuance of work permits, provision of protection and the repatriation of workers whose terms have expired. However, the results of interviews with Myanmar workers in Mae Sot clearly show that most Myanmar workers have no intention of returning home permanently. Legal and due repatriation will be difficult to enforce. An alternative to increasing migrant workers in Thailand is to relocate the industry to the Myanmar side. In this chapter, the authors examined why garment factories in Mae Sot have not crossed the small river to Myawaddy, where a more abundant and cheap labour force is available. This occurred mainly because of the Myanmar government’s restrictive and unpredictable policies toward businesses, especially toward foreign investors. The establishment of special economic zones (SEZs) can be an effective measure in promoting an industrial cluster on the Myanmar side. SEZs, which include export processing zones (EPZs) and free trade zones (FTZs), have been widely established in East Asia, and export-oriented industries that led the developing economies in the region were typically located in such zones. SEZs are designed to insulate themselves from the rest of the economy, where the business environment is not necessarily favourable. SEZs are also equipped with better infrastructure. Moreover, the single-stop and single-window services at SEZ are expected to reduce significantly service link costs and improve the business environment. Thus, Myawaddy will be able to strengthen its location advantages while lessening its disadvantages by setting up SEZs there. In October 2004, the Thai Cabinet endorsed the Mae Sot Border Economic Zone Project which covers Myawaddy as well (Huguet and Punpuing 2005, p. 35). In such special zones, CMP-based production on consignment should be allowed. Under this arrangement, garment firms located in a special zone in Myawaddy will be able to import raw materials from Mae Sot free of duties and without tedious import controls. Then they will sew, knit, and export products through the same

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border gate; the CMP system is currently applicable only to overseas transactions via the seaport in Yangon. Moreover, owners and managers of firms located in an SEZ in Myawaddy should be exempt from visa requirements, since they need to travel frequently between factories in Myawaddy and head offices in Bangkok or other cities. Also, since Myawaddy does not have an airport, owners or managers of factories, whether from Myanmar or other countries, should have free access to the airport in Mae Sot. All these schemes will enhance the location advantage of the SEZs and eventually lead to the development of an industrial cluster in Myanmar. Border areas in Myanmar are no longer backward regions that expect assistance from the centre. On the contrary, they are situated on the frontiers and are conduits which capture business opportunities originating from emerging countries (notably Thailand and China, and potentially India and Bangladesh in future) and pass them into the core of the Myanmar economy. The Myanmar government needs to recognize the potential of the border industry and to position it accordingly in its national industrial development strategy.

Notes 1. This chapter was rewritten from IDE Discussion Paper No. 122 (Chiba: Institute of Developing Economies, JETRO, October 2007). 2. Author’s interview with the chairman on 4 September 2007. 3. Based on the import data of twenty-two major importing countries including Australia, Canada, the European Union (fifteen member countries only), Japan, Korea, Malaysia, Singapore and the United States. 4. For the impact of the United States’ sanctions on the garment industry in Myanmar, see Kudo (2008). 5. See Liang (1990) for Myanmar’s foreign policy during the socialist period. 6. The military took power in a coup in September 1988 and established the State Law and Order Restoration Council (SLORC), which was re-constituted as the State Peace and Development Council (SPDC) in November 1997. 7. For Thai diplomacy toward Myanmar, see Battersby (1998–99). 8. See Smith (1999) for details. 9. The per capita monthly household expenditure was 2,626 kyat in 1997 and 5,458 kyat in 2001 (CSO SY, 1998; 2004), which was converted at the prevailing exchange rates of 240 kyat/dollar and 550 kyat/dollar, respectively.

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10. 11.

12. 13.

14.

15. 16.

17. 18.

19. 20. 21. 22. 23. 24.

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The official exchange rate, on the other hand, has been pegged at about 6 kyat/dollar. The author’s interview with a government official of the Cambodian Special Economic Zone Board (CSEZB) on 16 November 2007. The population of Mae Sot in 2000 was 106,413 according to Wikipedia (Available at ), accessed on 11 September 2008. These figures are from the Tak Chapter of the Federation of Thai Industries. The textile sub-sector here represents knitwear apparel production, while the garment sub-sector includes woven apparel production. There is almost no textile yarn and fabric production, which are more capital-intensive, in Mae Sot (interviews with the Tak Chapter of the Federation of Thai Industries in September 2006). In this chapter, the “garment industry” includes both sub-sectors. One of the authors joined a field trip to Mae Sot and Myawaddy with the Thammasat team in September 2006. He wishes to thank Dr Chanin Mephokee, Associate Professor at Thammasat University, and Mr Jarin Cholpaisal, Lecturer at Rangsit University, for their cooperation with the survey. See ERTC (2007) for the detailed survey results. Samples are small and were selected for convenience of interviews. A careful interpretation of the data is required. This firm answered that it employed no Myanmar workers out of a total of 390 employees. However, it responded to a question in the same questionnaire on why Myanmar workers are employed. It is thus doubtful that it employed no Myanmar workers. Some places indicated by interviewees were not identified because of incorrect transliteration of the Myanmar language by Thai enumerators. If we assume that their education background indicates the workers’ skill level, the wage gap becomes even wider because workers in Yangon had a better educational background than those in Mae Sot. Based on information from JETRO (2007). Interview with the MGMA chairman on 4 September 2007. Road transportation figures are based on a trial run by a truck operated by Sankyu Inc., a leading Japanese logistics company, in December 2004. CMP is also referred to as CMT (cut, make, and trim). As for CMP in Myanmar, see Kudo (2008, pp. 81–83). Kurosaki et al. (2004) also described Myanmar’s rural economy as a “rich periphery and poor centre”. The Irrawaddy Online News, 15 November 2006.

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References Asian Development Bank (ADB). Key Indicators for Asia and the Pacific (KI). Manila: ADB, 2008. Battersby, Paul. “Border Politics and the Border Politics of Thailand’s International Relations in the 1990s: From Communism to Capitalism”. Pacific Affairs 71, no. 4 (Winter 1998–99): 473–88. Central Statistical Organization (CSO). Statistical Yearbook (SY). Nay Pyi Taw: CSO, 1998. Economic Research and Training Centre (ERTC), Thammasat University. “Joint Study for Economic and Social Aspects of Migrant Workers of Garment Industry in Thai-Myanmar Border Area”, March 2007. Huguet, Jerrold W. and Sureeporn Punpuing. International Migration in Thailand, Bangkok: International Organization of Migration (IOM), 2005 . International Monetary Fund (IMF). Direction of Trade (DOT). Washington, D.C.: IMF, 2007. The Irrawaddy Online News. Available at . Accessed 11 September 2008. JETRO. JETRO Censor (in Japanese), February 2006. ———. ASEAN Logistics Network Map [in Japanese, ASEAN Butsuryu Network Map]. Tokyo: Japan External Trade Organization (JETRO), 2007. Kimura, Fukunari. “The Development of Fragmentation in East Asia and its Implications for FTAs”. In East Asia’s De Facto Economic Integration, edited by Daisuke Hiratsuka, pp. 16–31. New York: Palgrave Macmillan, 2006. Kudo, Toshihiro. “Industrial Policies and the Development of Myanmar’s Industrial Sector in the Transition to a Market Economy”. In The Economic Transition in Myanmar after 1988: Market Economy versus State Control, edited by Fujita Koichi, Mieno Fumiharu, and Okamoto Ikuko. Kyoto CSEAS Series on Asian Studies 1, pp. 66–102. Singapore: NUS Press, 2009. ———. “Growth and Decline of the Garment Industry in Myanmar: Market, Firms and Institutions”. In The Experiences and Prospects of Late-Comer ASEAN Countries, edited by Amakawa Naoko, IDE Research Series no. 553. Chiba: Institute of Developing Economies, JETRO, 2006:, pp. 101–39. [In Japanese, “Myanmar Hosei Sangyo no Hatten to Teitai: Shijo, Ninaite, Seido”, in Kohatsu ASEAN Shokoku no Kogyoka: CLMV Shokoku no Keiken to Tenbo]. ———. “The Impact of U.S. Sanctions on the Myanmar Garment Industry”. Asian Survey vol. XLVIII, no. 6 (November/December 2008). Kurosaki, Takashi, Ikuko Okamoto, Kyosuke Kurita, and Koichi Fujita. “Rich Periphery, Poor Center: Myanmar’s Rural Economy under Partial Transition

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to Market Economy”. Hi-Stat Discussion Paper Series no. 23. Tokyo: Institute of Economic Research, Hitotsubashi University, March 2004. Liang, Chi-shad. Burma’s Foreign Relations: Neutralism in Theory and Practice. New York: Praeger Publishers, 1990. Myanmar Economic and Management Institute (MEMI). Study on the Possibility to Improve the Transportation and Industrial Infrastructure and Trade between Myanmar and Thailand which will Develop the East West Economic Corridor: Survey Report. Commissioned by the Ministry of Economy, Trade, and Industry (METI) and prepared by Myanmar Marketing and Research Development (MMRD), February 2007. Smith, Martin T. Burma: Insurgency and the Politics of Ethnicity. Dhaka, Bangkok and London: The University Press, White Lotus and Zed Books, 1999. Tin Maung Maung Than. “Myanmar and China: A Special Relationship?”. In Southeast Asian Affairs 2003, pp. 189–210. Singapore: Institute of Southeast Asian Studies, 2003.

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9 The Batam, Bintan, Karimun Special Economic Zone: Revitalizing Domestic Industrialization and Linking Global Value Chain Toh Mun Heng and Ng Kwan Kee

I. INTRODUCTION The Special Economic Zone (SEZ) is not a new concept in economic development literature. Its predecessor takes the form of free trade zone (FTZ) and export processing zone (EPZ) where selected production activities (often manufacturing-related in nature) are permitted within the zone without the encumbrances of cross-border custom clearances and trade-related taxes so that industrial development and international trade can be given a boost. Popularized by the success of the SEZs in launching China into a new economic powerhouse, many aspiring developing economies are willing to spare resources to develop SEZs to catalyse economic growth.

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SEZs have evolved with changing international economic trends to take the form of industrial parks (e.g. Vietnam-Singapore Industrial Park; Suzhou Industrial Park in China); science, technology and high-tech parks (e.g. Incheon Science Park in South Korea; Bangalore IT Park in India), and on a larger scale like the “growth triangle” that involves Singapore, Johor (Malaysia) and Batam (Indonesia),1 and the contiguous economic hub consisting of Hong Kong and Shenzhen in the Pearl River Delta of China. The 1997 Asian financial crisis (AFC) had dealt a severe blow to the economic development programme in several of the ASEAN economies. Among these countries, Indonesia has perhaps been the most affected. Ten years after the AFC, Indonesia has yet to regain the same vitality and exuberance as before the crisis. The setting up of a SEZ on the islands of Batam, Bintan and Karimun (BBK) is viewed as one of possible positive steps to regain the growth momentum enjoyed by the Indonesian economy in the past. In the next section, we will review the use of concepts of global value chains (GVC) and global production networks (GPN) in promoting regional economic development. Following that we profile the progress and past efforts on economic reform and industrialization in Indonesia, keeping in mind the resultant impact on BBK. We next consider the stylized economic strategies for development in the globalized world. International trade promotion and attraction of foreign investments have become the main avenues to better economic performance. Facilitating the development thrust is the formation of SEZs and harnessing the capability to be part of the GPN and GVC. However, the passage to industrialization and growth is not always a smooth one. Indonesia is no exception, and it has a host of problems that need attention and solution. Results from an extensive survey conducted by the World Bank will be extracted to showcase the difficulties faced by investors in Indonesia. Valuable lessons and practices can be gleaned from the experience of SEZs in other parts of the world. This brings us to the question of how BBK has fared in attracting FDI and generating trade and employment. Of particular interest is the role of Singapore in assisting BBK to fulfil its aspiration of a SEZ which will play a catalytic developmental role for the whole of Indonesia. The chapter concludes with a discussion of government policy measures that could possibly

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foster economic growth in the BBK and create spillover benefits to the rest of Indonesia.

II. NEW PARADIGM OF ECONOMIC GROWTH: GLOBAL VALUE CHAIN AND GLOBAL PRODUCTION NETWORK In the past, economists would like to describe the path of development for an economy as following the sequence from an agriculture-based economy to one that is powered by industrial growth, and then to one that is service-oriented. Not all developed economies follow that sequence, but generally, it is a pattern that is observed for many countries. In recent years, that sequence of transformation is punctuated by many other developments because of technological advances made in information and communication technologies (ICT). For instance, the manufacturing of textiles was often the pioneering industry for embarking on an industrialization process by developing economies in the 1950s and 1960s. However, this has changed significantly. Developing economies in the 1970s could skip textiles and move on quickly with light industries in the electronics-related sector. The transition from one stage to another has sped up. Because of intense competition among developing economies for foreign direct investment to stimulate and promote growth, governments of developing economies have made concerted efforts to facilitate private entrepreneurs to secure contracts and businesses. At the international level, countries are participating in multilateral negotiations to remove barriers (tariff and non-tariff) to trade and capital flows. International agencies such as the World Trade Organization (WTO) and International Monetary Fund (IMF) are bustling with a multitude of fora, seminars and negotiations to nudge the world economy towards one that accommodates free trade in goods and services, as well as in capital and skilled labour. At the same time, the private sector, guided by market competition, has been responsive to changing consumer demand and availability of inputs, be they natural resources or factors of production such as skilled technicians and research engineers, to devise new forms of production arrangements to assure a healthy bottom line and sustainability. In particular, we see the establishment of global commodity chains (GCC)

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or global value chains (GVC)2 and global production networks (GPN). These GVCs and GPNs become new “port of entries” for developing economies to embark on their industrialization Programme for economic growth.

Concept of Global Value Chains A useful conceptual device which helps us to understand national and international business networks (including those established by MNCs) is the notion of “global value chains”.3 A value chain is a sequence of activities required to make a product or provide a service. The value chain concept is often attributed to Michael Porter who introduced it in his book Competitive Advantage: Creating and Sustaining Superior Performance (Porter 1985). Value chain analysis, as noted by Schmitz (2005), has become an increasingly useful approach to gain a comprehensive view of the various inter-locking stages involved from taking a good or service from raw material to production and then to the consumer. Activities in a value chain can be categorized into primary and support activities. Primary activities include manufacturing, marketing, outbound logistics and service. The support activities are finance, human resource management, technology development and procurement (Figure 9.1). FIGURE 9.1 Porter’s Value Chain

Technology Development

in rg Ma

Service

Marketing and Sales

Outbound Logistics

rgi n

Ma

Operations

Procurement Inbound Logistics

14444244443

Support Activities

Infrastructure Human Resource Management

144444444442444444444443 Primary Activities Source: Porter (1985).

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Two points need to be stressed at this stage. Each of these value chain activities can be further divided to facilitate a more thorough analysis. Even if the firm does not itself perform all these activities in-house, it still has to ensure that the outsourcing partner is efficient. Thus, more often than not, a thorough analysis of all the activities that make up the chain, extending from the basic raw materials suppliers to the final end-customer becomes necessary to identify scope for improvement and remove inefficiencies. Succinctly described by Schmitz (2005), the idea of a value chain becomes useful for analytical and policy purposes once we include three further features. Firstly, the activities are often carried out in different parts of the world, hence the term global value chain. Secondly, some activities add more value and are more lucrative than others. Policymakers will be concerned as to how to help local enterprises to move into lucrative activities. The third feature concerns the power of actors in the chain. Some actors in the chain have power over the others. The powerful actors are often called the “lead firms” who seek to “govern” the chain. They set and/or enforce the terms under which the others in the chain operate. A central concern of value chain analysis is to “unpack” the relationships between global lead firms and local producers — and the opportunities and constraints that result from entering such relationships. While the value chain is important for all companies, in the case of global companies, a highly sophisticated and well-coordinated approach to value chain management becomes critical. This is because global companies have to locate different activities in different countries to optimize the effectiveness of the value chain as a whole. Value chains can span firms of a local economy, a sub-national regional economy, the entire domestic economy and even the global economy, since activities that comprise a value chain can be contained within a single firm or distributed among different firms within the countries or across different countries. When value chains include activities which are divided among multiple firms and spread across wide swaths of geographic space, these chains now made up a large interconnected system of value chains called the Global Value Chain (GVC). For developing economies, an approach to engender growth and development is to be able to plug into the GVCs. It pays to recognize which are the “lead firms” in the GVC, and the governance4 of value chains, as

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these will enable appropriate strategies to be formulated and implemented in order to make participation in the value chain possible. Being able to secure a position in the value chain could well be the starting point for a cycle of cumulative causation: from simple labour-intensive assembly activities to higher value-added, technology-based production. There is a need to distinguish between global chains that are “driven” by two kinds of lead firms: buyers and producers. The GCC framework contrasted “buyer-driven” chains (such as large retailers like Wal-Mart) to “producer-driven” chains, dominated by large manufacturing firms (such as General Motors and IBM). Put simply, producer-driven chains have more linkages between affiliates of multinational firms, while buyer-driven chains have more linkages between legally independent firms. Underlying this distinction is the notion that buyer-driven chains turned out relatively simple products, such as apparel, house wares, and toys. Because innovation lies more in product design and marketing rather than in manufacturing know-how, it was relatively easy for lead firms to outsource production. In the more technology- and capitalintensive items made in producer-driven chains, such as autos and complex electronics, technology and production expertise were core competencies that needed to be developed and deployed in-house, or in captive suppliers that could be blocked from sharing them with competitors.5 Over the years, business practices among multinational enterprises have changed quite dramatically — outsourcing many activities and developing strategic alliances with competitors. Enterprises have become less vertically integrated and more network-oriented. Better global standards in the realms of business processes and product characteristics, and the heavy application of information technology in areas such as design, manufacturing, service provision, supply-chain coordination, and materials management, has enabled increased outsourcing in producer-driven chains and made it possible, and more compelling, for firms to forge modular linkages between buyers and suppliers in both producer- and buyer-driven chains.

Global Production Networks (GPNs) The GVC concept is increasingly complemented by the Global Production Networks (GPNs) of specialized independent enterprises, capturing

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complex relationships and interrelations between firms that are of systemic nature; GVC deals with vertical and linear sequences of events along the value chains, while GPN deals with complex network structures in which there are intricate links — horizontal, diagonal, as well as vertical — forming multi-dimensional, multi-layered lattices of economic activity (Henderson, Dicken, Hess, Coe, and Yeung 2002).6 On the other hand, D. Ernst defines GPN as a major innovation in the organization of international business, whereby these networks combine concentrated dispersion of value chains across the boundaries of the firm and national borders, with a parallel process of integrating hierarchical layers of network participants (Ernst and Kim 2002). The GPN concept reflects the processes of accelerated fragmentation in knowledge-intensive activities in some value chains. For instance, in product design and development, product technology is becoming increasingly modularized. Modularization of technological knowledge enables the adoption of characteristics of standard commodity, allowing design and other knowledge-intensive activities to be separated from the whole value-chain system and to be performed in different geographical locations (Ernst and Lüthje 2003). Modularization on the other hand offers opportunities for firms in developing countries to participate in GPNs. One of the benefits of participating in GPNs is knowledge diffusion. GPNs boost international knowledge diffusion by the transfer of knowledge from the global flagships or lead companies to their suppliers in developing countries (Rugman 1997, p. 182). Flagships which can be “brand leaders” such as GE and IBM, or “contract manufacturers” like Flextronics typically provide the local suppliers with knowledge which could assist them in building capabilities that are necessary to produce products and services with the expected quality and price. To stay on the GPNs, however, local suppliers must constantly upgrade their absorptive capacity (Ernst and Kim 2002).

GVC and Industrial Upgrading Participating in the GVCs and GPNs broadens the scope for gains from an open trade and investment regime, and thus diminishes pressures for protectionism. It can help developing country producers to enter foreign markets, earn more foreign currency, diversify their exports, and

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most importantly, to get new skills, knowledge and technology — all considered as key factors for productivity enhancement and growth. Late-comer firms from developing countries can exploit the advantage of their late arrival to tap into new technologies, rather than having to reproduce the entire previous technological trajectory. By recognizing the working and importance of GVCs and GPNs, policymakers and practitioners will have greater confidence in suggesting and implementing measures that contribute to successful industrialization and development. Understanding GVCs and GPNs offers opportunities for firms in developing countries to upgrade their technological and industrial capabilities so as to be able to participate in the global value chains and integrate into the global economy. Linking to global value chains can also provide countries better access to markets and to knowledge of leading players (Borrus et al. 2000; Gereffi 1994, 1995, 2002; UNIDO 2005). Concepts of GVC and GPN will also enable local entrepreneurs to take a more global view of business, thus production efficiency and managerial skills will likely be raised and sustained in view of competition and standards demanded by clients beyond the local economy. Local producers will benchmark against competing firms in other countries and will also encourage learning from buyers. One can envisage local producers who join global value chains having good prospects for upgrading from assembly of imported components to (1)

taking care of the entire production process (including the sourcing of inputs), design of their own products, sale of their own branded products in national and global markets.7

(2) (3)

In fact, we can identify five types of upgrading: • Process upgrading: transforming inputs into outputs more efficiently by re-organizing the production system or introducing superior technology. • Product upgrading: moving into more sophisticated product lines (which can be defined in terms of increased unit values). • Functional upgrading: acquiring new functions in the chain (or abandoning existing functions) to increase the overall skill content of activities. • Inter-sectoral upgrading: using the knowledge acquired in particular chain functions to move into different sectors.

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• Industrial composition upgrading: attraction of new industries (foreign and local) into the economy to increase diversity and economic sustainability.

III. INDONESIA ECONOMY: POST ASIAN FINANCIAL CRISIS ECONOMIC LETHARGY With a population of about 222.1 million in 2006, Indonesia is the world’s fourth most populous nation. It is also the world’s largest archipelago state, with more than 13,000 islands spread over a distance of five thousand kilometres from west to east. In the first twenty-five years after independence, Indonesia’s economic performance faltered. Later, however, Indonesia’s economic policy, particularly over the period 1985–97, was characterized by an openness to trade and foreign investment; high domestic saving rates; prudent macroeconomic management; sustained public investment in health, education, family planning, and in physical infrastructure. Successful implementation of the economic policies enabled the economy to grow by 7–8 per cent annually over the period 1985–97. During this period, Indonesia witnessed a dramatic reduction in poverty. In the mid-1970s, it is estimated that more than 40 per cent of the country’s population suffered absolute poverty. By 1996, it had improved to some 16 per cent of Indonesians living in absolute poverty. Despite all the importance assigned to FDI, it may be borne in mind that direct foreign investment accounted for only about 6 per cent of gross fixed capital formation in Indonesia during 1987–97. Most investment in the country came out of domestic savings, which averaged about 29 per cent of GDP. Relying on FDI to give a fillip to the Indonesian economy is still very much a relevant policy prescription. The current structure of the Indonesian economy is provided in Table 9.1 below. Impressive economic transformation was experienced between 1985 and 2000. As shown in Table 9.1, the share of manufacturing in GDP reached 26 per cent by the year 2000, from a share of about 16 per cent in 1985 (Table 9.1). There has also been significant structural change within the manufacturing sector over the past fifteen years (Table 9.2). The two large export oriented-sectors, textiles and garments and the pulp and paper industry, significantly increased their shares of the

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TABLE 9.1 Sectoral Shares (percentage) in GDP, 1985, 2000 and 2006

1. 2. 3. 4. 5. 6. 7. 8. 9.

Agriculture, Forestry and Fisheries Mining and Quarrying Manufacturing Industries Electricity, Gas and Water Supply Construction Trade, Hotels and Restaurants Transport and Communication Financial Services Other Services

1985

2000

2006

23 18 16 — 5 15 5 4 14

17 13 26 1 7 15 5 6 9

17 9 27 1 6 16 7 9 9

TABLE 9.2 Structural Change in the Manufacturing Sector (percentage shares) ISIC Sub-sector 31 Food 32 Textiles 33 Wood 34 Paper 35 Chemical 36 Non Metallic, Minerals 37 Basic Metals 38 Fabricated, Metals 39 Other, Manufacturing

1985

2000

31 11 9 4 18 5 8 14 0

24 19 8 6 16 3 3 2 1

manufacturing output. These two sectors are both of significance in terms of their environmental impact. Structural change seems to have come to a standstill since the final years of the twentieth century. For Indonesia, the Asian financial crisis dealt a severe blow to the economic liberalization and industrialization effort initiated in the 1980s. As a result of currency devaluation and

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the contraction brought on by the Asian financial crisis in 1997, GDP in 1998 contracted by 14 per cent, inflation reached 68 per cent and incidence of absolute poverty increased to 25 per cent. The Asian financial crisis caused a collapse in investor confidence, starting in Thailand, and spreading to other economies in Southeast and East Asia. Economic setbacks also have repercussion on the political landscape: the Soeharto administration which governed Indonesia for more than three decades was replaced. Through good policy and good fortune (oil boom), the Soeharto administration delivered economic and social progress unparalleled in the history of Indonesia. However, the nature of the regime denied the country an adequate mechanism for checking cumulative growth of corruption, nepotism and other narrow interests that complicated and impaired the quality of economic policies in later years. The demise of the New Order highlighted the importance of the quality of institutions in the development process — in this case, it was the inability of existing institutions to self-correct and respond coherently to unexpected stresses and strains that have become common in the globalized world (Boediono 2005). In May 1998, Soeharto was succeeded by his Vice-President, B.J. Habibie. Though his reign was short, Habibie made contributions to political and economic reforms in Indonesia. He managed to reduce the role of the military in politics and introduced legislation to hold Indonesia’s first democratic elections in thirty-four years in 1999 (Porter and Ketels 2007). He also sought to stamp out corruption, and improve competition in the economy by legislating competition law in 1999 and putting in motion a privatization programme to divest the state-owned enterprises. Regional inequality in terms of development and resource distribution is another national concern. The move to decentralize public decisionmaking was initiated. Eleven policy areas (health, education and culture, agriculture, communications, industry and trade, capital investment, environment, land cooperatives, manpower affairs, management of natural resources, and urban development) were designated for decentralization, beginning on 1 January 2001. One-third of all government spending was shifted to the regional and local level. In October 2004, the Indonesian parliament clarified the responsibilities of the different levels of government and limited the scope for additional taxes to be imposed at the local level (Porter and Ketels 2007).

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By mid-1999, macroeconomic stability improved, with the rupiah appreciating to 7,000 per U.S. dollar from its low of 12,000 in mid1998. Inflation dropped into single digits and interest rates fell. Large Indonesian business groups worked to reduce heavy debt burdens, and restructured through divestments and increasing focus. Traditionally well connected with the Soeharto regime, the business groups were also seeking to build contacts with the new government. The stabilization of the economy came too late to save Habibie, who was forced to resign in October 1999 by the People’s Consultative Assembly (MPR). Abdurrahman Wahid, a well-respected Muslim cleric, succeeded Habibie as president and Megawati Sukarnoputri became his VicePresident. The Wahid administration proved no more effective in implementing economic and political reforms against powerful interest groups. Meanwhile, the Indonesian parliament had granted labour unions significant political influence via the passing of the Trade Union Act and Basic Manpower Act. Concerns about the slow pace of reforms once again undermined macroeconomic stability. The rupiah devalued, and inflation picked up. The Bank of Indonesia was slow to respond, and pressure rose to rewrite the central bank law and remove top management (Porter and Ketels 2007). Wahid was eventually removed from office by parliament in July 2001. Megawati Sukarnoputri became the third president in three years of post-Soeharto Indonesia, promising to address widespread problems of corruption and poor governance. In its thirty-nine months in office, the Megawati government succeeded in re-establishing economic stability but was less successful in accelerating growth, largely due to the lack of a solid and focused programme for achieving this goal. In 2001, a new oil and gas law created a new regulatory agency for oil and an agency for gas, and removed these regulatory functions from the stateowned petroleum company (Pertamina) which became a limited liability company. Production-sharing agreements with foreign investors became more attractive and offered comparable terms to other countries in the region by 2006. The telecommunication sector was liberalized in 2002. New entrants no longer needed to partner with one of the two incumbents, though foreign ownership in the sector remained capped at 49 per cent. A law to liberalize the electricity sector was passed in 2002 as well. President Megawati declared 2003 a year of investment. A year later, however, domestic and foreign investment rates were still low and

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there was little sign of improvement. By 2003, 83 per cent of investment was in real estate development. The Megawati administration implemented the tariff reductions that had been agreed to under the ASEAN Free Trade Agreement, but repeatedly expressed concerns about the fast pace of liberalization and used emergency exit clauses to retain protection for some sectors. A new labour law significantly raised hiring costs and set severance pay higher than elsewhere in the region. Individual provinces set their own minimum wage levels. GDP growth increased from 0.3 per cent in 1999 to 5 per cent in 2004, prosperity growth turned positive reaching 3 per cent, unemployment fell and the poverty rate dropped from 19.1 per cent in 2000 to 16.6 per cent in 2004. External public debt declined from about 103 per cent of GDP in 1999 to 59.8 per cent in 2004. The rupiah recovered to about 8,500 per dollar and inflation fell, but stagnant tax collection remained a challenge for the health of government finances. By the end of 2004, there was full utilization of production capacity for the first time since the 1997–98 crisis (Porter and Ketels 2007). In September 2004, Dr Susilo Bambang Yudhoyono became Indonesia’s first directly elected president. He announced a “100-Day Plan” of economic reforms, including more active engagement in ASEAN and with the WTO. The plan included measures to improve the business environment, improve labour laws, liberalize trade, tackle corruption, lower taxation, utilize public-private partnerships for infrastructure investment, and address poverty. However, obstacles to the smooth implementation of the plan were evident. Progress has been the greatest in the financial sector. Revisions to the labour law proposed in April 2006 were on hold after strong resistance from the labour unions. Business-friendly tax measures were held up in Parliament and were not expected to take effect before the end of 2008. Numerous provincial laws deemed to be obstructing trade and investment were still under review by the central government. Significant surpluses appeared in the government budgets, not because of increased revenue productivity but due to regional governments being unable to implement needed infrastructure investments. Publicprivate partnerships were to be used for infrastructure upgrading, but interested foreign companies were being deterred by unclear rules on the government’s role and concerns about projected rates of return. Removal of fuel subsidies to parry market distortion was economically sound

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but was facing severe public opposition and becoming a threat to political stability. The Indonesian Parliament passed a long-awaited new investment law (Law No. 25/2007) in late March 2007. Key features are: • A unified law: unifying the two formely separate laws governing foreign and domestic investment. • A much longer time span for land titles: maximum title for land cultivation (from 35 to 95 years), building rights (30 to 80) and land use (from 25 to 75). • Fiscal incentives: tax exemptions and reductions offered for projects that generate significant employment, promote infrastructure and technological development, and develop rural areas and pioneer industries. • National treatment provisions: law provides legal grounds for equality of treatment for domestic and foreign investors. • Greater details: law includes more explicit criteria (e.g. for determining the negative investment list and the fiscal incentives an investor can obtain) and clearer explanation (e.g. of which taxes may be imposed at regional level and which may not). • Commitment to less red tape: law stipulates establishment of “onestop shop” services for investment applications, and centralizes the process at the national level; this task is assigned to the Investment Coordinating Board (BKPM). For the investment law to show efficacy, successful implementation of the tax and labour laws is essential. However, the tax law is currently being debated in parliament and the government is reluctant to revise the labour law in light of the coming 2009 election (Narjoko and Jotzo 2007). The Yudhoyono government launched an economic policy package (Presidential Instruction No. 6/2007) in June 2007 to accelerate policy improvements in four areas: (a) investment climate; (b) financial sector; (c) infrastructure; and (d) micro, small and medium enterprises (MSMEs) — included as a major item for the first time. The package aimed to help MSMEs by providing better access to financial resources, improving market access, and implementing other regulatory reforms. However, it becomes counterproductive if it restricts participation of larger firms in sectors where economies of scales are significant. Policies aimed at improving entrepreneurial skills

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and access to finance of small firms have a higher degree of political appeal than effectiveness. The notable difference between this and the previous packages is the clearer specification of expected outcomes and more transparent ways of evaluating them by an independent external team. This reflects the government’s recognition that effective monitoring of policy implementation is important for the package’s credibility. However, there is no indication that the government will face consequences (other than loss of face) if the package fails to meet its objectives. The underlying problem seems to be the lack of strong incentives for the bureaucracy to implement policy reforms that are often in conflict with its own interests (Takii and Ramstetter 2007). The Yudhoyono government unveiled the long-awaited new negative investment list in July 2007 which included twenty-five closed sectors to protect “national interests”, and 300 industries conditionally open to investment, in which MSMEs are to be promoted, where investments are subject to foreign equity limitations, location requirements or special licences. The new investment law guarantees equal treatment of foreign and domestic firms in open sectors, but not equal opportunity to invest in all sectors. It has been observed that the new list is more transparent as it clearly specifies the restricted industries and has clearer mechanisms for revising the list, making it more difficult to increase the number of protected industries than in the past. However, complaints were focused on the rationale for specific restrictions (e.g., eleven levels of foreign ownership limits — question was raised as to the need for such fine gradations of regulatory intervention; foreign ownership limits tightened in transport and logistics businesses from 95 per cent to 49 per cent where Indonesian facilities are deemed inefficient); the concern about implementation and uncertainty about whether the next review in 2010 will be more restrictive. It seems that the government failed to reassure current and potential investors, many of whom had hoped that the new list and the new investment law would significantly improve the business environment (Takii and Ramstetter 2007). In summary, Indonesia stands at a crossroads. She faces the challenge of simultaneously overcoming the effects of a debilitating economic reversal, creating a new democratic framework of governance and containing the threat of political instability or ethnic conflict. Meeting each of these challenges poses a significant task. Taken together, the challenges are formidable (Kong and Arief 2008).

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Indonesia has yet to regain its pace of development prior to the Asian financial crisis. With a new administration under President Susilo Bambang Yudhoyono, Indonesia’s policy focus is now to move beyond economic recovery and towards reconstruction of its productive economy. The new Government maintains the basic policy commitments of the previous administration, based on three key goals: (1) maintaining macroeconomic stability; (2) continuing the restructuring and reforming of the banking and financial sector, and (3) increasing the level of investments, exports and employment creation. The Government has set out three major objectives for the coming years: improving the investment climate; solving infrastructure bottlenecks, especially in electricity generation and transportation; and developing a strategy that will diversify agriculture into higher value-added activities and stimulate economic growth in the rural non-farm economy. Macroeconomic performance of the Indonesian economy has indeed improved. As shown in Table 9.3, the level of GDP per capita and domestic investment had recovered to levels just before the Asian TABLE 9.3 Macroeconomic Indicators 1992

1995

1998

GDP growth (percentage)

7.2

8.2

–13.1

GDP per capita (current US$)

754

1,043

Population (million)

186

Unemployment rate (percentage) Consumer price inflation (percentage)

2001

2004

2006

3.5

5.1

5.5

487

675

1,178

1,640

195

204

209

216

222

4.0

4.5

6.0

8.0

9.5

10.5

7.5

9.4

58.5

11.5

6.4

6.6

US$-Rupiah average conversion rate

2,050

2,250

9,600

10,400

8,900

8,995

Inward foreign direct investment stock/GDP (percentage)

7.9

9.3

29.7

9.3

6.3

5.2

FDI (current US$ bn)

11

40

14

15

10

6

Government debt/GDP (percentage)

25

25

73

87

55

35

Source: IMF Economic Outlook, various issues; World Investment Report.

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financial crisis. However, the unemployment rate remains at twice that before the crisis, and FDI is visibly lower.

IV. HURDLES TO INDONESIA’S QUEST TO JOIN THE GVC Indonesia has a number of obstacles to overcome in order to find its place in the global production network. As mentioned earlier, global value chains, defined as the internationalization of a manufacturing process in which several countries participate at different stages, can be important in enhancing the development process of a country. FDI and joint ventures are common global value chain entry strategies for firms in developing Asian countries, including Indonesia. Participating in global value chains is an important catalyst for learning and adapting advanced technologies. In this section, we probe deeper into the weaknesses of the Indonesian economy and lay bare the challenges faced by economic planners to get Indonesian enterprises to participate in the many facets of global value chains in the world.

Weaknesses in Indonesia’s Manufacturing A recent study by the United Nations Industrial Organization8 (UNIDO) highlighted several pertinent features that encumbered the Indonesian manufacturing sector. They are summarized as follows: • Manufacturing investment undertaken aimed at using the country’s existing assets of ample primary commodities, hence Indonesia has yet to graduate from the assembly stage of industrialization. • Manufacturing investment undertaken by domestic entrepreneurs too broad-based, hence inhibits the process of specialization in industrial innovation, the development of core competences of firms and, consequently, of the competitive advantage of the economy. There is little evidence of technology spin-offs to the domestic economy, although foreign-owned firms tend to be more specialized than domestic conglomerates, resulting in the technological profile of Indonesian manufacturing remaining stagnant. • Entrepreneurship tended to adopt a herd instinct, concentrating on obvious business opportunities and existing domestic assets, rather

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than taking risks in diversification, innovation and development of new capabilities. Hence the country has a very high degree of concentration of exported products and trading partners, which greatly increased its risk exposure. • Given the rapid rate of industrialization and the technological weakness of the industrial sector, industry in Indonesia was almost exclusively reliant on imported capital goods and technology, hence there was a high likelihood of current account and balance of payments deficits. • Given the shallow, export-oriented pattern of industrialization, and the essentially short-term nature of business strategies, the larger firms have not built domestic supplier and vendor networks, and larger firms tend to dominate the entire industrial spectrum. As a consequence of these factors, Indonesia’s competitiveness began to decline relative to other emerging economies in Asia. In addition, the financial crisis, and the ensuing IMF-led restructuring programme, has increased pressure on Indonesia to further liberalize its domestic market, leading to the flooding of the domestic market by imported goods, ranging from textiles and sandals, to motorcycles, hand tractors and consumer electronics. Inward foreign direct investment flows have slowed down, due to the lack of business confidence compounded by political and economic uncertainty and to serious competition in investment markets from equally reform-oriented countries in the Asian region and elsewhere. Indonesia now faces the threat of industrial stagnation or even substantial de-industrialization.

Business Environment and Investment Climate in Indonesia A conducive business environment and investment climate are important to attract foreign direct investment to Indonesia, an effective and frequently used conduit into the Global Production Network. Indonesia’s business competitiveness, ease of doing business and its investment climate were assessed to see whether Indonesia has fulfilled an important criterion to woo investors. The Business Competitiveness Index (BCI) by the World Economic Forum (WEF) ranked 121 countries (GCR 2006–07 Edition) according to overall business competitiveness made up of the two dimensions in

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Porter’s Microeconomic Foundation of Productivity, namely, sophistication of company operations and strategy, and quality of the national business environment (Porter and Bryden 2007). Indonesia’s Business Competitiveness rankings were among the worst in the selected Asian countries, as shown in Table 9.4, despite an improvement in 2006. It has managed to rank ahead of China in 2006, but it ranks behind the large ASEAN countries: Thailand and Malaysia. The most deteriorated factors from 2005 to 2006 are shown in Table 9.5. Poor infrastructure and logistic facilities top the list of factors that devalue the competitiveness of companies operating in Indonesia. Also noted as another factor that will lift the competitiveness score is TABLE 9.4 Business Competitiveness Index for Indonesia and Trade Partners BCI Ranking

Indonesia Vietnam Malaysia Thailand China India Brazil Singapore

2006

2005

2004

2003

2002

2001

2005 GDP per capita, (PPP)

35 82 20 37 64 27 55 11

59 77 23 35 54 31 51 6

53 78 23 35 48 31 39 12

50 56 24 33 46 37 40 6

66 61 25 33 39 37 35 10

57 64 37 39 49 38 34 10

4,458 3,025 11,201 8,319 7,204 3,344 8,584 28,100

Quality of National Business Environment

Indonesia Vietnam Malaysia Thailand China India Brazil Singapore

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2006

2005

2004

2003

2002

2001

2005 GDP per capita, (PPP)

38 83 20 37 65 27 58 11

58 78 23 36 54 32 53 5

55 77 24 36 48 31 41 12

52 55 24 34 45 38 42 5

67 61 25 35 40 36 37 10

58 64 35 38 49 36 37 9

4,458 3,025 11,201 8,319 7,204 3,344 8,584 28,100

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TABLE 9.4 (Cont’d ) Company Operations and Strategy Ranking

Indonesia Vietnam Malaysia Thailand China India Brazil Singapore

2006

2005

2004

2003

2002

2001

2005 GDP per capita, (PPP)

26 77 14 30 69 25 38 21

52 79 25 33 53 28 34 14

37 82 27 34 39 29 26 14

45 59 26 31 43 37 30 11

59 65 26 32 37 38 28 13

47 64 34 37 46 41 28 12

4,458 3,025 11,201 8,319 7,204 3,344 8,584 28,100

TABLE 9.5 Top 10 Most Deteriorated Factors for BCI from 2005 to 2006 (in order of magnitude) I. COMPANY OPERATIONS & STRATEGY Quality of port infrastructure University/industry research collabouration Overall infrastructure quality Railroad infrastructure Financial market sophistication Reliability of police services Stringency of environmental regulations Laws relating to ICT II. NATIONAL BUSINESS ENVIRONMENT Value chain breadth Nature of competitive advantage

the improvement in cluster development and measures that will add depth and breadth to the value chains of industries. The relatively weak business environment is further corroborated by the results from the World Bank survey on Doing Business published annually since 2004. The report provides objective measures of business

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regulations and their effects on businesses. The indicators in the Doing Business database document the degree of regulation, gauge regulatory outcomes, measure the extent of legal protection of property, measure the flexibility of employment regulations and document tax burdens on businesses. The “Ease of Doing Business” ranking is computed based on ten factors and sub-measures. Table 9.6 shows the “Ease of Doing Business” rankings for 2006 and 2007 for selected countries (The World Bank 2006). Among the countries included in Table 9.6, Indonesia is one of the three countries that suffered a drop in ranking in the 2007 “Ease of Doing Business” ranking. The other countries are Vietnam and the Philippines. The rank scores for the ten factors considered in doing business in each of the four countries — China, India, Vietnam and Indonesia — are shown in Table 9.7. The top three factors that caused the biggest drop in Indonesia’s rankings are ease of closing a business, ease of getting credit, and ease of trading across borders. Vietnam and China have better rankings than Indonesia. Among the four countries in 2007’s ranking, Indonesia has competitive strengths in protecting investors, trading across borders, and to a certain extent getting credit. However, it has competitive disadvantages in starting a business, employing workers, registering property, and closing business.

TABLE 9.6 Ease of Doing Business Economy Indonesia Malaysia Thailand Vietnam Philippines China India Singapore

2007 Ease of Doing Business Rank

2006 Ease of Doing Business Rank

Change in Ranking

Magnitude of Change

135 25 18 104 126 93 134 1

131 25 19 98 121 108 138 2

Decrease Same Increase Decrease Decrease Increase Increase Increase

–4 0 1 –6 –5 15 4 1

Note: Number of countries for 2006 is 155 and for 2007 is 175.

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China Vietnam India Indonesia

128 97 88 161

153 25 155 131

78 104 112 140 21 34 110 120

101 83 65 83

83 170 33 60

Starting a Dealing with Employing Registering Getting Protecting Business Licences Workers Property Credit Investors 168 120 158 133

Paying Taxes 38 75 139 60

Trading Across Borders

TABLE 9.7 Components of 2007 Ease of Doing Business Ranking

63 94 173 145

Enforcing Contracts

75 116 133 136

Closing a Business

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In 2003, the World Bank, Asian Development Bank, Kementerian Koordinator Bidang Perekonomian, Republik Indonesia, and Badan Pusat Statistik jointly conducted the “Productivity and Investment Climate Survey on Indonesia”. It was a survey with more than 700 company executives as respondents. The survey focused on the constraints to operations and growth of establishments. Table 9.8 reports the results. Essentially, investors were not happy about macroeconomic instability, policy uncertainty, corruption, tax rates and cost of financing. About half felt that local taxes had become a constraint for business growth. For those who indicated the reason(s), most felt it was the multitude of different local taxes, confusion caused in understanding them, and the high local tax rates that constrained their business growth. More than 60 per cent of the respondents indicated that government officials at both the local and national levels had been inconsistent and unpredictable in their interpretation of regulations. About labour relations, about 20 per cent of respondents felt that labour regulations posed an obstacle in layoff procedures and cost of retrenchment. In summary, the various indicators relating to business environment, investment climate and government regulations do not augur well for the continued expansion of the Indonesian economy. The various difficulties highlighted pertain to the whole Indonesian economy

TABLE 9.8 Constraints to the Operations and Growth of the Establishment Constraints

Percentage of respondents rated as major or very severe obstacles

Macroeconomic instability (inflation, exchange rate)

50.1

Economic and regulatory policy uncertainty

48.3

Corruption of national government (37.3 per cent) and local government

39.2

Tax rates

29.5

Cost of financing

28.5

Source: World Bank’s Productivity and Investment Climate Survey on Indonesia, 2003.

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and the BBK region is not excepted. In the next section we shall explore the possibility of a concentrated effort in pushing BBK as a SEZ to catalyse and revitalize the economic impetus in the Indonesia economy.

V. REVITALIZING THE INDONESIAN ECONOMY THROUGH JOINING THE GVC — WITH BBK AS THE LEADING “GOOSE” SEZ FOR INDONESIA The development of BBK into a SEZ can be seen as a viable strategy for attracting foreign direct investment into Indonesia. If BBK can be successfully developed into a SEZ, this can be used as a successful model for developing other SEZs in Indonesia, ultimately fulfilling the objective of revitalizing the Indonesian economy. There are some unique locational advantages that BBK enjoys that make the choice of BBK as a leading “goose” easier. Batam, part of the BBK, has a long history of being a manufacturing base and part of a growth triangle involving Singapore, Indonesia and Malaysia, and was co-developed by Singapore and Indonesia over the years. The following sections will highlight the historical background behind choosing BBK as the leading goose, the role of Singapore in BBK’s development, some recent development efforts, and more importantly, how the development of BBK into a SEZ can help to plug Indonesia into the GVC.

Location of BBK Riau Islands Province, established in July 2004, has 2,408 islands with a total area of 251,811 sq km (total land area is 10,600 sq km), comprising two cities (City of Batam and the provincial capital, Tanjung Pinang), and four regencies (Bintan, Karimun, Natuna and Lingga). The most populated islands in the Riau Islands Province are Batam, Bintan and Karimun (BBK). To the north of BBK lies Singapore, which is connected to BBK by regular high-speed ferry services. To Singapore’s north, Singapore is connected by a road bridge (Tuas Second Link) as well as a road and rail causeway to Johor Bahru, the capital of the southernmost Malaysian state of Johor. Figure 9.2 shows the location of BBK.

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FIGURE 9.2 Location Map of BBK

Development of Batam Indonesia’s intention to develop Batam goes back to 1970. Initially, Batam was developed with the view to compete with Singapore.9 Over the years, the Indonesian authority perceived that it would be more beneficial to leverage on the good infrastructure and distinctive economic performance of Singapore to develop Batam into an industrial location. The former aide to President Soeharto who become president after him, Dr Habibie propounded his “balloon theory” of development for Batam. He described Singapore as a balloon filling up with air. If the air does not find a second balloon, the first balloon will burst. Batam can benefit from Singapore’s “excessive growth” due to its proximity to Singapore and can be positioned as an extension of Singapore’s production base and reap agglomeration benefits. In 1971, Batam island was designated as an industrial zone by an Indonesian presidential decree. To facilitate the industrial development, the Batam Industrial Development Authority (BIDA) was established. In support of the industrialization plan, the state-owned oil company, Pertamina, was a key player in seeding and starting activities ranging

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from infrastructure, light manufacturing, industrial real estates, gas and chemical industries to offshore drilling. The 1976–78 period was the consolidation phase focusing on consolidation and maintenance of existing structures, infrastructure and assets amidst Pertamina’s crisis.10 In another presidential decree in November 1978, Batam island was declared a “bonded zone” to support the development of exportoriented industries. Over the next few years, the Indonesian authority gained more confidence in having private business enterprises as partners in economic development. On 29 October 1989, the law on the management of industrial estates by private companies was passed. About 1,700 hectares of land was allocated for eight industrial estates in Batam island. That move received favourable comments from private enterprises as well as political leaders in Singapore. In December 1989, the then Deputy Prime Minister of Singapore mooted the concept of a “Growth Triangle” a three-country economic sub-region comprising Singapore, Johor in Malaysia, and Riau in Indonesia. The “triangle of growth” fitted well with Singapore regionalization efforts of the 1980s and 1990s, to systematically relocate labour-intensive industries and land-intensive industries to neighbouring countries or regions such as the Malaysian state of Johor and the island of Batam in the nearby Indonesian province of Riau Islands. Singapore government-linked companies partnered with private Indonesian enterprises to develop Batam Industrial Park (Batamindo), an industrial estate on Batam Island, to take advantage of its status as a duty-free export processing zone (EPZ), and of the business generated when industries move over from Singapore (Kakazu 1997). By 1990, the scope and geographical coverage of regional development extended beyond Batam to neighbouring islands and provinces. Singapore and Indonesia signed an agreement to cooperate in the development of the Riau Province and the promotion and protection of investment between the two countries. The 1990 agreement also includes provisions: to simplify exit and entry procedures; to simply the tax system to facilitate investment; to jointly promote and develop tourism; to cooperate in water supply, transportation and infrastructure development and maintenance. The year 1994 saw the formation of SIJORI (Singapore-Johor-Riau), later known as the Indonesia-Malaysia-Singapore Growth Triangle

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(IMS-GT). The SIJORI Growth Triangle is a partnership arrangement between Singapore, Johor and Riau that combines the competitive strengths of the three areas to make the sub-region more attractive to regional and international investors. More specifically, it links the infrastructure, capital, and expertise of Singapore with the natural and labour resources of Johor and Riau. The status and importance of Batam was not diminished despite the onset of the Asian financial crisis in 1997. In fact, it becomes an icon for Indonesia to muster ASEAN and international support for trade and investment to jump start the economic recovery after the crisis.11 Batam became an autonomous or self-governing city in 1999. The signing of the Framework Agreement12 between Singapore and Indonesia on Economic Cooperation in the islands of Batam, Bintan and Karimun (BBK) took place on 25 June 2006. A key feature of the agreement is that Singapore will assist the development of the three islands as a Special Economic Zone (SEZ). Designation of a region as a SEZ requires the Indonesian Parliament’s approval, and this is not a done deal especially when the president and the majority of the members of parliament are not from the same political platform. Nonetheless, as a step towards that objective, on 28 June 2007, Batam was granted a Free Trade Zone status while Bintan and Karimun were granted enclave status. BBK will be regulated by the Government Regulation in lieu of Law (Perppu) on Free Trade Zone No. 1/2007. The changes will be formalized only after approval granted by the House of Representatives. On 20 August 2007, BBK was officially designated as FTZs for seventy years, to be run by a new supervisory council and each zone by a separate management body. A new SEZ law is to be tabled for Parliament in 2008. An SEZ is an enclave of enterprises operating in a well-defined geographic area where certain economic activities are promoted by a set of policy measures that are not generally applicable to the rest of the country. The term SEZ often encompasses types of zones that can come under classifications such as Free Trade Zone (FTZ) and Export Processing Zone (EPZ). An FTZ is an area where goods can be imported and warehoused, processed, fabricated, exhibited, and otherwise utilized and transhipped without customs processing and duties, whereas an EPZ is (similar to a Free Trade Zone) an area set off as a non-tariff area where manufacturers can import goods to process, assemble, or fabricate with the intention of export.

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Some of the key characteristics of successful special economic zones are that they offer immediate access to high quality infrastructure, facilities, and support services. In addition, streamlined regulatory enforcement, simpler business establishment rules, expedited customs administration, and other special administrative and approval procedures are also offered in such zones. Another key element of special economic zones is the offering of financial incentives packages for both zone developers and zone investors. Over a period of time the SEZ concept has expanded and evolved to encompass larger areas, higher levels of integration within the defined geographical boundaries of the zone, and increased integration with the local economy.

Pull and Push Factors in the Development of the BBK For many researchers and practitioners in Singapore and Indonesia, BBK is a natural choice location for development of a SEZ given the familiarity with and visible success of Batam. This will raise the competitiveness of BBK, by empowering it with the responsibilities to promote investment, create jobs and generate economic multiplier effects, and revenue from taxes and levies. It will also help to improve the quality of products for export, empower the local workforce, and enable knowledge and technology transfer. As alluded to in earlier section, Singapore’s strong support of the BBK SEZ is in alignment with its strategy to address the challenges of expanding economic space for industrial development and the needs for industrial upgrading and competition from emerging economies. Batam’s proximity to Singapore and its low-cost manufacturing capability will add depth and diversity to the industrial structure in Singapore. On the one hand, it enables Singaporean enterprises to integrate backward into activities such as production engineering, product design, and R&D; on the other hand, it encourages companies to integrate forward into marketing, technical support, after-sale services and ultimately management. For Indonesia, BBK can position itself as an extension of Singapore’s production base to benefit from Singapore’s economic expansion. Singapore as a growth pole can confer much positive agglomeration economies for the BBK enterprises. In facilitating Singapore’s aspiration to retain high value-added and high-tech industries, Batam benefits

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from being a choice location for industries which produced goods that are of lower value-added, labour and/or land-intensive. Singapore is an important conduit and source of such investments, and it serves as a centre for advanced tertiary services (finance, health, education) that BBK workers and employers cannot access easily within its territory or in other parts of Indonesia. The aim of the SEZ is to renew investor interest in the three Riau islands which has tapered off over the past five years. Officials will focus on seven areas — investment, finance and banking, taxation, customs and excise, immigration, manpower and capability development. However, there are some doubts about the prospects for the SEZ. What is so special about the SEZ or so different about this joint effort from previous efforts to carve out the islands as investment hot spots or “bonded zones”? In fact, investors have been steadily making their way to cheaper pastures such as China, India and Vietnam. Table 9.9 shows a comparison between the two sub-regions with the largest GDP within each SEZ. Batam and Guangzhou are chosen for the BBK and Pearl River Delta (PRD) respectively. As shown, Guangzhou’s GDP per capita is about five times that of Batam’s economy. This clearly indicates that the BBK SEZ has a long way to go in catching up with the PRD development. It is interesting to note that despite the gulf in GDP per capita, the minimum wage is almost similar at US$96 for Batam and US$98 for Guangzhou. There is therefore perhaps some basis when foreign companies in Batam complain that the minimum wage is high for a newly developing region. The FDI to GDP ratio is much higher for Batam as compared to Guangzhou. This reflects lower FDI productivity in Batam as compared to Guangzhou. The main industries in each city show that Guangzhou is relatively more advanced in manufacturing higher value-added products compared to Batam. Nonetheless, though competition has become inevitable the challenge is not insurmountable. The optimistic outlook is supported by several favourable happenings. According to Riau Islands Governor Ismeth Abdullah, the pro-jobs central government is fully committed to the SEZ; there is a spirit of cooperation between Singapore and Indonesia — both their leaders are eager for Riau to grow. More importantly, the new chairman of Batam Industrial Development Authority (BIDA) was Ismeth Abdullah’s deputy at BIDA before the latter left to become

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TABLE 9.9 Comparison of Key Statistics between Batam and Guangzhou, 2006 Batam

Guangzhou

GDP (US$ million)

1,919

79,860

GDP per capita (US$)

2,688

10,508

713,960

7,600,000

Minimum Wage (US$ per month)

96

98

FDI (US$ million)

446

2,457

5,160

32,377

415

7,434

Singapore, Japan, Malaysia

Hong Kong, Virgin Islands, Japan

Electronics, Audio-Video Eqpt, Oil Exploration Eqpt, Leather & Garment

Electronics, Petrochemical, Automobile, Iron and Steel

Population

Exports (US$ million) Area (sq km) Main Foreign investors

Main industries

Source: Batam Investment Board; Guangzhou Statistical Yearbook.

governor. They share the same vision and mission, and are “very anxious” to have the SEZ run well. The key political hurdle has now been overcome. Dr Ismeth says the two power centres will form a one-stop and joint service centre that investors have been demanding, and Jakarta is prepared to have essential business licences issued in the region instead of in the capital. The governor says the two-in-one investment agency should have an integrated system for customs, immigration and taxation that won't scare away businesses with hidden and additional costs from separate authorities. For example, businesses often cite the time-consuming process needed to obtain costly work permits that require clearance from various offices in Jakarta before they are issued locally. As the one-stop agency is set up, there is one cloud: the makeor-break factor for the SEZ will be the all-important labour law. The

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Yudhoyono government went too far trying to amend the law in favour of businesses. In the end, the changes were scuttled in the face of union protests in April 2007. Legislators are having another go at the draft law, this time with more consultation with stakeholders. However, Dr Ismeth says he is working with Jakarta to introduce a separate labour law for the SEZ to ensure that core business issues of union representation, minimum wage and the hiring and firing of workers can be better addressed at the local level more expeditiously. Can this be done? Dr Ismeth thinks it can because the national Parliament had set a precedent with the Free Trade Zone of old. Clearly, a separate labour law for the Riau Islands would boost the chances of the SEZ. But the devil is in the details. Businesses are now expected to pay hefty compensation to workers even if they resign or are fired for misconduct. Investors want the termination benefits reduced and the payout for sacked workers abolished. Overtime payment is too high: double during weekends and public holidays, and it can rise to four times more on graveyard shifts of some labour-intensive industries. The working week is currently 40 hours long, compared with 56 hours in some parts of India. Businesses want one union per industrial sector. Dr Ismeth thinks he can get all these for the Riau Islands ahead of the rest of the country, maybe in just six months. But if the last national strikes are any measure, maybe he is being unrealistic. Nevertheless, labour reform is necessary if the SEZ are to have a chance to succeed.

VI. ROLE OF SINGAPORE IN THE DEVELOPMENT OF THE BBK Singapore’s competitive advantage lies in her experience in attracting foreign investors, city planning and maintaining a corruption-free and efficient administration. These will come in handy in designing a training programme for the SEZ’s administrators. In return, Singapore and other foreign investors can enjoy investment opportunities that reap high profit margins due to the lower manufacturing costs and low taxes. This role is re-emphasized by Singapore’s Prime Minister Lee Hsien Loong during the press conference after the signing of the Framework Agreement (in 2006):

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Singapore will have three main roles in this collaboration. Firstly advisory — because we are close to the investors, we know what they want, we know what their problems are. We will communicate these requirements to Indonesia, and suggest ways how Indonesia can change its rules to be more investor friendly. And we can draw on our experience with other SEZs in Suzhou, Vietnam.

Singapore will also help with investment outreach, using the Economic Development Board’s network to match potential investors to Batam and Johor and even help train workers. Table 9.10 shows the different roles that Singapore plays in the various industries with respect to the Johor and Riau regions.

TABLE 9.10 Business Activities and Opportunities in the IMS-GT Business or Activity

Singapore

Johor/Riau

Electronics

Major regional base for manufacturing; major international procurement office

Lower labour/ land costs for labour- land-intensive assembly operations

Oil

Refining/petrochemical processing, trading, storage and distribution

Riau island (e.g. Karimun Island) offers environmentally isolated space for oil storage

Maritime Services

Full range of ship-building, repair, and maintenance activities

Johor and Riau islands (e.g. Singkep) offer sites for shipbuilding/repair

Telecommunications and Distribution

World-class information technology infrastructure and wide range of business services; operational headquarters of many large MNCs

Many manufacturing, marketing, procurement and technical support activities by MNCs requiring coordination

Logistics and Distribution

Excellent telecommunication/ transportation facilities and logistics management services

Wide range of export manufacturers requiring transportation and logistics management support

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TABLE 9.10 (Cont’d ) Business or Activity

Singapore

Johor/Riau

Research and Development

Large pool of R&D scientists and engineers; R&D manpower training facilities & supporting infrastructure

MNC products requiring applied R&D and design for local market adaptations; MNC operations requiring process improvement R&D

Tourism

Excellent air travel gateway for tourists; emerging regional sea-cruise centre; cosmopolitan shopping centre; multicultural city.

Abundant leisure resources such as beach resorts, golf courses, etc.; cultural diversity.

Agribusiness

Food processing technology and biotechnology R&D capability

Abundant land resources for agriculture and animal husbandry

As discussed earlier, it is sometimes difficult to separate the BBK region from the bigger Indonesia-Malaysia-Singapore growth triangle. Debrah et al. (2000) demonstrates the key roles that each of the three countries play in the synergic relationship in Figure 9.3. Singapore provides the capital, access to world markets, and advanced technology and infrastructure, while Malaysia supplies the raw materials and midlevel technology. Indonesia has an abundance of cheap resources such as undeveloped land and unskilled labour which reduces the cost of operations. Each of the three countries complements one another and thus a beneficial relationship can be formed to achieve a win-win situation for each country. With the push for the establishment of more FTAs, Singapore makes it a point to include the Integrated (Out) Sourcing Initiative (ISI) clause into its FTAs to benefit these SEZs. This ISI clause is included in the USA-Singapore FTA which came into effect in January 2004. This clause recognizes the fact that many of Singapore’s products have components that are outsourced to the neighbouring regions. By including the ISI into the FTA, 266 types of IT and medical-related products produced in offshore production bases such as Batam, can be treated as originated from Singapore. Hence, these products are eligible for tariff-free importation

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FIGURE 9.3 The Triangle of Complementarity in IMS-GT Singapore • capital-skilled labour • advanced technology • access to world markets • advanced physical infrastructure • advanced commercial infrastructure

Indonesia • unskilled labour • basic technology • natural resources • undeveloped land

Growth Triangle

Malaysia • land-natural resources • semi-skilled labour • intermediate technology • basic infrastructure

Source: Adapted from Debrah et al. (2000).

into the United States. This will make products manufactured in BBK more competitive and undoubtedly benefits the BBK SEZ. It also helps Singapore because the tariff-free imports now make Singapore’s exports more competitive in the United States. FTAs have helped Singapore remain competitive in a time when countries such as China and India are vying for foreign investments. There are 928 foreign companies and 29 industrial estates in Batam and half are Singaporean joint ventures as of June 2007. The sentiment in the Singapore Framework Agreement camp is: “there is never a good time to have a deal — the challenges are immense — but the moment is right for a win-win outcome”. BBK can be revitalized as it has strong international brands and is fully supported by the Indonesia government (local and central). BBK is also Indonesia’s new economic hub and one of the seven SEZs of Indonesia. It was hoped that the BBK SEZ can be revitalized to effect a rebound in non-oil domestic exports (NODEX) as NODEX from BBK

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once constituted almost 14 per cent of Indonesia’s export. The target is to lure new investment amounting to US$1 billion and create 100,000 new jobs in the next three years.

VII. GOVERNMENT POLICIES AND STRATEGIES TO GET BBK INTO THE GVC With a good understanding of the current economic situation and the difficulties faced in furthering economic expansion, we now turn to what suggestions and measures can be put in place to stimulate the BBK economy. We reckon that having BBK designated as a SEZ is just one platform that hopefully will trigger the cumulative causative mechanism, (a la Myrdal 1957)13 to propel the economy forward.

Getting the Business Environment Conducive for Investment The investment climate and domestic business conditions have to be put right. Adequate infrastructure development as in roads, telecommunications, and logistics, and enlightened legislation relating to investment, employment and taxation are important ingredients for encouraging steady growth in economic activities. A domestic investment agency that is able to coordinate and guide investors through the morass of regulations and statutory requirements will be helpful. However, the scope of activities of such an agency cannot be limited to simply the standard “one-stop shop” to ease the administrative burden of investors. It will have to do more promotional activities in (a) gathering and disseminating information about new trends relating to markets and products; (b) matching the needs of companies in identifying suppliers and distributors; (c) organizing fora to provide opportunities for the creation of alliances in product development, market scanning and expansion, and research and development; (d) identifying a list of industries that best suit the endowment in terms of labour, technology, and availability of specific inputs, in the region. In the context of BBK, Indonesian officials at both central and local government have tried to act in concert to provide a conducive environment for investment. The Batam Industrial Development Authority (BIDA) is the regional investment promotion agency set up by the

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central government in Batam, and it has liaison offices in Singapore and Japan. It has also helped to identify the sectors that will suit the business environment and resource endowment of the three sub-regions. Sectors to be developed in BBK include: • Batam: Electronics, electrical equipment, mechatronics, and ICT, as well as the existing industries of rigs, oil and gas platforms, and chemicals, and shipyards. • Bintan: Garment, food industries, footwear, canning, moulding and its supporting industries, marine tourism. • Karimun: Shipyard and components and casting, foundry and forging, agro base industry, fishery, marine tourism. An Integrated Investment Service Unit was formed in line with the under one-roof policy to simplify investment licences and permits both from the Indonesian Central Government and local Government of Batam, Bintan and Karimun. It was officially launched on 25 July 2006 at Sumatera Promotion Centre (SPC). Institutions included are: Investment Coordinating Board, Ministry of Finance (Taxation and Customs and Excise), Ministry of Manpower, Ministry of Laws and Human Rights (Immigration), Batam Industrial Development Authority, and the Municipality of Batam. Production fragmentation, a key feature in the modern manufacturing production system, is a very relevant concept to BBK SEZ enterprises aspiring to plug into the GVC and GPN. The feasibility of fragmentation depends heavily on the nature of technologies in the industry and economic environment. As pointed out by Kimura (2008), it has been widely recognized that international production and distribution networks in East Asia are the most advanced and sophisticated form of international division of labour among countries of different income levels and have led to the dynamism of Asia. Thus a foreign company partnering with a local enterprise to produce an electronic component will be an important step into the global production network. In the process of generating value, it mobilizes the resources in the services of labour, land, machinery, finance and logistics. An important policy implication is that the mechanics of international production and distribution networks allow us to effectively utilize globalizing forces for accelerating economic development of developing countries or regions if a proper policy environment is set up.

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Indonesia did not yet fully participate in production networks since the shares of machinery goods and parts and components in total exports and imports as of 2005 were quite low. The concept of fragmentation is particularly important in understanding the nature and characteristics of international production networks in East Asia, and Indonesia. Fragmentation of production processes makes sense when (i) the saving of production costs per se in production blocks is high, and (ii) incurred service link costs for connecting remotely located production blocks are low. Firms can cut out production blocks so as to exploit differences in location advantages in remote areas. On the other hand, service link costs that include not only transport and telecommunications costs but also various coordination costs should not be too high. Due to its history of development and proximity to Singapore, BBK is the best choice location to be picked for SEZ development. If the BBK can be successfully developed into a SEZ, the Indonesian economy will be revitalized as it will be used as a success model for the development of other SEZs in Indonesia. By developing BBK into a SEZ, more sophisticated forms of industries where wages are a small proportion of total cost, such as the electronics industry, will be attracted as these types of industry are willing to pay a premium for good infrastructure, efficient customs clearance, significant cost savings in terms of tax holidays and other transaction costs savings. The subsequent development of BBK into a burgeoning SEZ plugging into GVC and GPNs will have spillover effects in the development of the Indonesian economy. Furthermore, partnering Singapore and BBK to form production networks will tap the unique complementary locational advantages of the two locations, thereby reducing network set-up costs, service link costs and production costs per se. Singapore can focus on its knowledgeor technology-intensive production process while BBK is competent in its labour-intensive production process. That is, the motivation for Singapore is to extend its spatial constraints in production, outsource auxiliary activities to the proximate BBK to reap network effects, and focus on higher level activities. Thirdly, it is noteworthy that labour market conditions in BBK and Indonesia such as the minimum wage, labour regulations in retrenchment,

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labour unions, etc., should be improved to reduce the variable costs of the production cost per se. In addition, the investment climate in BBK and Indonesia as a whole need to be improved as set-up costs and production costs per se are high based on current assessments of the investment climate. Furthermore, the efforts in free trade agreement negotiations and the setting up of free trade areas need to be strengthened so that service link costs can be reduced.

SEZ as a Vehicle for Growth The rapid development of the Chinese economy is often credited to the establishment of SEZs. In the same vein, the establishment of SEZs in Indonesia will help to jump-start the stalled industrialization process in the aftermath of the Asian financial crisis. SEZs enable business activities to be developed in an unencumbered environment so that synergies and agglomeration economies among clusters of firms are realized. An SEZ can be an effective vehicle to attract FDI into the economy. FDI, in turn, can be the building blocks for plugging into the global value chain by participating as a nodal point for sales in the domestic markets and for exports into international markets. Formulation of national export strategies and related management approaches can be initiated from the perspectives of creating value, capturing value, adding value, projecting value and confirming value. Creating value: moving from comparative to competitive advantage reviewed the implications for the public-private sector partnership of maintaining a dynamic strategy which increasingly emphasizes specialization and technology — and innovation-based competitiveness. Availability of relatively inexpensive resources such as labour and land can be the basis to attract FDI to start and stimulate the industrial sector. As experience and learning-by-doing cumulate, the ability to stay and contribute to the GVC will be enhanced. Capturing value: a value chain approach to national export strategy development looked at this new concept as a tool for developing sectorspecific export strategies that both increase competitiveness and “value-

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retention” from exports while maximizing the contribution of improved export performance to overall economic development. Debate focused on the importance to sectoral strategy of identifying and meeting “critical success factors”, of positioning national supply capability within the context of the global value chain, and of focusing the national trade support network on those linkages within the national value chain that dictate the sector’s efficiency. Adding value: partnering with foreign enterprises to generate values suggested that for many developing countries, including Indonesia, the route to increased export capacity and value addition lies in building alliances among local firms, and actively promoting foreign direct investment. The potential contribution to competitiveness of industrial clusters, backward-forward linkages between local producers and foreign production partnerships can be substantial. Such in-country alliances can be facilitated through a national export strategy. Projecting value: is there a case for national branding? Even when an industry is embedded in a GVC, competition is not precluded. There is a need to identify the features that distinguish their country (and export) capacity from those of competing nations and to assess the suitability of investing in a national branding programme. A best practice road map for national branding can then be developed. It is important to expend resources to remind potential investor the presence and advantage of the SEZs in Indonesia, and BBK in particular.

Policy Lessons The role of the government is very important, especially in the formulation of pro-business and pro-investment policies, innovation-driven export strategies, and in negotiations of free trade agreements. In creating a conducive and investor-friendly environment to attract investors, the government can facilitate through providing fiscal incentives, building necessary infrastructure as in telecommunication, transportation and utilities, and having cross-border agreements to ensure protection of investment and smooth flow of goods and services. A business environment that fosters national competitiveness pays dividends across the board.

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However, the role of the government should not be limited to policy formulation. It should include timely and consistent policy implementation. More often than not, the changing of political administration could lead to the abandonment of policies being formulated and implemented by the previous administration. This lack of continuity and consistency, especially in creating a conducive investment climate, will frustrate many investors and render the location unattractive to investors. In addition, the timeliness in implementing key policies to woo investors is another critical success factor, especially in the current trends of globalization with many locations competing for foreign direct investment. If a government could not streamline its process of passing key investment laws efficiently and quickly, investors would be pushed away to new pastures. Whatever its stage of development, export strategies that support innovation and use of technology will help a country move forward. Recent studies of national competitiveness have two messages for strategy-makers: • Competitive advantage can be created or, at the very least, raised significantly. • The improvement of competitiveness within an economy should be a key element of national export and investment strategy. This means strategic initiatives should address competitiveness issues not only at the level of the individual product and service sector but at the national level as well. Developing and transition economies, almost by definition, face severe resource constraints when organizing trade development and export promotion. Existing trade support programmes are likely to lack funding, and financing is not available to launch new ones. The government could allocate more budget for trade development and export promotion. Key institutions in the national trade support network are, in many instances, technically weak, but resources, financial and otherwise, to improve capacities remain limited. Staff lack specialized training but there are few opportunities to upgrade their competency. The government could facilitate by increasing its budget for upgrading the facilities and manpower competency so that domestic and foreign investors could benefit from the trade facilitation services provided by them.

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Amiable labour and industrial relations are an important aspect of a conducive investment climate. Good relations among employers (companies), workers (unions) and the government would instil confidence in investors. An enlightened trade union is needed to partner the business management to face the challenge of globalization. Unions confined to narrow objectives of raising wages and salaries without regard to the viability of the enterprises will have the unintended effect of hurting the income and employability of the workers. On the other hand, exploitative employers disregarding the welfare and training of the employees will not be able to compete in the international market for long. The role of government in creating harmonious labour relations could be through the passing of manpower or labour laws that would not significantly raise labour costs for investors while keeping in mind the welfare of workers, and through setting up a national tripartite framework in managing employers and labour unions relations. The government needs to strike a balance between taking care of the welfare of workers and ensuring that labour issues are not a key obstacle to investment growth.

VIII. CONCLUSION The value chain approach helps strategy-makers gain a better understanding of how sectors can contribute to national socio-economic development. By helping to explain the distribution of benefits, particularly income, to those participating in the global economy, value chain analysis makes it easier to identify the policies that can be implemented for individual producers and countries to increase their share of these gains. It gives an overview of how the sector is addressing the issues of employment creation, skills development, geographic diversification of industry and other development issues. This can feed into the strategy design process, helping the strategy team determine priorities, both in terms of action for the sector under review and for the sector’s relevance to national export strategy. The establishment of the BBK as an SEZ will facilitate its entry into the global production network (GPN) or global value chain (GVC). However, an SEZ on its own will not achieve the desired outcome. Concerted efforts on the part of the government and the

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private enterprises are needed. The government can play a constructive role in providing necessary infrastructure such as transportation linkages, utilities and telecommunication systems that are essential for modern trans-border and cross-continent coordination of management and production. The private sector needs to be proactive in seeking out new markets and new business partners; and to adapt to modern modular style of production to get a foothold into the GVC or GPN. It pays to recognize the positive effect of agglomeration or clustering. Industry cluster policies are a current trend in economic development planning. These policies represent a major shift from traditional economic development programmes, which focused on individual firm-oriented policies. Cluster policies, on the other hand, are based on the recognition that firms and industries are inter-related in both direct and indirect ways. Michael Porter (1990) argues competition is a driving force behind cluster development. Clustering is a dynamic process, and as one competitive firm grows, it generates demand for other related industries. As the cluster develops it becomes a mutually reinforcing system where benefits flow backwards and forwards throughout the industries in the cluster. Porter argues that it is the competition between rival firms in the cluster that drives growth because it forces firms to be innovative and to improve and create new technology. This, in turn, leads to new business spin-offs, stimulates R&D, and forces the introduction of new skills and services. Because many of the industries within the cluster employ a similar labour force, the labour force can freely move to other related firms within the cluster, thus transferring knowledge to new firms, and continuing to promote competition and therefore growth. The strategy of complementing the industrial restructuring drive in Singapore is a sound one. Instead of head-on competition, BBK can rely and build on the economic spillover from Singapore to establish a more solid foundation to launch into higher order manufacturing and services industries in the future. At the current stage, Singapore provides a convenient “window” to the world. The efficient communication, financial system and logistic infrastructure are available to supplement the inadequacies in BBK. Singapore has been actively involved in the setting up of industrial estates or parks in other emerging economies.

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Notable examples include the Suzhou Industrial Park, Wuxi Industrial Estate in China (Shee 2005); Vietnam-Singapore Industrial Park in Ho Chi Minh City; and Bangalore IT Park in India. An industrial park project has also recently been mooted for Russia. BBK is part of the network of Singapore’s overseas industrial parks reflected by the presence of the Batamindo Industrial Park on Batam Island and the Bintan Industrial Estate on Bintan Island. Over the last ten years, investments in Batam and Bintan have generally done well. The Batamindo Industrial Park and the Bintan Industrial Estate have together attracted US$1.7 billion in investment and employ 80,000 Indonesians. In summary, it is important to reiterate that due to its history of development and proximity to Singapore, BBK is the best choice location to be picked for SEZ development. If successful, the Indonesian economy will be revitalized as it will be used as a success model for the development of other SEZs in Indonesia. Secondly, by developing BBK into an SEZ, more sophisticated forms of industries willing to pay a premium for good infrastructure, efficient customs clearance, significant cost savings in terms of tax holidays and other transaction costs savings will be attracted. Furthermore, partnering Singapore and BBK to form production networks will tap the unique complementary locational advantages of the two locations, thereby reducing network set-up costs, service link costs and production costs per se. Singapore can focus on its knowledgeor technology-intensive production process while BBK is competent in its labour-intensive production process. That is, the motivation for Singapore is to extend its spatial constraints in production, outsource auxiliary activities to the proximate BBK to reap network effects, and focus on higher level activities. Thirdly, it is noteworthy that labour market conditions in BBK and Indonesia such as the minimum wage, labour regulations in retrenchment, labour unions, etc., should be improved to reduce the variable costs of the production costs per se. In addition, the investment climate in BBK and Indonesia as a whole need to be improved as set-up costs and production costs per se are high based on current assessments of the investment climate. Finally, the efforts in free trade agreement negotiations and the setting up of free trade areas need to be strengthened so that service link costs can be reduced.

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APPENDIX 9.1 Chronology of Events Relating to BBK SEZ Year

Key Milestones

1950

Riau incorporated into Republik Indonesia in April 1950.

1971

Batam island designated as an industrial zone by Presidential Decree No. 71/1971.

1971–75

Preparation phase for the development of Batam island and the formation of Batam Industrial Development Authority (BIDA). Development focus was on activities of Pertamina and offshore drilling.

1972

Master plan of Batam island development was issued covering a period of twenty-five years, till the end of 2006.

1973

Batam island designated as a bonded zone by Presidential Decree No. 41/1973.

1976–78

Consolidation phase focusing on consolidation and maintenance of existing structures, infrastructure and assets amidst Pertamina’s crisis.

1978

In November, Batam island was again declared as a bonded zone region by Presidential Decree No. 41/1978 in order to support the development of industries with export orientation.

1978–83

Phase of development planning and construction of key infrastructure, taking into account building strategy, national development strategy and the world economic recession.

1984

Batam island was again declared as a bonded zone region by Presidential Decree No. 56/1984.

1989

On 29 October, the law on the management of industrial estates by private companies was passed based on Presidential Decree No. 53/1989. About 1,700 ha area of land was allocated for eight industrial estates in Batam island. Concept of “Growth Triangle” first mooted by Mr Goh Chok Tong of Singapore in December 1989, a three-country economic sub-region comprising Singapore, Johor in Malaysia, and Riau in Indonesia. Agreements signed between Singapore and Indonesia to develop Batam Industrial Park (Batamindo), an industrial estate on Batam Island designated as a duty-free export processing zone (EPZ).

1990

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Development agreement of Riau Province between Singapore and Indonesia was signed in Batam.

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Key Milestones

1994

Formation of Sijori (Singapore-Johor-Riau), later known as the IndonesiaMalaysia-Singapore Growth Triangle (IMS-GT).

1999

Batam became an autonomous or self-governing city.

2004

Riau Islands Province established in July 2004 based on Law No. 25/2002.

2006

Signing of Framework Agreement between Singapore and Indonesia on Economic Cooperation in the islands of Batam, Bintan and Karimun on 25 June 2006 in Batam towards the development of the three islands as a Special Economic Zone (SEZ). On 17 July, Indonesia and Singapore established a Joint Steering Committee (JSC) to implement the bilateral Framework Agreement signed on 25 June to create a SEZ in Batam, Bintan and Karimun. On 27 July, JSC met for the first time and agreed on four agenda items, namely, establish a crisis centre to list and deal with investment problems within three months; to hold joint promotional activities within three to six months; to revise joint promotional programme for application in Karimun and Bintan after Batam; and to develop information system networks at BKPM (Indonesia Investment Coordinating Board) office, Singapore EDB, and the joint marketing office. At the second JSC Meeting on 1 September, the Action Roadmap detailing initiatives and milestones critical for the successful implementation of the BBK SEZ over eighteen months was endorsed. The nine areas highlighted were capability development, customs, immigration, infrastructure development, investment, industrial relations, manpower & wages, training & certification, and taxation. In September, Batam municipal government and the Batam Industrial Development Authority (BIDA) signed a memorandum of understanding to avoid overlaps in jurisdiction that have been confusing to investors, by clearly spelling out the responsibilities of the two bodies in areas such as land acquisition, taxation, infrastructure development and security. At the third JSC Meeting on 3 November, plans for training programmes to develop the capabilities of administrators and the industrial workforce in the BBK SEZ were endorsed. The training package includes a two-phase training programme for SEZ administrators and the development of vocational training for the industrial workforce at the Batam Polytechnic. The vocational training package that Singapore has tailored for BBK includes consultancy services, “train-the-trainer” programmes, and guidance from Singapore to develop a vocational training arm at the Batam Polytechnic.

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Key Milestones On 28 June at a coordinating meeting of economic ministers, it was decided that Batam will be granted a Free Trade Zone status while Bintan and Karimun are granted enclave status. BBK will be regulated in the Government Regulation in lieu of Law (Perppu) on Free Trade Zone No. 1/2007. The changes will be formalized only after approval granted by the House of Representatives. On 3 July, the government decided to build Batam and Karimun into a full SEZ, while Bintan will only be developed into a level-seven category enclave. On 20 August, BBK was officially designated as FTZs for seventy years, and it will be run by a new supervisory council and each zone by a separate management body. On 29 August at the fifth JSC meeting, the appointment of Riau Islands Governor Ismeth Abdullah and Investment Coordinating Board chief Muhammad Lutfi to lead the advisory council overseeing investment in BBK was announced. In September, four factions representing more than 260 of the 550-members of the House of Representatives decided to reject the legislative foundation that would have given the government the mandate to designate certain areas as FTZ.

2008

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New SEZ law to be tabled before Parliament in 2008.

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APPENDIX 9.2 Singapore Helps Indonesia to Develop the BBK SEZ and Framework Agreement 2006 A Joint Steering Committee (JSC), responsible for the implementation of the Framework Agreement, is to be established. The JSC will comprise relevant ministers and other representatives from Indonesia and Singapore, appointed by the President of the Republic of Indonesia and the Prime Minister of the Republic of Singapore, to whom the JSC will report. The JSC will supervise the action plan for the development of the special economic zones in Batam, Bintan and Karimun and promote and adopt market- oriented proposals.

Framework Agreement 2006 The Framework Agreement outlines seven key areas that Indonesia and Singapore will cooperate in to ensure that business, regulatory and labour conditions in these islands are favourable to investors. The seven areas are: (i)

Investment — Indonesia and Singapore are to cooperate on promoting international investment into Indonesia for mutual benefit. (ii) Finance and Banking — Indonesia and Singapore are to cooperate on taking steps to actively facilitate the availability of, and access to capital and banking services. (iii) Taxation — Indonesia and Singapore are to cooperate on adopting measures to ensure clarity and transparency in tax administration procedures. (iv) Customs and Excise — Indonesia and Singapore are to cooperate on simplifying the procedures and documentation processes to achieve efficient flow of goods between the two countries, in particular the flow of goods within, and in and out of the special economic zones. (v) Immigration — Indonesia and Singapore are to cooperate on adopting measures to facilitate the flow of business persons, specialists, and tourists between Singapore and Indonesia, including simplification of visas.

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(vi) Manpower — Indonesia and Singapore are to cooperate on implementing appropriate laws applicable to persons working in the special economic zones, so as to achieve and maintain internationally competitive manpower resources and harmonious industrial relations. (vii) Capacity Development — Indonesia and Singapore are to cooperate on enhancing capacity development through initiatives such as the training of the industrial workforce and special economic zones’ administrators.

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Notes 1. A review of the formation of “growth triangles” in Asia can be found in Toh and Low (1993), as well as Thant (1994). 2. The concept of Commodity Chain is attributed to Gereffi, while the concept of Value Chain was pioneered by Porter. We have used the two concepts interchangeably in this paper. 3. A very useful description of the global value chain and global production network can be found in the UNIDO working paper entitled “Inserting Local Industries into Global Value Chain and Global Production Networks: Opportunities and Challenges for Upgrading”, . 4. Governance concerns questions relating to who decides what is produced, how are the rules of trade determined, and what is the nature of relationships between participants. Governance of the GVCs is discussed by Gereffi, Humphrey, and Sturgeon (2005). See also D. Kaufmann, A. Kraay, and M. Mastruzzi, (2007). 5. Another typology classified value chain into four different categories: (1) Market-based: enterprises deal with each other in arm’s length transactions; (2) Modular: enterprises have complementary competences; no enterprise exercises control over others; (3) Captive: lead firm sets the parameters under which others in the chain operate; (4) Hierarchy: enterprises are vertically integrated; the parent company controls its subsidiaries. 6. It is important to clarify the concepts of a “chain” in GVCs and a “network” in GPNs. According to Sturgeon (2001), a chain maps the vertical sequences of events leading to the delivery, consumption, and maintenance of goods and services — recognizing that various value chains often share common economic actors and are dynamic in that they are reused and configured on an ongoing basis — while a network highlights the nature and extent of the inter-firm relationships that bind sets of firms into larger economic groups. 7. See UNIDO working paper “Inserting Local Industries into Global Value Chain and Global Production Networks: Opportunities and Challenges for Upgrading”. See also Schmitz Value-Chain Analysis for Policy Makers and Practitioners. (Geneva: ILO, 2005). 8. UNIDO implemented project NC/INS/99/004 “Policy Support for Industrial Recovery”. 9. A more detailed chronology of events relating to Batam and the BBK SEZ is in Appendix 1 of this chapter. 10. Pertamina with its enormous resources from oil revenue in the 1970s had over extended itself into activities beyond oil: retailing, steel milling, real

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estate, chemicals, banking. Without proper check and management, it was heavily in debt. Pertamina’s external debts exceeded US$l0 billion, equivalent to almost 30 per cent of Indonesia's GDP at that time (Hossain Akbar 2006). 11. BIDA played an active role to complement the strategy of the central government in organizing business missions to the developed industrialized economies to solicit foreign investment and trade links for Batam as well as the rest of Indonesia. 12. The details of the Framework Agreement signed in 2006 are included in Appendix 9.2 of this chapter. 13. Myrdal (1957) developed the Principle of Cumulative Causation, which states that economic development in one region will engulf another region. The productive efficiency and employment opportunities in the relatively wealthier areas will attract capital and work force from less developed areas. The concepts of “virtuous cycle” and “vicious cycle” can be viewed as an extension of the principle.

References: Boediono. “Managing the Indonesian Economy: Some Lessons From the Past”. Bulletin of Indonesian Economic Studies 41, no. 3 (2005): 309–24 Borrus, Michael, Ernst Dieter and Stephan Haggard, eds. International Production Networks in Asia: Rivalry or Riches. London and New York: Routledge, 2000. The Competitiveness Support Fund. “Special Economic Zone Benchmarking And Policy Action Plan”, 31 May 2007. Debrah Y.A., I. McGovern and P. Budhwar. “Complementarity or Competition: The Development of Human Resources in Southeast Asian Growth Triangle: Indonesia, Malaysia and Singapore”. International Journal of Human Resource Management 11 (2000): 314–35. Ernst, D. and B. Luthje. “Global Production Networks, Innovation, and Work: Why Chip and System Design in the IT industry are Moving to Asia”. East West Centre Working Papers no. 63, 2003. Ernst, D. and Kim Linsu. “Global Production Networks, Knowledge Diffusion, and Local Capability Formation”. Research Policy 31 (2002): 1417–29. Gereffi G., ed. Commodity Chains and Global Capitalism. London: Greenwood Press, 1994. ———. “Global Production Systems and Third World Development”. In Global Change and Regional Response, edited by Barbara Stallings. New York: Cambridge University Press, 1995. ———. “The Organization of Buyer-Driven Global Commodity Chains: How U.S. Retailers Shape Overseas Production Networks”. In Commodity Chains

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and Global Capitalism, edited by G. Gereffi and M. Korzeniewicz. Westport: Praeger, 1994, 95–122. ———. “Prospects for Industrial Upgrading by Developing Countries in the Global Apparel Commodity Chain”. International Journal of Business and Society 3, no. 1 (2002): 27–60. Gereffi, G., J. Humphrey, and T. Sturgeon. “The Governance of Global Value Chains”. Review of International Political Economy 12, no. 1 (2005): 78–104. Henderson, J., P. Dicken, M. Hess, N. Coe and H. W-C Yeung. “Global Production Networks and the Analysis of Economic Development”. Review of International Political Economy 9 (2002): 436–64. Hossain, Akhtar. “Macroeconomic Developments, Policies and Issues in Indonesia, 1950–2005: A Review”. Malaysian Journal of Economic Studies (June-Dec 2006). Kakazu H. “Growth Triangles in ASEAN: A New Approach to Regional Cooperation”. GSID APEC Discussion Paper Series 9. Nagoya: Nagoya University, 1997. Kaufmann, D., A. Kraay, and M. Mastruzzi. “Governance Matters VI: Governance Indicators for 1996–2006”. In World Bank Policy Research, June 2007. Kimura, Fukunari. “Mechanics of Production Networks in Southeast Asia: The Fragmentation Theory Approach”. In Production Networks and Industrial Clusters: Integrating Economy in Southeast Asia, edited by Ikuo Kuroiwa and Toh Mun Heng. Singapore: Institute of Southeast Asian Studies, 2008. Kong, Tao and Arief Ramayandi. “Survey of Recent Developments”. Bulletin of Indonesian Economic Studies 44, no. 1 (2008): 7–32. Myrdal, Gunnar. Economic Theory of Underdeveloped Regions. Duckworth, London, 1957. Narjoko, D.A. and F. Jotzo. “Survey of Recent Development”. Bulletin of Indonesian Economic Studies 43, no. 2 (2007): 143–170. Porter, M.E.. Competitive Advantage: Creating and Sustaining Superior Performance. Simon & Schuster, 1985. ———. The Competitive Advantage of Nations. New York: Free Press, 1990. (Republished with a new introduction, 1998.) Porter, M.E. and R. Bryden. “International Cluster Competitiveness Project, Institute for Strategy and Competitiveness”. Harvard Business School”. Boston, MA: Harvard Business School 2007, . Porter, M. and C. Ketels. “Indonesia: Attracting Foreign Investments”. Harvard Business Review, 29 March 2007. Rugman, A.M. “Canada”. In Governments, Globalization and International Business, edited by J.H. Dunning. London: Oxford University Press, 1997. Schmitz, H. Value Chain Analysis for Policy Makers and Practitioners. Geneva: International Labour Office, 2005.

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Shee, P.K. “Singapore-China Special Economic Relations: In Search of Business Opportunities”. Ritsumeikan International Affairs (2005): 151–76 Sturgeon, T.J. “How Do We Define Value Chains and Production Networks?”. Institute of Development Studies Bulletin 32, no. 3 (2001): 9–18. Takii, Sadayuki and Eric D. Ramstetter. “Survey of Recent Developments”. Bulletin of Indonesian Economic Studies 43, no. 3 (2007): 295–322. Thant M. et al., eds. Growth Triangles in Asia. Asian Development Bank. Hong Kong: Oxford University Press, 1994. Toh M.H. and L. Low, ed. Regional Cooperation and Growth Triangles in ASEAN. Singapore: Times Academic Press, 1993. UNIDO. “Inserting Local Industry into Global Value Chains and Global Production Networks”. Working Paper. Vienna: UNIDO, 2005. World Bank. Doing Business 2007. Washington, D.C.: The World Bank and the International Finance Corporation, 2006.

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Index

A Abdullah, Ismeth, 273–75, 290 ACFTA (ASEAN-China FTA), 94, 171 ACMECS (Ayeyawady-Chao PhrayaMekong Economic Cooperation Strategy), 173, 207, 217 ADB (Asian Development Bank), 86, 173, 267 adjustment costs, 104 AFTA (ASEAN Free Trade Area), 8, 37, 42, 51, 64, 67, 69, 77, 94, 96, 102, 104, 128, 170, 257 “AFTA Plus”, 106 agglomeration economies, 5–7, 65, 118, 128 Agreement on Subsidies and Countervailing Measures, see SCM Agreement on Trade-Related Aspects of Intellectual Property Rights, see TRIPs Agreement on Trade-Related Investment Measures, see TRIMS agro-industry, 25 AIA (ASEAN Investment Area), 77–79, 101

10 PPNetwkindex.indd 297

AICO (ASEAN Industrial Cooperation), 51, 79 AMBDC (ASEAN-Mekong Basin Development Cooperation), 173, 207–08 anti-export bias, 40 APEC (Asia-Pacific Economic Cooperation), 170 apparel exporter, 60 apparel industry, 49, 51, 60, 62 APPTIAD (Asia-Pacific Preferential Trade and Investment Agreements), 105 arm’s length (inter-firm) fragmentation, 16, 18, 20, 30, 33 arm’s length transaction, 101–102, 293 Asahi Maxima (Laos) Co. Ltd, 125, 134 ASEAN (Association of Southeast Asian Nations), 1, 8, 16, 28, 30, 33, 40, 51, 94, 246, 257, 271 CLMV integration, and, 90–93 developmental divide, and, 81–88 economic integration, 72–75, 80–81, 88, 95

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298

economic structure, 82 established, 73 foreign direct investment (FDI), 74–75, 78 FTA as policy tool, 95–96, 105 gross domestic product (GDP), 73, 82 incidence of poverty, 86–87 intra-, trade, 78, 84, 91–92, 94 macroeconomic indicators, 83 market, 81 members, 73, 87, 170, 217 regional economic cooperation, 3, 9 ASEAN-5, 73, 77 ASEAN-6, 77, 84, 88–89, 171 ASEAN+6, 16, 84 ASEAN Charter, 80, 106–07 ASEAN-China FTA, 94, 171 ASEAN Concord II, 74, 107 ASEAN Court of Justice, 81 ASEAN, e-, 76 ASEAN Economic Blueprint, 101 ASEAN Economic Community (AEC), 9, 42, 72–76, 79, 81, 93, 106 ASEAN Economic Ministers, 77 ASEAN Framework Agreement on Services (AFAS), 77, 79, 101 ASEAN Free Trade Area see AFTA ASEAN FTAs, 101–05 ASEAN High Level Task Force, 75–76, 107 ASEAN Industrial Cooperation, 51, 79 ASEAN Integration, Initiative for (IAI), 88–90 ASEAN Investment Area, 77–79, 101 ASEAN-Korea FTA, 94, 171 ASEAN-Mekong Basin Development Cooperation, 173, 207–08

10 PPNetwkindex.indd 298

Index

ASEAN Ministerial Meeting, 89 ASEAN regionalism, 72 ASEAN Secretariat, 81 ASEAN Summit 2003, 73 ASEAN Summit 2004, 76 ASEAN Summit 2007, 74, 76, 80, 106 “ASEAN Way”, 80, 107 ASEAN-X principle, 79 Asia-Europe Meeting (ASEM), 170, 207 Asia-Pacific Economic Cooperation, see APEC Asia-Pacific Preferential Trade and Investment Agreements, see APPTIAD Asian Development Bank, 86, 173, 267 Asian financial crisis, 10, 176, 183, 195, 246, 254–55, 257, 260–61, 271, 282 Indonesia, 246, 254, 255 Asian NIEs, 43, 60–63 “Asian noodle-bowl”, 104 Asian Tables, 69 Association of Southeast Asian Nations, see ASEAN Association of the Thai Garment Industry, 142 Australia, 101, 103, 106, 171 automotive industry, 46, 50–51, 60, 63, 66, 119 automotive sector, 49 Ayeyawady-Chao Phraya-Mekong Economic Cooperation Strategy, 173, 207, 217 B backward linkage effects, 50, 67–68 see also forward linkage effects; spatial linkages

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Index

Badan Pusat Statistik, 267 Bali Concord II, 74, 107 “balloon theory”, 269 Bangalore IT Park, 246, 287 Bangkok, 21, 24, 30, 133, 234, 241 quality of amenities, 118, 232 Bangkok Port, 220, 232–33 Bangladesh, 147, 152 Bank of Indonesia, 256 Batam, 271, 276, 280, 289 comparison with Guangzhou, 274 development of, 269–72, 293 “growth triangle”, 246 labour costs in, 46 see also BBK Batam, Bintan and Karimun (BBK), 10, 62–63, 65, 246–47, 268, 271, 277, 285–87 development of, 272–75 FDI, 246 government policies, 279–85 location of, 268–69 revitalizing Indonesia economy, 268–75 SEZ, and chronology of events, 288–90 Singapore’s role, 275–79 Batam Industrial Development Authority (BIDA), 269, 273, 279, 289, 294 Batam Industrial Park (Batamindo), 270, 287, 288 Batam Polytechnic, 289 Bay of Bengal Initiative for Multi-Sectoral Technical and Economic Cooperation (BIMSTEC), 217 Bintan, 280 see also BBK Bintan Industrial Estate, 287

10 PPNetwkindex.indd 299

299

BKPM (Indonesia Investment Coordinating Board), 258, 289 bond market, 177 bonded transport, 121–22 “bonded zone”, 270, 273 boomerang-type vertical fragmentation, 124–25 border industry, 10, 47, 215, 225, 236, 239, 241 business environment, 223–24 Mae Sot, 222 Myanmar, 219–24, 241 Bouphavanh, Bouasone, 138 Brunei income level, per capita, 84 build-operate-transfer (BOT), contracts, 179 Burma Communist Party (BCP), 216 Business Competitive Index (BCI), 262–64 Business Competitiveness ranking, 263 “buyer-driven” chains, 250 C Cambodia, 1, 24, 28, 37, 40, 60, 66 employment, 161–62 export share, 91–92 exports, 61 foreign direct investment, 53–54, 60, 63, 159 garment firms, 156–63 import share, 91, 93 infrastructure, 156 investors, 61 Special Economic Zone (SEZ), 64, 223 trade performance, 57 see also CLM; CLMV; CLV Cambodian Special Economic Zone Board (CSEZB), 242

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300

Canada, 147, 158 Canon, 186, 196 Canon Thailand, 128 Canon Vietnam, 192 capital costs, 32 capital realization, 184 CBTA (cross-border transport agreement), 224, 235 Central Institute of Economic Management, 210 central planning, 66 CEPEA (Comprehensive Economic Partnership in East Asia), 102 CEPT (Common Effective Preferential Tariffs), 76–77, 79, 170, 207 “chain”, concept of, 293 change in tariff classification (CTC), 103 Chiang Mai, 125, 132 China, 30, 37, 91, 101, 106, 125–26, 133, 146, 152, 171, 199, 245, 278 Business Competitiveness ranking, 263 “Ease of Doing Business” ranking, 265–66 foreign direct investment, 74, 159 relations with Myanmar, 216 Special Economic Zone (SEZ), 282 wage level, 135 China Communist Party (CCP), 216 Chinfong, 199 Choonhavan, Chatichai, 216 CLM (Cambodia, Laos, Myanmar), 219 CLMV (Cambodia, Laos, Myanmar and Vietnam), 1, 3, 9, 51, 72, 77, 81–82, 84, 89–90, 107 ASEAN integration, and, 90–93

10 PPNetwkindex.indd 300

Index

domestic reform, 93 economic transition, 40 infrastructure, 87–88, 93 intra-ASEAN trade, 92 trade imbalances, 84 trade openness, 91 CLV (Cambodia, Laos, and Vietnam), 91, 93 clusters, 286 defined, 147–48 frontier, 149 pillars, 150–52 codified knowledge, 10 see also tacit knowledge Cold War, 216 collective efficiency, 136 Common Effective Preferential Tariffs, see CEPT Communist Party of Vietnam (CPV), 169, 207, 209 Competitive Advantage: Creating and Sustaining Superior Performance, 248 complete knock-down (CKD) production, 200 completely built units (CBU), 69 Comprehensive Economic Partnership in East Asia, 102 consumer market, 75 continuous process industries, 45 costs adjustment, 104 capital, 32 network set-up, 29, 31, 45, 96, 101–102, 287 production, 29–30, 32, 45, 64, 96, 121, 130, 281, 287 service link (SL), 18–19, 29–30, 32, 45–46, 64, 96, 101–102, 130, 210, 219–22, 235, 237, 239, 281, 287

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Index

trade link, 116 transportation, 130, 143 see also labour costs Craft Industry Co. Ltd, 125, 133 cross-border barriers, 96, 133 cross-border production networks, 1–2, 19 cross-border transport agreement, see CBTA cross-country, production networks, 7–8 cut, make and trim (CMT) garment operations, 147, 153–54, 158 cut, make and pack (CMP) production, 235, 240–42 D de-industrialization, 28, 262 development phases fragmentation framework and, 25–28 “digital divide”, 87 “direct investment”, 178 diseconomies of agglomeration, 117–18 distribution networks, 15–18, 25 spatial structure of, 16, 19 Doha Round Talks, 171 Doi Moi, 9, 40, 168, 174–75 see also renovation E e-ASEAN, 76 Early Harvest Scheme, 107 “Ease of Doing Business” ranking, 265–66 East Asia, economic development of, 15–16 economic integration, 93 production networks, 18 East Asian countries, 91, 93, 102

10 PPNetwkindex.indd 301

301

East Asian Miracle report, 5 East-West Economic Corridor, 226, 235 East-West Corridor, 8, 37, 64, 67 Economic Development Board (EDB), 276, 289 economic reform, 40, 66 economic regionalism, 72 Economic Research and Training Centre (ERTC), 227 Economic Research Institute for ASEAN and East Asia (ERIA), 16 electronics industry, 45–47, 52, 60, 64, 66 spatial linkages of, 50 electronics sector, 48, 50 embodied technology, 159 Emilia Romagna, 157 Ernst, D., 251 EU (European Union), 81, 106, 133, 147, 158, 170, 217 European Commission, 170 European-style common market, 106 EWEC (East-West Economic Corridor), 226, 235 export-oriented industrial (EOI) policy, 37, 39–40 export-oriented industries, 46, 75, 194–95, 240, 270 export-processing zone (EPZ), 40, 146–47, 149–51, 154, 191, 240–41, 270–71, 288 F factor costs, 3–4 financial services, 32 Flextronics, 251 foreign direct investment (FDI), 2, 9–10, 29–31, 52, 73, 95, 107, 118, 132, 147, 247, 282

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302

ASEAN, 74–75, 78 BBK, 246 Cambodia, 53–54, 60, 63, 159 China, 74, 159 Indonesia, 53–54, 253, 268 Laos, 53–54, 61, 63, 125, 133, 159 Thailand, 53–54, 133, 159 see also Vietnam, foreign direct investment (FDI) Foreign Investment Law (FIL), 216 forward linkage effects, 47, 50, 68 see also backward linkage effects; spatial linkages Foxcon, 186 fragmentation arm’s length (inter-firm), 16, 18, 20, 30, 33 concept of, 17, 281 costs in, 20, 210 five types of, 121–28 intra-firm, 18, 20 production process, 18, 116 vertical, 121–24 vertical, boomerang-type, 124–25 fragmentation framework development phases, and, 25–28 fragmentation theory, 16–17 fragmentation, two-dimensional, 33 concept of, 17–18 framework, 16, 21, 33 review of, 17–24 Framework Agreement 2006, 291–92 Framework Agreement on Economic Cooperation, 2, 271, 275, 289 Framework Agreement on the ASEAN Investment Area, 181 free trade agreement, see FTA free trade area, 77, 106, 287 free trade hub, 106

10 PPNetwkindex.indd 302

Index

free trade zone (FTZ), 240, 245, 271, 275, 290 frontier clusters, 149 FTA (free trade agreement), 9, 37, 40, 44, 66, 73, 107, 171, 277, 287 policy tool, as, 95–96, 105 production networks, development of, 95–106 regional economic development, role of, 93–95 FTA hubs, 103 FTA provisions, 99–100 Fujikura Thailand Co. Ltd, 128 Fujitsu, 196 G garment exports, 215 garment firms in Cambodia, 156–63 in Laos, 156–63 garment industry, 25, 46, 119, 214 in Mae Sot, 215–16, 225–38, 242 innovation in, 160 garment lead times, 154–55 garment regions, key, 147 GATS-Plus agreement, 79 GATT, 41 General Agreement on Trade in Services (GATS), 40–41, 79 General Electric, 251 General Motors, 250 General Statistical Office, 169 General System of Preferences, 125–26, 133, 135 geographical proximity, 63, 69, 116, 132 global commodity chains (GCC), 247, 250 global production networks, see GPN global value chains, see GVC

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Index

globalization, 8, 15, 37, 115, 150, 284–85 Goh Chok Tong, 288 governance, good, 65 governance indicators, 43 government economic intervention, 2–3 government intervention, selective, 43 government-linked companies, 270 GPN (global production networks), 10, 246, 248, 250–52, 262, 280–81, 285–86, 293 concept of, 251–52 definition, 251 gravity model, 116, 132 Greater Mekong Subregion (GMS), 173–74, 217, 219, 224, 226 “growth triangle”, 246, 268, 293, 270, 288 GSO (General Statistical Office), 169 GSP (General System of Preferences), 125–26, 133, 135 Guangzhou comparison with Batam, 274 GDP, 273 GVC (global value chains), 10, 246, 248, 251–52, 280–83, 285–86, 293 concept of, 248–50, 252, 293 definition, 261 governance of, 249, 293 Indonesia joining, 261–68 H Ha Noi Declaration on Narrowing the Development Gap, 89 Habibie, B.J., 255–56, 269 Hanoi, 24, 186, 189, 202 hard disk drive (HDD), industry, 4–5, 7, 65, 69

10 PPNetwkindex.indd 303

303

high-technology industries, 45 Hino, 121 HLTF (ASEAN High Level Task Force), 75–76, 107 Ho Chi Minh City, 24, 186, 189–90, 202 Honda, 121, 199 Hong Kong, 246 human capital, 32, 65 Human Development Index (HDI), 84, 85 I IAI (Initiative for ASEAN Integration), 88–90 IAI Work Plan, 89 IBM, 250–51 ICT (Information and Communication Technology), 87–88, 247, 280 IFC (International Finance Corporation), 137 IL (Investment Law), 178–81 IMF (International Monetary Fund), 42, 247, 262 import substitution industrial (ISI), policy, 37, 40 import tariff, 124–25, 127 IMS-GT (Indonesia-MalaysiaSingapore Growth Triangle), 270, 277, 278, 289 Incheon Science Park, 246 incidence of poverty, 86–87 India, 101, 103, 106, 125, 146, 171, 278 “Ease of Doing Business” ranking, 265–66 “indirect investment”, 178 definition, 179 Indochina, 37 Indochinese countries, 40, 66

10/2/09 3:13:58 PM

304

Indonesia, 28, 31, 43, 147, 151, 246 Asian financial crisis, 246, 254, 255 Business Competitiveness ranking, 263 business environment, 262–68 decentralization, 255 “Ease of Doing Business” ranking, 265–66 economic agreement with Singapore, 2, 271 economy, 253, 260, 267 economy, revitalizing of, 268–75 foreign direct investment (FDI), 53–54, 253, 268 global value chain, joining, 261–68 gross domestic product (GDP), 255, 257, 260, 294 income level, per capita, 84 investment law, new, 258–59 investors in, 52 least integrated into production networks, 50–52, 62, 281 manufacturing sector, 254, 261–62 motorbike market in, 200 primary commodities in, 52 trade partners of, 52 trade performance, 55 Indonesia Investment Coordinating Board, 258, 289 Indonesia-Malaysia-Singapore Growth Triangle, see IMS-GT industrial agglomeration, 19–20, 24, 27–32, 96, 118 industrial cluster, 5–6, 65, 116–18, 121, 134–35, 240, 286 functions of mother factories in, 128–29 development of, 117–18 see also operational cluster; technological cluster industrial collaboration, 79

10 PPNetwkindex.indd 304

Index

industrial estates, 64, 132, 149–50 industrial parks, 246 industrial policy, 2–3, 40, 42–43, 67 evolution of, 38–39 export-oriented (EOI), 37, 39–40 first phase of, 28–31 institutional resources for, 5 second phase of, 31–33 Southeast Asia, 8, 37–40 industrial strategy, 115–142 industrial zones, 191–92, 197, 209 industrialization four phases of, 25, 27–28 infant industry protection, 41–42 Information and Communication Technology, 87–88, 247, 280 Initiative for ASEAN Integration, 88–90 input-output analysis, 37 input-output tables, 47, 67 Institute of Developing Economies (IDE-JETRO), 227 Institute of World Economics and Politics, 210 Integrated Investment Service Unit, 280 Integrated (Out) Sourcing Initiative (ISI), 277 Intel, 196 intellectual property rights, 102 inter-bank market, 177 International Finance Corporation, 137 International Monetary Fund, 42, 247, 262 international poverty line, 86 intra-ASEAN trade, 92 intra-regional production networks, 93 intra-regional trade, 75 investment capital, 183–84, 186

10/2/09 3:13:58 PM

Index

Investment Coordination Board, Indonesia, 258, 289 investment evaluation, 180 investment incentives, 40 Investment Law, 178–81 investment law, new, 258–59 inward foreign direct investment, 262 Ireland, 146–47, 152 Isuzu, 121 Italian industrial districts, 136 IZs (industrial zones), 191–92, 197, 209 J Jakarta, 24 Japan, 101, 103, 106, 147, 158, 171, 199, 280 linkage effects on, 50–51 Japanese Business Association (JBA), 210 Japanese Chamber of Commerce and Industry, 137 JBIC Bangkok, 138 just-in-time production, 46, 150 JETRO, 210 JETRO Bangkok, 138 JICA Laos Office, 138 Johor, 276 “growth triangle”, 246, 270 Joint Steering Committee (JSC), 289–91 K Karimun, 280 see also BBK Kementerian Koordinator Bidang Perekonomian, Republik Indonesia, 267 Klong Toey Port, 232 Korea, 43, 69, 101, 103, 106, 171

10 PPNetwkindex.indd 305

305

Krugman, Paul, 115 Kurabo Thailand Co. Ltd, 135 L labour costs, 2–4, 63, 74, 86, 222, 237 Batam, in, 46 direct, 119–21 indirect, 119–21 Myawaddy, 237 Singapore, 46 Thailand, 46, 117–20, 237 see also costs labour-intensive industries, 63 labour-intensive processes, 44–46 labour migration, 32 Laem Chabang Port, 220, 232–33 Lamphun Industrial Park, 132 land costs, 2 Lao Business Forum, 137 Lao-Japan Public and Private Sectors Joint Dialogues, 137–38 actions recommended, 139–41 Lao National Chamber of Commerce and Industry, 136–37 Lao Shoes Co. Ltd, 125 Lao Yamaki Co. Ltd, 125, 133 Laos, 1, 24, 28, 30, 37, 66 development strategy of, 9 employment, 161–62 export share, 91–92 exports, 61, 121–22 foreign direct investment (FDI), 53–54, 61, 63, 125, 133, 159 garment firms in, 156–63 industrial strategy, 115–142 infrastructure, 156 labour cost in, 46, 117, 120 outsourcing to, 2, 8 technology survey, 152, 163 trade performance, 58 wage level in, 29, 119

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306

WTO membership, application for, 40 see also CLM; CLMV Law of Promotion and Management of Foreign Investment, 133 “lead firms”, 249–50 Lee Hsien Loong, 275 less developed economies, 36 challenges, 2 strategies of, 3 liberalization, 115 Licensing Authority, 180, 208 Lifan, 199 Likert scale, 152 linkage effects, 50–51 lock-in effects, 142–43 logistic infrastructure, 29–30, 32 logistic services, 29–30, 32 lower wage countries labour-intensive processes to, 44–46 low-technology industries, 46 Lutfi, Muhammad, 290 M Mabuchi Motor, 192 machinery industry, 25 Mae Sot, 214 border industries, 222 garment industry, 215–16, 225–38, 242 location, 225–26 Myanmar workers in, 228–32, 240 survey, 227–28 wage level, 231 Mae Sot Border Economic Zone Project, 240 Malaysia, 37, 43, 61, 103, 146 apparel industry in, 51 Business Competitiveness ranking, 263

10 PPNetwkindex.indd 306

Index

export-oriented industrial (EOI) policy, 37, 39–40 import substitution industrial (ISI), policy, 40 income level, per capita, 84 rubber industry in, 51 Mani Laos Co. Ltd, 135 Manila, 24 manufacturing industries, 202, 210 manufacturing sector, 254, 261–62 market access, 4 market economy, 66, 75 market institutions, establishment of, 176–77 market liberalization, 42, 44 Maruhachi, 133 mass infrastructure, 32 Matsuda, 121 Matsushita, 196 Maung Aye, General, 233 medium-technology industries, 45 Mekong-Ganga Cooperation, 217 Mekong Private Sector Development Facility, 137 MEPE (Myanmar Electric and Power Enterprise), 236 methodology and data, 152–59 MFN (Most Favoured Nation), 101, 104, 182 MGMA (Myanmar Garment Manufacturers Association), 214, 230, 242 micro, small and medium enterprises (MSMEs), 258, 259 Microeconomic Foundation of Productivity, 263 Millennium Goals, 168 Ministry of Electric Power, 236 Ministry of Industry and Trade (MOIT), 169

10/2/09 3:13:58 PM

Index

Ministry of Labour, Invalids, Social Affairs (MOLISA), 169, 197, 209 Ministry of Planning and Investment (MPI), 169, 197 Mitsubishi, 121 modularization of technological knowledge, 251 Most Favoured Nation, 101, 104, 182 mother factories, 116–17, 122, 124–25, 135 functions in industrial cluster, 128–29 motorbike market, 200 motorcycle industry, 69 MPR (People’s Consultative Assembly), 256 mufakat, 80 Multilateral Investment Guarantee Agency (MIGA), 181 multinational corporations (MNCs), 1–2, 4, 36, 75, 79, 81, 220 musyawarah, 80 Mutual Recognition Arrangements (MRAs), 76, 80 Myanmar, 1, 24, 28 border industry in, 219–24, 241 electricity shortage, 235–36 Foreign Investment Law (FIL), 216 garment exports, 215 household expenditure, per capita, 217, 238–39, 241 income level, per capita, 82 labour costs, 237–38 open-door policy, 216–19 policy recommendations, 239–41 relations with China, 216 sanctions, 214–15, 217, 230, 241 trade, 218

10 PPNetwkindex.indd 307

307

workers in Mae Sot, 228–32, 240 see also CLM; CLMV Myanmar Electric and Power Enterprise, see MEPE Myanmar Garment Manufacturers Association, see MGMA Myawaddy, 214–15, 229, 231, 238, 240–41 electricity provision to, 236 labour costs, 237 location, 226 N National Science Foundation (NSF 2003), 149 National Treatment, 101 Naypyidaw, 233 network cohesion, 157–58 “network”, concept of, 293 network set-up costs, 29, 31, 45, 96, 101–02, 287 newly industrialized economies (NIEs), 43, 69 New Order, 255 New Zealand, 101, 103, 106, 171 Nguyen Minh Triet, 186 Nissan, 121 non-oil domestic exports (NODEX), 278 non-tariff barriers, 93, 95 Non-Tariff Measures (NTM), 76, 103 North-South Corridor, 8, 21, 37, 64, 67 NTB, 77 O “one-stop shop”, 279 open-door policy, 216–19 operational cluster, 5, 6 see also industrial cluster; technological cluster

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308

Orion Hanel, 192 outsourcing, 46 P Panasonic, 186 “path dependency”, 121 PBs (production blocks), 18, 29–30, 31, 44–45, 69, 101, 107, 121–22, 209, 219 attracting, 62–65 Pearl River Delta (PRD), 273 Penang, 152 People’s Consultative Assembly (MPR), 256 Pertamina, 256, 269, 270, 293–94 Philippines, 31, 146–47, 152 “Ease of Doing Business” ranking, 265 income level, per capita, 84 linkage effects on, 50–51 Phnom Penh, 9, 147 infrastructure, 154–55 wages, 162 plastics industry, 201 Plaza Agreement, 118 policies first phase of industrialization, 28–31 policy liberalization, 102 policy matrix, 2x3, 97–98 policy space, 40–42, 44, 66 Porter, Michael, 248, 263, 286, 293 “port of entries”, 248 preferential trade agreements, 171 primary commodities, 52, 61 primary industries, 52 private sector investment promotion, 93 privatization, 40 “processing on commission”, 125 “producer-driven” chains, 250

10 PPNetwkindex.indd 308

Index

production blocks, see PBs production costs, 29–30, 32, 45, 64, 96, 121, 130, 281, 287 production fragmentation, 2, 30, 44–46, 280 production networks, 15, 25, 30, 33, 36 cross-border, 1–2, 19 cross-country, 7–8 design of, 25 development of, 198–201 East Asia, 18 expansion into less developed regions, 52–62 extension into Southeast Asia, 3–8, 16, 51 hard disk drive in Southeast Asia, 1, 3 Indonesia, least integrated, 50–52, 62, 281 international, 31, 198 intra-regional, 93 local, 198 regionalized, 63 spatial structure of, 16, 19, 25 vertical, 116–17, 121, 134, 142 production processes fragmentation of, 18, 116 technical divisibility of, 45 vertically-integrated, 2, 44–45 Productivity and Investment Climate Survey on Indonesia, 267 protectionism, 84 PTAs (preferential trade agreements), 171 public policies, 4–5, 65 public-private partnership (PPP), 32 R Rangsit University, 242 Regional Trading Arrangements (RTA), 76

10/2/09 3:13:59 PM

Index

renovation (Doi Moi) industrial policies under, 174–83 period, 171 policy, 169 see also Doi Moi research and development (R&D), 66, 147–50, 153, 156, 159–60, 196, 209, 272, 286 Rest of the World (ROW), 91 reverse engineering, 42 Riau Islands, 268, 270, 289 Robotech, 186 Route 128, 149 rubber industry, 51 Rules of Origin (ROO), 76, 103–104, 108 S “S” curve, 160, 162 Saha Union Group, 142 Samsung, 148 sanctions, Myanmar, 214–15, 217, 230, 241 Sankyu Inc., 242 Sante Lao Co. Ltd, 125, 135 SCM (Agreement on Subsidies and Countervailing Measures, The), 40–41 Selangor, 24 service link costs, 18–19, 29–30, 32, 45–46, 64, 96, 101–102, 130, 210, 219–22, 235, 237, 239, 281, 287 services sector, 79 SEZ (Special Economic Zone), 10, 29–30, 67, 138, 222, 240–41, 245–46, 268, 271–81, 285, 287 BBK, and chronology of events, 288–90 Cambodia, 64, 223 China, 282

10 PPNetwkindex.indd 309

309

spoke network, 104 vehicle for growth, 282–83 Shannon International Airport, 146 Shenzhen, 246 Shinawatra, Thaksin, 118, 207 Sihanoukville, 158, 222 Silicon Valley, 149 Singapore, 21, 24, 37, 66, 147, 152, 280, 286 apparel industry in, 51 development stage, 10 economic agreement with Indonesia, 2, 271 export-oriented industrial policy, 37 government economic intervention, 2–3 “growth triangle”, 246, 270 income level, per capita, 82, 84 labour costs in, 46 linkage effects on, 50 role in BBK, 275–79 Singapore Framework Agreement, 278 Singapore FTA, 94–95, 101, 103 Singapore-Johor-Riau (SIJORI), 270–71, 289 Singapore Port, 233 single market, 74, 77, 93, 101 SLORC (State Law and Order Restoration Council), 216, 241 small and medium enterprises (SMEs), 107, 224 Soeharto, 255–56, 269 SOEs (state-owned enterprises), 174, 176, 196, 255 software outsourcing, 25 Sony, 201 Southeast Asia economic integration of, 42 extension of production networks into, 3–8, 16, 51

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310

industrial policy, 8, 37–40 Japanese FDI in, 118 labour costs in, 46 locational heterogeneity of, 7 production networks of hard disk drive, 1, 3 trade liberalization, 40 Southern Economic Corridor, 37, 64, 67, 222 Soviet bloc, 40 Soviet-style central planning model, 175 “spaghetti-bowl” argument, 104 spatial backward, 47 spatial linkages, 67–69 Asian countries, in, 47–51 electronics industry, 50 structure of, 50 types of, 47 see also backward linkage effects; forward linkage effects spatial structure of production networks, 16, 19, 25 spatial structure of transactions, 25 special and differential (S&D) treatment, 42 Special Economic Zone, see SEZ state capability, constraints of, 43–44, 66 State Law and Order Restoration Council, 216, 241 State-owned Economic Enterprises (SEEs) Law, 236 state-owned enterprises, 174, 176, 196, 255 State Peace and Development Council (SPDC), 216, 233, 241 sub-regional complementary (SRC) industrialization, 117 four-stage process, 133–35 fragmentation, five types of, 121–28

10 PPNetwkindex.indd 310

Index

implementation, 130–31 Sukarnoputri, Megawati, 256–57 Sumatera Promotion Centre (SPC), 280 supporting industries, 198–202 Suzhou Industrial Park, 30, 246, 287 Suzuki, 121, 199 systemic quad, 151, 162 T tacit knowledge, 6, 10, 152 see also codified knowledge Taiwan, 43, 69, 146, 148, 199 linkage effects on, 51, 69 tariffs, 93, 95, 104, 130, 170–71, 199–200, 207, 247, 257 tariff protection, 40–41 Tak Chapter of the Federation of Thai Industries, 242 Tak Province, 228–29 factories in, 226 Technical Barriers to Trade, agreements on, 76 technological cluster, 5, 6 see also industrial cluster; operational cluster technological intensities, 159–62 technological transfer, 33, 129, 203 Technology Group, 186 technology survey, 152, 163 Texmaco, 151 Thai Ministry of the Interior, 228 Thai Yamaki Co. Ltd, 133 Thai Yazaki Group, 132 Thailand, 28, 43, 103, 146, 147, 255 apparel industry in, 51 Board of Investment, 125 Business Competitiveness ranking, 263 electronics industries in, 52 exports, 61

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Index

foreign direct investment (FDI), 53–54, 133, 159 FTA, 94, 107 high production cost in, 2 industrial clusters, development of, 117–18 labour costs, 46, 117–20, 237 linkage effects on, 50–51 minimum wage, 118–19 motorbike market in, 200 rubber industry in, 51 technology survey, 152, 163 trade performance, 59 wage level in, 29, 119 Thaisin Southeast Asia Import Export Co. Ltd, 142 Thammasat University, 227, 242 Third World countries, 118 three-dimensional evaluation, 29 “Three Ds” (3D) jobs, 228, 239 Tokyo, 202, 232–33 Tokyo Coil (Laos) Co. Ltd, 125, 134 Tokyo Coil (Thai) Co. Ltd, 132 Toyota, 119, 121, 125, 201 trade barriers, 76, 82 “trade costs”, 130 trade diversion, 106 trade imbalances, 84 trade liberalization, 8, 51, 94–95, 101, 104–105 trade link costs, 116 trade openness, 91 Trade Policy Council, 233 trade reform, 40 trade support network, 284 transaction choices, factors affecting, 21 transaction costs, 19–20 transactions four layers of, 16, 25, 30 concept, 21

10 PPNetwkindex.indd 311

311

spatial structure of, 25 transportation costs, 130, 143 Triangle Development Programme, 174 triangle manufacturing, 60, 62 TRIMS (Agreement on TradeRelated Investment Measures), 41–42, 208 TRIPs (Agreement on Trade-Related Aspects of Intellectual Property Rights, The), 40–42 TSB Laos Co. Ltd, 128, 135 two-dimensional fragmentation framework, 97–98 U Unilever, 211 Union Yagi, 133 United Nations (UN), 207 United Nations Economic and Social Commission for Asia and the Pacific (UNESCAP), 105 United Nations Industrial Organization (UNIDO), 261, 293 United States, 147, 158, 278 linkage effects on, 50–51 sanctions on Myanmar, 214–15, 217, 230, 241 United States Bilateral Trade Agreement (USBTA), 170–71 Universal Hat Co. Ltd, 125, 133 urban transport system, 32 USA-Singapore FTA, 277 V value-added (VA) rule, 103 value chain, 248–50, 283, 285, 293 value chain analysis, 248 “value-retention”, 282–83 value to weight ratio, 45

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312

Vedan, and river pollution, 210 “vertical FDI”, 116 vertical fragmentation, 121–24 vertical product differentiation, 125–26 vertical production networks, 116–17, 121, 134, 142 vertical specialization definition, 116–17 vertically-integrated production process, 2, 44–45 Vientiane, 9, 147 infrastructure, 154–55 wages, 162 Vientiane Action Programme, 76, 84 Vientiane Automation Product Co. Ltd, 125, 134 Viet kieu, 189 Vietnam, 1, 9–10, 31, 37 “Ease of Doing Business” ranking, 265–66 economic growth, 176 employment, 197 exporter of apparel, 60 export share, 91–92 GDP, 171–73 General Statistical Office (GSO), 169 integration of, 169–74, 207 Investment Law (IL), 178–81 investment sectors prohibited by law, 179, 208 investors in, 60 Licensing Authority, 180, 208 Millennium Goals, 168 Ministry of Industry and Trade (MOIT), 169 Ministry of Labour, Invalids, Social Affairs (MOLISA), 169, 197, 209 Ministry of Planning and Investment (MPI), 169, 197

10 PPNetwkindex.indd 312

Index

motorbike market in, 200 policy recommendations, 204–205 state capability of, 44 stock market, 177 supporting industries in, 198–99 trade performance, 56 trade reform, 40 wage level, 135, 198, 209 WTO commitments, 170–71, 181, 200, 204, 210 see also CLMV; CLV Vietnam, foreign direct investment (FDI), 53–54, 60, 63, 168–69, 171 approved, 189, 191, 206 impact of, 192–98, 209 issues in, 201–203 law, 190 policies promoting, 177–83, 208 realized, 186 sources, 184–85 trends and changes, 183–92 see also foreign direct investment (FDI) Vietnam Chamber of Commerce and Industry (VCCI), 210 Vietnam Development Forum, 200, 210 Vietnam-Singapore Industrial Park, 246, 287 virtuous circle, 31 W Wahid, Abdurrahman, 256 Wal-Mart, 250 weaving industry, 51 World Bank, 42–43, 246, 264, 267 East Asian Miracle report, 5 two-part strategy, 68 World Economic Forum (WEF), 262 World Intellectual Property Organization, (WIPO), 181

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Index

World Trade Organization (WTO), 37, 44, 66, 76, 94–95, 170, 186, 207, 247, 257 impact on industrial policy, 40–42 membership, application for, 40 special and differential (S&D) treatment, 42 Vietnam commitments, 170–71, 181, 200, 204, 210 Wuxi Industrial Estate, 287

10 PPNetwkindex.indd 313

313

Y Yamaha, 199 Yangon, 234–35 factories in, 230 wage level, 231 Yangon Port, 232–33 Yazaki, 125, 134 Yokohama Port, 232 Yudhoyono, Susilo Bambang, 257, 259–60, 275

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