C. Recommendation to countries and companies – the devil is in the details
C. Recommendation to countries and companies – the devil is in the details
1. Main country lesson: Governments need to remove the relevant set of barriers for their industries
In The Competitive Advantage of Nations, Michael Porter argues that countries should build up and sustain competitive advantage in a cluster of industries that fit naturally with the country’s economic structure, institutions and culture. No nation, he says, “can or will be competitive in every or even most industries”.29
Some of the most successful competitive clusters in the world have been built up by tapping foreign expertise and by opening up the borders to foreign competition. Singapore is one such country. It has successfully leveraged overseas expertise to foster its industries’ competitive advantage. It has also removed barriers to foreign investment and trade. At this time, it is the number one country in the Enabling Trade Index (ETI), and it has been consistently ranked as one of the most business-friendly countries in the world.30
Ever since it gained independence from Malaysia in 1965, Singapore has adopted the stance that its development is highly dependent on resources beyond its borders, and that the government should therefore reduce barriers to foreign investment and trade.
From 1965 to 1970, for example – unlike other developing countries that adopted an import-substitution policy – Singapore quickly transitioned to an export-oriented strategy. This shift was encouraged by the loss of the Malaysian hinterland, with its significant base of consumers, and by Britain’s decision to pull its troops out of Singapore.31
Believing that Singapore lacked the skills and capital to develop strong domestic enterprises, the government looked to attract foreign investment, implementing a set of measures to improve the investment climate and reduce barriers:
- Border administration – The government took a firm stand against corruption, establishing an independent body, the Corrupt Practices Investigation Bureau, that reports directly to the Prime Minister. The government made examples of prominent officials, prosecuting and imprisoning some for corruption.32
- Business environment – Singapore reduced tax rates for certain industries from 40% to 4% for up to 15 years. The government passed legislation to control the nation’s trade unions, which had been prone to strikes. These laws also gave employers greater discretion in hiring and firing.
By 1969, major electronics multinationals such as National Semiconductor and Texas Instruments had located factories in Singapore, making components to ship back to parent companies in the US. Singapore’s manufacturing and net exports grew from 15% to 25% and 12% to 20% of GDP, respectively.33
In the 1970s and 1980s, increasing land and labour costs started to affect the competitiveness of Singapore’s labour-intensive exports. With its changing comparative advantage, it shifted to attracting foreign investments in higher value-adding industries, such as electronics and chemicals.34 The government also promoted investment possibilities to multinational oil companies looking to develop oil deposits in Indonesia. It accompanied these moves with a set of macroeconomic policies and regulations that further reduced the barriers to foreign investment and trade:
- Market access – The government opened nearly all economic sectors other than basic services such as power and telecommunications to foreign investment. It progressively reduced tariffs from 1983 on.35
- Business environment – The government increased the number of work permits for foreign workers. Unskilled foreign workers increased from 3% of the labour force in 1970 to 13% in 1973. The government removed foreign exchange controls and eliminated restrictions on capital repatriation and remittance of funds.36
During this time, oil companies such as Shell and Esso established refineries in Singapore, and the nation became the third-largest oil refining centre in the world.37
From the 1980s through the 2000s, as its cost advantage continued to decline, Singapore expanded its presence overseas, joining Malaysia and Indonesia to develop manufacturing sites in those countries. Malaysia and Indonesia would provide the land and labour, Singapore the infrastructure and administrative skills. These ventures allowed Singaporean firms to capture contracts beyond the country’s borders.38 Meanwhile, the focus at home was on improving linkages between Singapore and the rest of the world by investing in air and sea infrastructure.
- Market access – Singapore was the first country in Asia to enter into an Open Skies Agreement with the US in 1997.
- Infrastructure – Changi Airport opened in 1981, and just seven years later Business Traveller (UK) recognized it as the world’s best airport. Today, it is the seventh busiest airport globally by international passenger traffic.39 The Port of Singapore made similar advances through heavy investment in technological innovations.
Growth of the Singapore economy started to slow in the late 1990s, partly because of external shocks such as the 1997 Asian financial crisis. In response, the government formed an Economic Review Committee in 2001 to review economic restructuring and maintain Singapore’s competitiveness. In 2000, the government began to promote biomedical science and technology in hopes of turning Singapore into an Asian hub for the sector.40 The government also believed that Singapore should become a regional services hub to meet the needs of the growing markets of China and India. Among the actions the government took were the following:
- Market access – Foreign investors in biomed gained tax relief on profits for up to 15 years. A Fortune 100 biopharmaceutical company that expanded its manufacturing operations to Singapore estimates the incentives would reduce the company’s overall tax rates from approximately 40% to nearly 30%.41
- Business environment – Singapore built a state-of-the-art biomedical park. Housing and recreation facilities were designed to attract foreign scientists to Singapore. It also liberalized its financial sector and opened it to foreign bank participation, granting full licenses to six foreign banks between 1999 and 2001.42
Leading multinational pharmaceutical companies set up R&D centres in Singapore in 200243 and announced plans to expand their activities; the biomedical sector in general experienced rapid growth. The financial sector contributed about 13% to Singapore’s GDP in 2008 and registered a growth rate of 7.3% despite a general slowdown of financial services in other parts of the world.44
Key success factors and potential lessons for other governments
Singapore focused on barriers that were critical to key industries at different points in time. For instance, from 1965 through the 1970s, it wanted to attract the wave of foreign investment required to jump-start an export-oriented strategy in manufacturing. So it concentrated on providing tax and financial incentives while greatly reducing corruption. It also ensured a stable labour force to meet the needs of labour-intensive manufacturing. In the 2000s and beyond, to build Singapore into a knowledge-based manufacturing and services hub, the government has focused on creating the necessary business environment via a supporting ecosystem of professional, financial and legal services.
Market access and border administration barriers were eliminated early on. Singapore used a technocratic approach to common barriers and the government’s credible commitment to eliminating corruption helped it avoid the Achilles heel of many other South-East Asian countries. Making examples of prominent civil servants showed that no one was above the law. (The most recent prosecutions occurred in 2012.) The temptation for corruption of civil servants was further reduced by competitive compensation pegged to the private sector.
Singapore not only eliminated infrastructure and business environment barriers, it turned these areas into sources of competitive advantage. It didn’t just provide a functional port and airport, it built world-class systems. It didn’t just provide a clear regulatory framework and a crime-free environment, it built a supporting ecosystem of services to encourage foreign multinationals to set up a base in Singapore.
Today, most countries show varying performance across the different types of barriers. Governments must understand what industries they have and could develop and address the most relevant barriers. Singapore has done just that.
Some companies have a vested interest in preserving barriers
It would not be entirely surprising to find that certain stakeholders may resist efforts to lower supply chain barriers. What may be less obvious is that many of these companies are not local businesses enjoying protection from foreign competitors. In fact, the authors have identified four other categories of companies resistant to such efforts: (1) companies whose added value depends on the supply chain barrier; (2) those that have already incurred sunk costs in response to the supply chain barrier; (3) those that perceive the status quo as inevitable; and (4) those that fail to act because of a “coordination problem”. Each category is considered in detail below:
- Companies that depend on supply-chain barriers – A key component of some companies’ added value is mitigating supply chain barriers. In air cargo transportation, for example, freight forwarders act as intermediaries between shippers and carriers. Some of the freight forwarders differentiate themselves by handling the complex paperwork pervasive in the air cargo industry – a valuable service. Although proposed e-freight initiatives would substantially improve efficiency in the industry and produce substantial cost savings, some freight forwarders might lose their differentiation and a portion of their contribution to the value chain. It would therefore be unsurprising if some would resist electronic shipping documentation.
- Companies that have incurred sunk costs – As addressed previously in this report, overcoming supply chain barriers to trade can require substantial upfront investments. Some companies have decided to make these investments, and for them the expenditures represent a large and potentially unrecoverable fixed cost. Such upfront costs can act as a barrier to entry, providing incumbent firms with a competitive advantage.45 Once a company incurs the cost, it has an interest in seeing the supply chain barriers maintained; if the barriers are removed, the investment will have been a waste. This point of view was heard many times in the course of company interviews. One large CPG manufacturer, for example, built a factory in an African country to bypass supply chain barriers in selling to the local market. Having made the investment, this company enjoyed a strong local competitive advantage and explicitly opposed a reduction in supply chain barriers. Such cases illustrate the need for gradual and transparent reductions in barriers, as uncertainty about the future could impede investment decisions.
- Companies that simply accept the status quo – In the course of the research, the authors found that many companies are so accustomed to adverse conditions that they fail to fully appreciate potential improvements. In discussing India’s poor Enabling Trade Index score with companies in the region, for instance, it was found that businesses leaders did not perceive it as a particularly pressing problem. Similarly, firms that do substantial business in Brazil do not view security issues as important, whereas companies that are unaccustomed to the poor security environment there would surely view security as a first-order problem. This passivity towards barriers that are accepted as inevitable is reinforced when they affect all competitors more or less equally, so that much of the added cost is transferred to the customers. What was seen in the study was that companies seem to underweight the importance of barriers, such as infrastructure, that affect all companies doing business. They overweight barriers, such as market access, that bestow a competitive advantage on some companies relative to others.
- Companies that fail to act because of lack of coordination – Finally, the authors found that the interdependencies between different stakeholders’ decisions can also impede action. These problems are best viewed through the lens of game theory, which studies how actors interact when making strategic decisions.46 In the example of air cargo transportation, a coordination problem was seen, in that the returns to an investment in e-freight initiatives are realized only if all other actors in the shipping process also make the required investment. If even one part of the paperwork process remains manual, an electronic system in the other parts of the process makes little sense. This coordination problem is exacerbated when the party likely to benefit most from a reduction in supply chain barriers is not best positioned to influence its implementation. Shippers, for instance, would realize substantial gains from implementation of e-freight, but freight forwarders and carriers are in a better position to spearhead the initiative.
One general takeaway from these observations is that initiatives to reduce supply chain barriers must account for the individual actions required for success, and for each party’s incentives to contribute to those actions. This task is made particularly challenging by the fact that the relevant parties may be difficult to identify, and that some stakeholders – for instance, firms that do not as yet have a presence in the country – may be inaccessible. An implication for policy is that governments, business and civil society should establish mechanisms to identify potential gains from actions to improve supply chain efficiency and to analyse the distributional impacts of policies and policy reforms.
2. Main company lesson: Companies may not recognize costs where they should
Companies must look beyond factor costs such as labour and raw materials when assessing investment and operational decisions. The reason is that supply chain trade barriers create additional direct costs and add to risks. Understanding these barriers will give companies a more complete view of the real costs of a global operation; proper risk assessment will lead to better investment decisions. For example, delays in the supply chain require increased buffer inventory, which adds to direct costs such as warehousing. Delays may also generate risks such as depreciation, spoilage, theft, opportunity costs, or even production bottlenecks.
Most companies pay close attention to labour costs. On a closer look, however, supply chain barriers may offset a given country’s labour cost advantage. When Global Co. looks into locating production for the North American market, the obvious choice would seem to be Mexico. Its labour costs are about 20% of those in the United States, and its capital costs are about 10% lower. Examining the hidden costs resulting from supply chain barriers, however, Global Co. would realize that the decision is not as clear-cut as it might seem. Until 2011, Mexican truck drivers were not allowed into the US, and so the company needed to switch truckers at the border. An inadequate infrastructure compared to Canada or US would mean slower movement, raising transport costs significantly. And security issues in Mexico would mean that armed guards would have to ride along with the trucks. All these effects limit Mexico’s competitive advantage by reducing the cost advantage by over half.
In general, companies must take into account supply chain impacts from each of the main barriers when making investment and operational decisions:
- Market access issues and regulations constrain any company’s supply chain and may force inefficiencies. For example, chemical products imported to the European market must comply with Registration, Evaluation, Authorization and Restriction of Chemical Substances (REACH) regulations and be tested in European labs. Mexican Chemical Co. has to rerun all laboratory tests in certified European labs in order to register products in the European Union. Companies can sometimes work around these non-tariff barriers, but the resulting inefficiencies lead to decreased competitiveness.
- Transport infrastructure and services always affect a supply chain. For example, Brazil moved towards an electronic freight invoicing system that would theoretically speed the supply chain for Agriculture Co., an agribusiness company. But Brazil suffers from poor ICT infrastructure and the government’s systems were unable to handle the volume of electronic documents, crashing frequently. This ended up causing more delays than the old system.47
- Companies must factor border administration barriers into their cost analyses. Customs hours of operation and the degree of adherence to the World Customs Organization’s (WCO) best practices will affect physical inspections, caged shipments and dwell times. Express Delivery Co. has estimated that inspection rates on its shipments vary from about 2% in the Netherlands to roughly 10% in Mexico. Some countries still carry out physical inspections of all shipments. In a 2009 study by the Global Express Association, 18 out of 114 countries surveyed physically inspected 100% of shipments.
- Finally, the business environment is a factor companies must consider. The business environment includes many different socio-political aspects, but will mostly be reflected in security issues and risk. A poor business environment not only adds to direct operating cost, it may also limit what companies offer within a country. For example CPG Co., like other companies in its industry, limits its product lines in the African continent.
Figure 12: Singapore is consistently recognized as one of the most business-friendly countries globally
Source: World Economic Forum, Global Enabling Trade Report, 2008, 2010, 2012. World Bank, Ease of Doing Business Report, 2012. “Singapore Tops World Bank Survey”, Bloomberg, 2010.