Chapter One:

Structural Reform and the Role of the Economic Committee in APEC

APEC has worked since its inception in 1989 to increase the prosperity of member economies by cooperatively acting to strengthen the Asia-Pacific community. It has worked to secure the sustainable economic growth necessary to boost members’ prosperity by encouraging free and open trade within developing global marketplaces.

This was, and continues to be, an ambitious goal given that the region, which contains over half the world’s population, is as culturally diverse as it is broad in geographical scope.

In what has become known as the “Bogor Goals,” APEC Leaders agreed in Bogor Indonesia in 1994, to set the target of free and open trade and investment in the APEC region to be achieved by 2010 for industrialized economies and 2020 for developing economies. Good progress has been made toward achieving the Bogor Goals, but much still needs to be done if the people of the APEC economies are to continue to benefit from the region’s historically strong growth. Average tariff rates fell from 16.9 percent in 1989, to 5.5 percent in 2004, with over half the tariff lines within the APEC region now sitting below 5 percent.¹ To maintain the growth that this progress has stimulated, APEC’s ongoing challenge is to continue to advance new and innovative ways to encourage economic development.

As tariffs have declined, the spotlight has naturally shifted to the structural and regulatory obstacles that inhibit cross-border trade by creating behind-the-border barriers to doing better business. The region’s historic growth performance, which doubled between 1989 and 2003, defined the region as one of the world’s most dynamic, but APEC Leaders recognized in the late 1990s that “structural and regulatory weakness had contributed to… [the Asian] economic downturn²” of that time. Thus, APEC acknowledged that the “full potential for improved economic and social well-being” was reliant on how competitive the region was within international markets and that competitiveness is influenced not only by an openness to trade and competition, but also by the region’s regulatory and structural architecture.

The objective of this chapter is to provide leaders, ministers and policymakers with a brief summary of the work that APEC has undertaken on structural reform and its policy implications. In 2006, this chapter will act as a high-level introduction to the new APEC structural reform work program, setting the scene for the more specialised chapters that are intended to follow in subsequent years’ publications. A key goal of this year’s chapter is to draw together and synthesise the relevant work that has already been done on the topic of structural reform.

The chapter is divided into three main sections. The first section introduces structural reform and the regional changes that have been acting as drivers for the new structural reform focus. This section will also discuss the Leaders’ Agenda to Implement Structural Reform (LAISR) which has broken the broad topic of structural reform into five priority areas. The LAISR statement will form the basis of the Economic Committee’s (EC’s) ongoing work agenda and will be the subject of the more specialized chapters that will follow this chapter in subsequent years’ publications.

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APEC (2005) A Mid-Term Stock Take of Progress Toward the Bogor Goals: Busan Roadmap Toward the Bogor Goals. ² APEC (1999) Leaders’ Declaration: The Auckland Challenge.

The second section will examine how a whole-of-government approach can increase the effectiveness, support and potential success of a structural reform program. It will discuss how economies may address the short-term costs that reforms may generate by first, displaying commitment to implementing reforms across the whole of government and second, by transparently communicating the longer-term benefits to the population.

The final section will look at some specific examples of the work that the EC and other fora have already undertaken. To date most of this work has focused on regulatory reform. The OECD regulatory reform checklist and private sector development plan will also be discussed as examples of APEC’s work to date.

1. THE IMPORTANCE OF STRUCTURAL REFORM

2. What is Structural Reform?

Structural reform consists of improvements made to institutional frameworks, regulations and government policies such that the economic environment supports the efficient functioning of markets, and ultimately enhances living standards in a sustainable way. Thus, the immediate goal is to create markets that are stronger and more efficient. Ultimately, the goal is the sustainable improvement of the well-being of citizens. Structural reform is an evolutionary process that can provide ongoing benefits for all APEC economies. While sweeping reforms may at times be necessary, even economies with highly efficient markets can benefit from precisely targeted reforms.

1.1.1 Why is market efficiency important?

Efficient markets ensure that domestic resources are used to obtain the highest sustainable output levels and growth rates. Resources, which are always scarce, can act as a constraint on a domestic economy’s growth potential. By ensuring that resources such as land, labour and capital are efficiently utilised, an economy ensures that both output and the welfare of an economy’s citizens may be maximised³.

Efficient markets use prices to facilitate the optimal allocation of resources by providing firms and consumers with timely and reliable information. Prices rise as a good becomes scarcer relative to its demand. This encourages consumers to economise on the good in question, and producers to seek new sources of it. Thus, not only does a good’s market value act as an accurate signal of its scarcity value, it acts to encourage appropriate responses to changes in its value. The ability of prices to convey information has led them to be labelled price signals. Rapid and more complete responses to shocks and opportunities minimize the negative impacts of the former and maximize the benefits of the latter. More efficient markets transfer this information into prices at a higher speed and with greater reliability.

The efficient market that structural reforms aim to create can produce numerous benefits. With efficient markets, consumers benefit from the lower prices and the increased choice that competition creates. Firms also benefit from being able to make more informed decisions that increase their competitiveness, reduce their costs and eventually maximise their profits. Moreover, the structural reforms themselves often give firms greater scope to make these adjustments at lower cost. The economy as a whole benefits from a more efficient allocation of resources to industries in which it has a comparative advantage; increased competition

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Urata, S. (2005), The Impacts of Structural Reform on Trade, FDI, and Economic Growth, presentation at the “APEC-OECD Symposium on Structural Reform and Capacity Building” (held 9.9.2005).

that encourages innovation and productivity gains; and a higher level of macroeconomic stability and economic growth.

In an increasingly globalized world, structural reform has benefits that spill across borders. Structural reforms in one economy can enhance economic outcomes in other economies. This results from reductions in costs and prices, increasing competitive pressures and rationalizing supply chains. The existence of these spillover effects is a good reason for structural reform to enter the agenda of multilateral forums, and increasingly it is doing so. For example, the World Bank, the OECD and the European Union have all been active in studying and pursuing structural reform. It is appropriate that APEC is joining these institutions in encouraging structural reform.

1.1.2 Why is there a government role in the economy?

If efficient markets support the well being of citizens, then why are governments involved in markets in the first place? The answer is that there are occasions where free markets are not efficient due to market failures, which create price distortions. Classic examples of market failures are where business or workers exploit monopoly power, or where production processes create unpriced damage to third parties, but there are many others also. Market failures can cause markets to collapse altogether, or to fail to come into being in the first place. ⁴ Moreover, often market failures create situations whereby individuals, groups or businesses are able to benefit from rents at the expense of others.⁵ Rents can continue to be reaped only if competitive pressures are impaired, otherwise new entrants to the market, who are attracted by the existence of the rents, would dissipate those rents. The existence or possibility of rents encourages rent-seeking behaviours, which are counter-productive from an economy-wide viewpoint, particularly as it often involves undermining competitive

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pressures.

Governments have attempted to counter market failures through their powers to enact laws, to regulate, to tax and to grant subsidies. While often governments have been able to mitigate the impacts of market failures, sometimes these interventions have had economic impacts that go beyond the specific market failure they were designed to address. Furthermore, it sometimes happens that rent-seekers have been able to lobby or otherwise influence governments such that their interventions have actually reinforced rent-seekers’ positions. Even where government interventions are individually well managed, the aggregation of interventions across an economy may not be coherent, and may lead to economy-wide rigidities which slow adjustment processes. Thus, it is extremely important that governments review their interventions, in light of the market failures they were designed to address, and engage in appropriate structural reforms.

Thus, market failures are inherent, and there is often no other means besides government intervention (broadly speaking) that can address them. However, the ideal interventions are economically efficient at the individual, business and aggregate levels.

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The classic case of market collapse, due to informational asymmetries, is Nobel laureate, Ackerlof’s (1970) market for lemons example. ⁵ Economic rents are returns to labor or capital above and beyond what a well-functioning market would offer.

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Rent-seeking behaviour is distinguished from profit-seeking behavior in that the former seeks benefit from the manipulation of the economic environment rather than from increasing trade and production, which increases total wealth.

1.1.3 Why are structural reforms so difficult to implement?

Given that structural reform is all about changing the arrangements that support markets, and any change in those arrangements implies a redistribution of wealth arising from the relevant markets, it is almost inevitable that there will be some who would be financially hurt by structural reforms and therefore resist them. Thus, some sort of conflict, usually political, is almost intrinsic to structural reform. Moreover, given resistances to structural reform, many reforms end in either outright failure, or in diluted versions that have impacts that are reduced or negligible relative to what was originally planned. Also, the prospect of conflict can often deter even the attempt at structural reform.

Since structural reform is about ensuring that market forces function properly, it is not only about investment and building new and stronger businesses. It is also about letting, and indeed encouraging, inefficient businesses to exit. This means bankruptcies and people losing their jobs. This, in turn, makes human and other resources available for absorption into the expanding sectors of the economy. However, the transition period can be stressful.

Therefore, successful structural reform needs political support from the highest levels and a well-planned strategy. A significant element of any structural reform strategy often involves conflict management. This can include either galvanizing support for reform by educating people about its benefits and building broad coalitions to support it, or by undermining resistance by developing transition programs and assisting the adjustments of those who stand to lose immediately.

1.1.4 Structural reform aims to create effective institutions

Structural reform is commonly associated with the adaptation of, or the creation of, the organisations that form the underlying economic framework within which the economy must operate. Organisations are important as they channel the behaviour of individuals within the economy via internal protocols and the regulations that they enforce. For example, an agency tasked with monitoring commerce aims to prevent anticompetitive behaviour by ensuring that its employees are effectively enforcing competition regulation.

However, structural reform in practice reaches far beyond just organisations to the wider institutional structures that support these organisations. Institutions within the context of structural reform were more broadly defined by the Nobel Prize-winning economist Douglas North as the “rules of the game… [or the] humanly devised constraints that guide… behaviour.” North maintained that these rules create “the incentive structure of society.” Organizations are commonly referred to as institutions as they are able to channel behaviour. But regulation, government policy and laws are able to affect how individuals behave and so may be defined as institutions that affect how efficient an economy is. Thus, structural reform does not only consider organisations, such as agencies tasked with monitoring commerce, but also the laws, regulations, and government policies that affect these organisations as well as the public and private sectors broadly. Ultimately structural reform is very broad in scope.

1.1.5 Structural reform and economic development

Structural reform and economic development are closely linked. Economic development generally involves substantial and sustained increases in private sector investment in physical capital and increases in output. The benefits of development then radiate out to all sectors of society. The private sector, however, reacts to the economic environment. Well designed and implemented structural reform can bring forth an unleashing of the private sector which strongly supports economic development. Indeed, those economies that have implemented substantial structural reform in the past tend to be the most developed, and those that are undergoing the most rapid sustained growth have engaged in significant structural reform in recent years.

1.1.6 Structural reform complementarities

Given that the elements of structural reform are broad and diverse, what does economic theory have to say about the implementation of structural reform? According to Lipsey and Lancaster’s (1956) theory of the second best, where there are large numbers of distortions an individual reform may not be beneficial, and could even be counter-productive. However, according to Foster and Sonnenschein (1970), a more radical strategy of proportional reductions in all distortions is welfare improving. The insight behind this theoretical result is that there are complementarities in individual structural reforms. That is, implementing one reform increases the value of implementing other reforms. An alternative view cited by Braga de Macedo and Martins (2006) suggests that rather than focus on broad based reform, it is important to concentrate on the key barrier(s) to growth. Unfortunately however, in practice it might be difficult to conclusively determine precisely what the key barriers might be.

1.1.7 Only targeted adjustments may be necessary

While in some economies there may be scope for broad and sweeping reforms, in others structural reforms may only need to include small and more targeted adjustments. These adjustments can ensure that the economy continues to benefit from ongoing changes that may occur in the global economy. Case studies often focus on the dramatic benefits that resulted from the sweeping reforms undertaken by economies such as New Zealand or the United Kingdom throughout the 1980s. However, many of the dramatic reforms undertaken by these two economies were prompted by domestic economic crises that had arisen as a result of prolonged and inflexible responses to ongoing changes in the international economy. However, there has been a growing recognition that economies that have engaged in broad reforms in the past can opt for more a more flexible approach that adopts frequent and timely structural adjustments. This approach can ensure that crises are less likely to occur and make the economy more flexible and allow it to adjust more rapidly and completely to shocks that do develop.

1.1.8 The benefits of well targeted reforms should outweigh the costs

Blanchard and Giavazzi (2003) suggest that structural reform is fundamentally about reducing and redistributing rents. Thus, it is almost inevitable that some individuals and businesses may bear the costs of structural reform, at least in the short run. However, these should be offset by the net benefits that well targeted structural reforms produce. Often, this creates an initial period of uncertainty as resources are reallocated. In the long term, the reallocation of resources will be toward projects that will produce stronger economic growth. Therefore, in the longer term, per-capita incomes rise.

1.1.9 How do we know structural reform supports growth?

While there is not a great deal of empirical literature linking structural reform to macroeconomic variables, some studies have started to appear. For example, Bassanini, Scarpetta and Hemmings (2001) found some evidence that stringent regulations and administrative burden in product markets has a negative effect on economic growth. Similarly, Nicoletti and Scarpetta (2003) found that reforms to private sector governance and competition policy have a positive impact on total factor productivity, which is a key determinant of economic growth.

Recently, empirical literature has appeared which focuses on the interactions between income, institutions, geography and trade. Conventional wisdom holds that geography drives trade and that trade and institutions drive income. The problem is that standard techniques are subject to causality questions (that is, does institutional quality cause growth or does growth cause institutional quality?), which can lead to biased results. Thus, more indirect econometric techniques, such as instrumental variables and identification through heteroscedasticity are necessary. ⁷ Within this literature Rodrik, Subramanian and Trebbi (2002) and Rigobon and Rodrik (2004) find strong support that institutional quality is a significant determinant of growth, Levechenko (2004) finds that institutions drive trade flows, and Desroches and Francis (2006) find that institutions drive comparative advantage. While the weight of the literature cited above support the conclusion that institutions are important, Sachs (2003) is unconvinced.

1.2 Key Drivers of Structural Reform

Changes that have occurred throughout the region have created challenges and provided opportunities that provide the incentive to adopt an ongoing structural adjustment program. These changes have in many cases increased the importance of the structural reform agenda for member economies. Even economies that have undertaken extensive reforms may find ways in which they can respond to ongoing regional changes within the business environment. While these changes have been broad and diverse, three distinct trends are clearly discernable: trade and investment have continued to be liberalised; technology has advanced at an ever accelerating rate; and economies have increasingly been subjected to economic shocks that originate beyond their borders. The following sections will discuss how each of these trends creates an incentive for structural reform.

1.2.1 Trade and investment liberalisation

The benefits that trade and investment provide include strong incentives to address structural and regulatory weaknesses, and these incentives have grown as liberalization has progressed.⁸ Structural and regulatory arrangements have increased in relative importance as their impact on trade strengthens and tariff barriers fall. Trade is sensitive to the business environment, the cost of trade, and the time that it takes to trade, and each of these three items can act as a behind-the-border barrier. Moreover, in order to gain entry into the WTO often economies are required to engage in structural reforms that support the openness of their economies.

A decrease in the cost of trading within an economy can increase that economy’s relative competitiveness. This can create benefits that help to offset the short-term costs that may be associated with structural reform. As an economy’s compliance costs rise relative to neighbouring economies, its relative competitiveness falls. In this way, higher compliance costs decrease the relative profitability of its firms and raise costs, which could price an economy’s businesses out of certain foreign markets. Structural reforms that decrease

⁷ See Rigobon and Rodrik (2004) for an intuitive discussion of these techniques.

⁸ The Busan Roadmap to the Bogor Goals includes: support for the WTO; more effective and ambitious IAPs

and CAPs; a more intensive focus on trade facilitation including the behind the border business environment;

a more focused and action-oriented cooperation on ECOTECH and a strategic approach to capacity

building; a comprehensive work plan on RTAs/FTAs.

compliance costs offer economies the opportunity to further benefit from trade. It has been estimated that a five percent decrease in the costs of doing business could create growth in GDP across the APEC region worth over US$154 billion.⁹

The time that it takes to trade may also act as a barrier to obtaining the benefits of trade. New manufacturing and production techniques, such as the use of just-in-time inventories, have boosted the importance of delivery times within global supply chains. Firms that are unable to provide goods or services within required timeframes are unable to participate in these supply chains. Structures that expose both exporters and importers to fewer government departments may encourage trade as any decrease in delivery times may make domestic firms more competitive. According to one study, a doubling of the time that it takes to get goods to markets could decrease the price exporters receive by eight percent.¹⁰

The domestic business environment may also affect the attractiveness of an economy to foreign firms and investors. Ineffective structures that allow anti-competitive behaviour may act as a barrier for firms. For example, if competition regulation allows practices such as price fixing, firms may find it difficult to compete. Firms in the APEC region can now choose to compete in many different domestic markets, but may still need to prioritise which markets they enter. Thus, if one market has a more favourable business environment compared with its neighbours it will probably be seen as a more desirable and less risky economy to trade with, or invest in.⁸

Increasing international trade and investment opportunities have increased competitive pressures everywhere. Firms are realizing a growing scope to locate their productive and other facilities anywhere on the earth. Critics of globalization contend that this is facilitating a sort of regulatory “race to the bottom.” This concern is clearly overblown, as there are so many other factors involved in location decisions, beyond “easy” regulation, and at any rate, raw market failures do not necessarily make an economy more attractive to locate in. However, the growing locational flexibility of firms imparts an extra incentive to ensure that potential market failures are dealt with effectively, in ways that impose minimal burdens on businesses and society as a whole.

While rising trade and international investment flows have increased competitive pressures that have created an incentive to support structural reform, a lingering issue remains. Some governments continue to engage in policies that support various elements of their economies. These measures can include such things as agricultural subsidies and those on other elements of the production process or factors of production, support for non-competitive domestic market practices, or unduly resisting upward exchange rate pressures. These are contentious issues that the international community must try to resolve.

1.2.2 Technology

Technology, which has advanced at an ever-increasing pace, has also created a strong incentive to undertake structural adjustments because technology can drive economic growth. Technological innovation in transport, communication and information technologies has changed the way that economies have chosen to regulate, structure and develop many sectors of the economy. For example, improvements in telecommunications technology have facilitated an increase in the ability of the private sector to compete in this sector. This has allowed governments to privatise state owned firms and also further encourage private sector

₁₀ See Wilson et al. (2002).

Hummels, D (2001) Toward a Geography of Trade Costs, Purdue University, Dept. of Economics. ⁸ The APEC Private Sector Development plan discussed in section 3.5 discusses this.

competition. Privatisation often encouraged further structural reforms as the needs for regulatory policy and competition policy receded in this sector.

Any structural adjustments that open an economy to international trade and investment will also allow an economy to better capitalize on technological growth. Trade exposes an economy to competition that encourages firms to adopt the new practices and products that are available within the global market. This can drive strong productivity growth that allows economies to produce more with the same scarce resources.

Structural adjustments, which strengthen property rights, can also encourage both technological and economic growth. Firms invest in research and development in order to earn profits, and these profits are essential if firms are to recoup the cost of developing new products. The economies that have benefited from the highest levels of innovation are increasingly the economies that allow firms to profit from innovation through patents and effective intellectual property rights protection.⁹

Structural reforms may also be able to encourage technology growth by reducing compliance costs. Small firms that have a limited ability to absorb costs are often responsible for the development of new product lines. Poorly designed structures that impose high costs on small firms may prevent these innovative new product lines from developing into new industries. Thus, structural impediments may impact not only on the incentive to innovate, but also on the ability of an economy to capitalise on innovation.

1.2.3 Economic shocks

Structural reform can help an economy to maintain macroeconomic stability when exposed to large, often international, economic shocks. These shocks might involve large capital flows; changes in the price of important commodities such as oil; and political crises that affect the confidence of markets. Adjustments that create stronger economic structures may encourage macroeconomic stability for two reasons.

First, structural adjustments seek to boost market efficiency. Efficient markets rapidly transfer economic shocks into prices, encouraging all members of an economy to react and adjust promptly to the changing economic environment. When the investment community has confidence that an economy with efficient markets will adjust rapidly to a shock, then expectations of changes to longer-term impacts on financial market variables are alleviated, which mitigates the short-term impact on financial market prices, such as the exchange rate. This can help to prevent market participants from panicking and precipitating large and damaging capital flows when economies are exposed to shocks. The APEC Finance Ministers’ Process, which has done extensive work around financial and macroeconomic stability, notes that the “contagion [of economic shocks] can be reduced by the adoption of effective transparent arrangements with sound and credible economic and financial policies.”¹⁰ This may help to prevent a shock from turning into a crisis.

Second, market structures that restrict the ability of price signals to convey accurate information risk encouraging relatively less efficient, or sub-optimal, capital investment decisions. These decisions can lead to overpriced assets and excess capacity in particular sectors that may create macroeconomic instability if the economy readjusts in a disorderly fashion at a later point in time.

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₁₀The APEC Intellectual Property Rights Export Group (IPEG) has done work around this area.

The Voluntary Action Plan for Promoting Freer and More Stable Capital Flows, undertaken by the APEC

Finance Ministers’ Process, Pg. 24.

1.2.4 Case Study: Singapore during the Asian Crisis

When the currency and financial crisis erupted in Thailand in July 1997, and swept through East Asia, no economy was unaffected. Despite Singapore’s strong macroeconomic and financial fundamentals at that time, Singapore also felt the shock. The immediate impact was a fall in demand for Singapore’s exports, but equally worrying was the fact that the exchange rate of numerous trading partners fell with respect to the Singaporean dollar, which adversely impacted on competitiveness.

Serendipitously, Singapore had formed the Committee on Singapore’s Competitiveness in May of that year. In November of the following year the committee released a report outlining a number of short-term responses to the crisis. These included cost- and tax-cutting measures to improve wage competitiveness, improve business access to working capital, to support skill upgrading, and to support international marketing, both to support Singaporean enterprises to break into new international markets, and to attract foreign firms to locate in Singapore.¹¹

The important point is that Singapore’s advanced state of structural reform at that time sheltered it from the worst of the storm. Nevertheless, Singapore’s high degree of economic integration with the region meant that impacts were felt. However, the appropriate response could afford to be incremental, rather than dramatic and sweeping.

1.3 Principles and Practices

There are many different types of markets, from real estate to stock markets, from wholesale computer chip markets to farmers’ produce markets. However, despite the myriad differences, when markets work well, they conduct some basic functions that are common to all markets, and there are certain elements of the institutional environment that are necessary for well functioning markets, no matter what the market is, or where it is, or who is transacting on the market. For example, buyers and sellers must have enough of a sense of the product in order to engage in a transaction in confidence. Thus there would seem to be some universal principles involved in well functioning markets. It is therefore probably not too much of a stretch to imagine that there are some basic principles that underlie structural reform.

However, APEC is a vast and enormously diverse region, with economies that span the entire spectrum of economic development, where people of vastly different cultures and histories dwell. Thus, institutional arrangements that are effective and appropriate in one APEC economy could be grossly ineffective and inappropriate in another. Therefore diversity is to be expected.

It would seem that universal principles underlying structural reform could be well met by any one of a wide range of different practices. Thus in its work to support structural reform in the APEC region, the Economic Committee is seeking to uncover and understand the core principles in each of the key elements of structural reform, but also to encourage member economies to support these principles with the practices that make the most sense given their particular customs, culture, history and general situation.

¹¹ For more details of this report, see http://app.mti.gov.sg/data/pages/885/doc/NWS_CSC.pdf.

1.4 The LAISR Statement and APEC Priority Areas

Structural reform is a broad and far reaching topic with many different facets. In order to give impetus to, as well as focus and guide APEC’s work on structural reform, APEC Leaders have developed the Leaders’ Agenda to Implement Structural Reform (LAISR), which suggested five possible priority areas.¹² APEC aimed to discover good practice principles within each of these priority areas that may be applicable to the more specific reforms that individual economies may choose to voluntarily adopt. The five LAISR priority areas are:

• regulatory reform;

• competition policy;

• public sector management;

• strengthening economic and legal infrastructure, and

• corporate governance.

In practice even targeted structural adjustments will draw on principles specific to each of the five LAISR priority areas. Competition policy, corporate and public sector governance all use regulation as a fundamental tool. But, without a suitable economic and legal infrastructure that has the capacity for the enforcement and implementation of regulation, even well-designed policy will fail. Thus, in practice the LAISR areas all interact and act to complement one another. As mentioned above, in general the elements of structural reform, both within the five LAISR elements and outside of them too, are mutually reinforcing.

An important precursor to the LAISR statement was the APEC High Level Conference on Structural Reform that Japan hosted in Tokyo in September 2004. This conference, which attracted over 200 delegates, featured very high level speakers from many key APEC economies, including Japan, the United States and Australia. Key discussions included the Japanese special zones for structural reform, corporate restructuring and corporate governance, and the promotion of structural reform.

In 2005, APEC Leaders decided to create the LAISR 2010 “roadmap” which started to define plans for APEC’s ongoing work on LAISR. At present the Economic Committee is responsible for overseeing this agenda. To date much of the work has considered the broad structural reform agenda and regulatory reform as an important subset of structural reform.

1.4.1 Regulatory reform

Regulation is one of the primary tools that can be used to implement government policy. Regulation helps to define the “rules of the game.” These rules partially define the interface between society, the state and the wider economy. Regulation is most useful when the presence of market failure would allow an unfettered market to produce undesirable outcomes.

Many types of regulation exist and a number of APEC fora are working on these various aspects of regulation. One level of regulation can be targeted at ensuring appropriate health and safety standards within APEC, which is discussed within the Sub-Committee for Standards and Conformance (SCSC). The private sector development plan and work undertaken by the SME Working Group consider another level of regulation that is targeted at the smooth operation of smaller businesses.

APEC Economic Committee work on regulatory reform is outlined in section 4.4 below.

¹² The LAISR statement is attached at end of Chapter One (See page 25).

1.4.2 Competition policy

Competition is fundamental to the efficient operation of markets. A lack of competition, or practices which seek to limit competition, may need to be addressed by competition policy to create desirable outcomes. The Competition Policy and Deregulation Group (CPDG) have done extensive work on competition policy which has included:

• the APEC Training Course on Competition Policy;

• the Competition Policy and Law Database;¹³ and

• the OECD/APEC regulatory reform database.

This work has addressed how to build and strengthen the domestic institutions needed to support effective competition in markets, the interaction between regulatory restrictions and competition, and how to ensure competition in factor markets, including labour and natural resource markets.¹⁴

1.4.3 Public sector management

Good public sector management encourages the wider public sector to work efficiently toward the achievement of a government’s goals. The public sector is critical as it is often the largest employer in an economy and controls a large percentage of an economy’s assets. The APEC Economic Committee initiated discussions on public sector governance in 2006. Three areas considered were:

• setting performance targets;

• designing of organisations, and

• how to monitor progress.

A symposium was held in 2006 and a good practices paper, which sets out high level principles for public sector governance, will be produced in 2007.

1.4.4 Strengthening economic and legal infrastructure

Economic and legal infrastructure protects property rights and enforces the contracts and regulations that are fundamental to the operation of the market. The APEC Strengthening Economic and Legal Infrastructure (SELI)¹⁵ coordinating group is responsible for this area of the APEC work program and has undertaken work in areas such as:

• capacity and institution building;

• corporate law/policy;

• competition law/policy;

• insolvency law;

• accounting systems and standards, and

• international dispute resolution.

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http://www.apeccp.org.tw/¹⁴ CPDG has created and undertaken a series entitled the “APEC training program on competition policy”, ₁₅these have run since 2002 and are expected to continue until 2009.

SELI ran a conference in 2004 on “strengthening investor confidence”; in 2007 they will run a seminar that

will encourage APEC economies to share experiences on how they have strengthened economic and legal

infrastructure.

1.4.5 Corporate governance

Corporate governance seeks to certify that corporations, which generate the majority of economic activity within the APEC region, hold the resources of their investors in good stewardship. Good governance ensures that corporations act in the interests of shareholders by transparently ensuring that investments create the highest possible rate of return. This also creates benefits for the wider economy as it encourages stronger growth and macroeconomic stability.

There is no one group within APEC that will be entirely responsible for the corporate

governance work agenda. However, SELI, CPDG, FMP and the EC may all undertake

relevant work in this area. Topics that could be addressed in future include:

• the specification of shareholder rights;

• accounting and disclosure standards that encourage transparent business practice and the provision of appropriate information to the market;

• clearly defined duties for directors that ensure they behave in a transparent manner to protect shareholders’ investments;

• clearly defined procedures that define how boards may come to a decision and manage risk, and

• a regulatory, judicial and legal system capable of enforcing breaches of good corporate governance practices.

1. WHOLE-OF-GOVERNMENT APPROACHES TO STRUCTURAL REFORM

2. The Importance of a Whole-of-Government Approach

A whole-of-government approach to structural reform can benefit society. Structural reforms span the public sector, affecting numerous departments and agencies. The barriers to trade that exist in practice are often determined not by a single department, but by the interaction of several different departments. The benefits of removing these impediments and improving policy coherence can include a reduction in uncertainty, increases in public sector productivity, and a reduction in the cost to the government which can lead to stronger economic growth.

A whole-of-government approach requires an overriding strategy, or roadmap that defines the direction that structural adjustments will take in order to achieve an economy’s long-term goals. A well formed and credible strategy can signal to both the public and private sectors what changes may be necessary in future.¹⁶

Defining how each part of the public sector contributes to this overriding strategy can boost public sector productivity. Clear accountabilities create a defined area for which each department is responsible. Accountable departments can then work to streamline processes within their area and be recognised for their results. This encourages public sector productivity gains. Egypt, for example, created a single department to oversee trade documentation. This clear accountability allowed the department to streamline procedures, which reduced the documentation required to trade from 26 to five pieces.¹⁷

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Salas, F & Kikeri, S., (2005) Regulatory Reform-Institution building: Lessons from Mexico, Public Policy

Journal, pg. 282. ¹⁷ World Bank (2006) Doing Business: Creating Jobs.

Mapping out clear accountabilities across the public sector also allows economies to identify policy overlaps and conflicting work agendas. Policy overlaps create waste as work is replicated across numerous public sector departments, while conflicting work agendas reduce the effectiveness of public policy as departments expend scarce financial resources working against other departments. By removing these overlaps, departments can specialise, thereby allowing them to work together to implement an economy’s strategy. This can reduce government budgets and private sector uncertainty. The World Bank noted that one of the most popular reforms in 2004 was to introduce a single point of contact for entrepreneurs. This has cut the time to start a business in some economies from 51 days to 15 days. ABAC has noted that the ease of starting a business was one of the primary inhibiting factors on doing business in the APEC region.

2.1.1 Case Study: Canada’s Privy Council Office

In Canada, regulation is coordinated through the Privy Council Office (PCO). The PCO stands at the heart of the Canadian government, and acts as the ministry for the prime minister and as the cabinet secretariat. In that context the PCO is the focal point of action of the Canadian public service and requires close and continuous interaction with other federal departments and agencies. The head of the PCO, the clerk, acts as the deputy minister to the prime minister, as the secretary to the cabinet and as the head of the federal public service.

The PCO is therefore responsible for ensuring that the analysis provided by the line departments on policy and regulatory proposals is consistent with the Directive on Regulating, and that there is coherence among new proposals, existing regulation and the government’s policy agenda. Moreover, the PCO provides a challenge function, to ensure high quality analysis, with regard to new and existing regulation. In addition to the PCO, two other central agencies are involved in regulatory issues. The Department of Justice provides legal advice to federal departments and agencies on the legality of proposals for enabling and subordinate legislation and the legal requirements of the regulatory process. In addition, the Treasury Board, as the government’s management board, advises departments and agencies on resource management related to regulatory proposals.

The centralization aims to create regulatory and policy coherence across a broad range of regulation overseen by federal departments and agencies, and to support cooperation with provincial and territorial governments in the development and implementation of regulation.¹⁸

2.1.2 Case Study: Japan’s Council on Economic and Fiscal Policy

The Council on Economic and Fiscal Policy (CEFP) is a consultative organ placed within the cabinet office, whose purpose is to facilitate full exercise of the prime minister’s leadership while sufficiently reflecting the opinions of private-sector experts in economic and fiscal policy formation. The CEFP is chaired by the prime minister, and its members include the Chief Cabinet Secretary, the Minister of State for Economic and Fiscal Policy, other relevant ministers, and private-sector experts. The CEFP deliberates on and drafts the basic policy of economic management including structural reform, fiscal management, budget formulation and other important issues in economic and fiscal policy, which then become the government’s formal policies after the adoption by the cabinet.

¹⁸ For more details on the Canadian system, see www.regulation.gc.ca.

There are three chief advantages of the CEFP:

(i)

It enhances the consistency and comprehensiveness of economic policy making. The CEFP has promoted the establishment of a new budgeting cycle, in which the linkage between economic policy and fiscal policy is strengthened, and the direction of major issues of structural reform is decided. Also, there has been an innovation in government policies because the private-sector experts of the CEFP have proposed various policies, making full use of their management know-how.

(ii)

It enables policy achievement evaluation and feedback to new policy making. Following managerial methods used in private companies called PDCA (Plan-Do-Check-Action) cycles, clear and concrete numerical targets and timetables have been set up in formulating these policies. This makes it possible to evaluate the achievement of individual policies and to feed back the results to new policy making.

(iii) It increases the transparency of the decision-making process. Transparency of the decision-making process has been improved significantly because the results of the discussion are open to the public immediately. (Almost all of the materials used in the meetings are disclosed on the day of the meetings. The minutes are released three days after the meetings.)

In this way the CEFP has drastically changed the decision-making processes related to Japan’s structural reform and acted as a driving force to promote the structural reforms of the Koizumi Cabinet.

2.2 Overcoming Short-Term Adjustment Costs

Structural reform can create short-term adjustment costs, but in the longer term these costs should be more than offset by the benefits that well targeted reforms can create. An initial challenge for economies undertaking reforms is to generate enough support and commitment to ensure that the wider benefits of reforms are allowed to become apparent.

Some economies maintain social safety nets, which ensure that individuals who lose their jobs, for example, do not fall into extreme poverty. Moreover, time-limited employment insurance schemes and job retraining programs can assist individuals with their transitions. In some cases, whole physical regions within economies could lose significant employers. In such cases, regional governments or regional economic development institutions could be financially supported in determining alternative viable strategies. While all of these programs might require financial support from central governments, it is important that these programs be temporary in nature and not create dependency, and the incentives should always be to support the transition.

The design of reforms may be able to mitigate some of the short-term cost of reforms. There may be many potential reforms, or ways to sequence the implementation of the elements that can create the same desired end result. By giving consideration to the costs that each option may generate, an economy may be able to reduce the short-term costs associated with a proposed set of reforms, which in turn can help to alleviate any resistance to the reforms that may exist. Some economies have created policies to accompany reforms that help to reduce any residual costs. Explicitly addressing these costs can help to guarantee the success of reforms.

2.2.1 Whole-of-government commitment

Whole-of-government commitment is essential if any short-term adjustment costs are to be minimised and overcome. This commitment can ensure that the longer-term benefits of stronger economic structures are allowed to become apparent. Uncertainty accompanies reforms in the short term as many sectors of an economy adapt to changing prices and increased competition. In the long term, however, the benefits of reform become clearer and public support for the reforms grows. According to one study, well-targeted structural reforms can increase growth within two to three years.¹⁹

2.2.2 Transparency

Transparency can assist in generating the public support that economies require to successfully undertake reforms²⁰ at a much earlier stage in the process. On balance, well-targeted reforms should produce net economy-wide benefits that far outweigh the initial adjustment costs of implementation. Transparency can also highlight what measures that have been taken to reduce the cost of reforms. Transparency can mobilize the support of the population who stand to gain from the proposed reforms. In New Zealand, the government undertook significant reforms which transformed the economy from one of the most protected in the OECD into one of the most open in a matter of a few years. Prior to the commencement of the reform process in 1984, an initial step undertaken by the then-incoming administration was to publicise why regulatory changes were a necessity, what the goals of the reforms were, and what the reform strategy was. Although strong debate existed, both inside and outside of the government, to date most of the reforms have not been repealed.

2.2.3 Case Study 1: Japanese Financial Sector Reform

By the mid 1990s, many Japanese financial institutions were faced with high levels of non-performing loans and instability of the financial system became the largest concern of the time.²¹ As a first step, the newly created Financial Supervisory Agency (FSA, now called the Financial Services Agency) let the banking sector improve their disclosure of balance sheet information, with widening coverage of non-performing loans. Then, it was found that the non-performing loans problem was more severe than expected and it was recognized that rapid disposal of bad loans by banks was fundamentally important in order to restore confidence in the financial system. However, significant capital injections accompanied with the failures of some banks allowed financial institutions to take a step-by-step approach rather than drastic reform of their management. Partly because of deflation, non-performing loan problems had not improved for a couple of years.

Finally, the FSA urged banks to take a number of measures to effect a prompt and complete resolution of the problem. These included placing sufficient reserves, securing adequate levels of capital and improving the corporate governance of the banks. The Industrial Revitalisation Corporation of Japan was set up, parallel with the enhancement of the Resolution and Collection Corporation to facilitate efforts to revitalize borrower companies through the purchase of these loans. Consequently, the Japanese financial sector reestablished its resilience. The non-performing loan ratios of the major banks were lowered from 8.4 percent (March 2002) to 1.8 percent (March 2006) which allowed the banks to

¹⁹ Rodik, D., (1996), Understanding Economic Policy Reform, Journal of Economic Literature, 34: pp 9-41.

Salas, F & Kikeri, S., (2005). Regulatory Reform-Institution building: Lessons from Mexico, Public Policy

Journal, pg. 282. ²¹ The Long-Term Credit Bank of Japan and the Nippon Credit Bank both failed in late 1998.

expand their business. Also, full deposit guarantees for possible bank failures were removed in March 2005.

2.2.4 Case Study 2: Japanese Special Structural Reform Zones

Structural reform is hard work. Not only is it analytically difficult, it is also politically difficult. Given the difficulties involved, special mention should be made regarding innovative new approaches. The Special Zones for Structural Reform that went into effect in Japan in April 2003, is just such an approach.

According to this initiative, a special zone for structural reform is to be created where a local government and the private sector have a proposal to except the region from one or more specific regulations. In this way, the region becomes a pilot project for a particular initiative, and the overall economy becomes a giant structural reform laboratory with multiple experiments. Moreover, the specific proposals arise from the local level and not from a centralized authority, which allows those who are closest to the issue to develop the ideas, and also support the building of a diversity of experiments. Where a proposal is shown to have good results, the experiment is studied for broader implementation. Shortly after this initiative was launched, hundreds of proposals came forward.

2.2.5 Case Study 3: Mexico’s “Government with Quality” Strategy

In coordination with the productive sector and civil society organizations, the Mexican Ministry of Public Administration has taken major steps to guarantee that government services and procedures are performed with quality and with the least red tape for citizens and businesses. This is based on an inventory of services and procedures with high citizen impact, which represents 80 percent of all procedures that government requires from citizens, collected between January 2004 and August 2006. The Mexican government has improved and simplified the procedures, resulting in time and cost savings in 436 of these procedures which were the most important.

The Mexican government has also published 216 citizen charters on behalf of 64 government agencies, which are public documents, written in plain language, that give citizens all necessary information on how to carry out a procedure or request a service, clearly stating the quality standards that the government institution is committed to.

2.2.6 Case Study 4: Malaysia’s Vision 2020

Malaysia has a very clear goal to be a fully developed nation by the year 2020. This means that Malaysia will comprise a united and mature democratic society, with an economy that is competitive, dynamic, robust and resilient. The recently launched National Mission, which charts the course of the remaining 15 years until 2020, focuses on moving the economy up the value chain in high-tech and knowledge-intensive activities, raising the capacity for knowledge and innovation, while addressing socio-economic inequalities constructively and productively. This effort will seek to improve the quality of life, as well as strengthen the institutional and implementation capacity of both the public and private sectors.

2.3 Building Capacity for Each Step of Structural Reform

Structural adjustments, no matter how small, require departments to have or to develop the capacity to undertake the work necessary to implement the desired changes. While departmental capacity requires resources such as finances, suitably qualified staff and infrastructure, this section focuses primarily on human resources. Allocation of sufficient financial resources is a necessary condition to building and maintaining human resource capacity. This capacity allows results to be achieved at minimal cost, within the desired timeframes.

Structural reform is an ongoing process whereby reforms are designed, implemented and monitored. ²² The four stages are: problem definition; solutions development; implementing solutions, and monitoring or reappraisal. By monitoring reforms economies are able to highlight how effective reforms have been, and how they may be refined by smaller and perhaps more targeted adjustments. Capacity is needed at each step of this reform process.

2.3.1 Capacity is needed to define the problem

If economies are to achieve their structural adjustment goals they need to first accurately define what the problem is with existing structures. By correctly identifying the problem, solutions can be more precisely targeted. This can reduce the cost of the reforms, as resources may be focused on addressing the key issues involved. However, if the wrong problem is identified then resources are wasted on reforms that may be unnecessary, ineffective, or even damaging. By allocating sufficient resources to problem definition, the net cost of reforms may be decreased.

2.3.2 Capacity is needed to form effective solutions

Effective solutions create a map for how structural adjustments will solve the problem that has been identified. The most effective solution will be the one that manages to address the problem at the lowest possible cost to the government and the wider public. Although solutions should be focused on the long-term, they can gain more support if they also attempt to ease the adjustment costs in the short-term. The design of effective solutions requires capacity, especially with the provision of experienced staff.

Expertise and experience aid the creation of targeted solutions, but for economies that have relatively little experience with structural adjustments this experience may not exist. APEC has provided a forum where economies may share their lessons and experiences with the wider APEC community. By sharing experiences in APEC’s fora member economies have been able to compile a list of good practice principles which may be voluntarily adopted into economies’ reform agendas.²³

2.3.3 Capacity is needed to implement solutions

Any structural adjustment, no matter how small, will require departments that have the capacity to implement the reforms. Even well-designed solutions will be ineffective unless resources are allocated to implementing them. The development of economic and legal infrastructure can prove essential to successfully implementing these reforms.

²² Carpinter, P., (2005), Public Sector Management- Building Capacity for Reform. Presented to the EC

₂₃9.11.2005 (2005/SOM3/EC/APEC-OECD/007).

Examples of some of APEC’s work on good practice principles are the “Osaka Action Agenda” or the “APEC

Principles to Enhance Competition and Regulatory Reform.”

2.2.4 Capacity is needed to monitor results

Ongoing monitoring can ensure that resources are not needlessly wasted on ineffective reforms. If the initial problem was ill-defined, or the solution poorly targeted, then the result, once implemented, could be ineffective or damaging. In the worst case scenario the solution may have been worse than the initial problem. Ongoing monitoring allows economies to appraise how effective their solutions are at achieving their economy’s goals. If the solution is ineffective, economies may choose to curb wasted ongoing expenditure, by either refining the definition of the problem or designing a new solution.

In this way the four-step process creates a dynamic loop that allows economies to undertake a series of ever more targeted adjustments. This iterative process acts to continually refine the economy’s structure.

3. REGULATORY REFORM

To date most of the work that APEC has done on structural reform has focused on regulatory reform. Regulatory reform was a natural starting point for APEC’s work as it is arguably the core of structural reform and contributes to all of the four other LAISR priority areas. Moreover, poor regulatory policy can be one of the major inhibiting factors on doing business and trade. Regulation is also one of the fundamental tools of government as it allows governments to influence the behaviour of firms and consumers by changing the incentives that individuals face. Regulation can be used to protect a group or a resource; to encourage or discourage certain actions; or to prevent specific actions altogether. By changing the action of individuals, governments can change the behaviour of the economy. This section will look at regulatory reform as an important subset of structural reform.

3.1 The Link between Regulatory and Structural Reform

Regulatory policy has much in common with structural reform. Broadly speaking, the goal in both cases is to ensure that the operation of the market creates the best possible outcome for society.²⁴ While structural and regulatory reform concur that competition and prices create the fundamental mechanism by which resources may be best allocated they, however, approach the market in slightly different ways.

A primary assumption associated with structural reform is that a free and efficient market will create the best possible outcome. However, regulatory reform aims to identify as specifically as possible the instances when a free market does not yield an efficient nor desirable outcome. These specific instances are called market failures. Structural reform aims to liberalise the economy to ensure that prices can reflect changes in relative scarcity as quickly as possible, regulatory reform aims to rectify the market failure and to ensure that these prices create economically desirable outcomes. Regulatory reform in this way acts as a complement to structural reform.

Structural policy may also act as a substitute for regulatory policy. For example, in the event of a monopoly regulatory policy may seek to limit the rate of return that the monopolist is allowed to earn, which then affects the price and quantity produced. However, structural policy might seek to

²⁴ To be precise, regulatory reform aims to correct a market failure effectively and efficiently, whereas

structural reform would seek to ensure that regulatory policy is coherent with all other government

interventions and that together they are effective, efficient and generate the best possible outcome for

society.

break up the monopoly and ensure that the resultant elements compete with each other. An example of the dissolution of a large company for these reasons was the break-up of the Standard Oil Trust in the United States in 1911.

There are several general types of market failures, which include externalities, and lack of competition, which regulation is often brought in to control. Externalities occur when production or consumption produces an unpriced by-product, which affects uninvolved people. Thus there is an economic impact which is external to the market. The classic example is pollution. Monopoly power typically occurs when there is a so-called natural monopoly. Natural monopolies exist where there are very high fixed costs and low marginal costs. An example is a pipeline, where it makes sense to install one large capacity pipeline, and not multiple small pipelines for the sake of competition. In the externality example, regulatory authorities could directly regulate the quantity of the externality that may be produced. However, other ways to address the issue could include taxation, compensation of the injured parties, or extension of property rights to the external agent, and the development of a market in that agent. So in the pollution example, this would involve the creation of a market in pollution rights. Where natural monopolies exist, regulation of the rate of return is typical.

The privatization of government-owned enterprises can highlight the link between regulatory and structural reform. Privatised firms in competitive markets can produce lower prices, better services and a higher level of innovation within the industry. However, many government-owned enterprises are natural monopolies that are protected from strong competition by large start-up costs. ²⁵ Industries that require a large amount of infrastructure and provide essential services such as the electricity or telecommunications industries are classic examples of such natural monopolies. Privatised firms may be able to use their market position to exclude competition by the use of anti-competitive practices. As the government can no longer directly control these firms they may instead use regulation that protects or introduces market forces. This regulation can act as a complement to privatisation by ensuring that privatised firms do not use their market dominance to stifle innovation and competition, to the detriment of the overall economy.

3.2 Regulatory Reform and Management

Regulatory reform aims to boost the effectiveness of an economy’s existing regulatory framework. Effective regulation targets specific market failures at the minimum possible cost. Thus, any reform agenda has two aspects. First, it should be results-focused. Second, it should try and ensure that the regulatory arrangements produce these results at the lowest possible cost to both the government and the private sector. The benefits that can result from this process can create a strong incentive for reform.

Regulatory reform is focused on how well regulation targets market failures. Reform could create new regulation, or it could retarget old regulation. However, in situations where no market failure would exist within an unfettered market, it would involve removing unproductive regulation.

3.2.1 The costs of ineffective regulation

Effective reforms will ensure that a government’s regulatory costs are more than offset by net benefits for the economy. Effective reforms will also attempt to ensure that the revised regulations achieve their goals while minimising the burden that they exert on the private sector.

25

APEC (2005a), A Mid-Term Stock Take of Progress Toward the Bogor Goals: Busan Roadmap Toward the Bogor Goals.

Governmental regulatory costs include the cost of monitoring behaviour, prosecuting offenders and imposing sanctions. Effective regulation would minimise these costs. For example regulation that addresses corporate governance may change the behaviour of firms by ensuring that they provide sufficient information to investors and the market. This allows the market to monitor firm’s behaviour rather than the government. The cost of monitoring reporting standards in easily obtainable reports costs less than directly monitoring behaviour that may not be directly observable.

Regulation also creates compliance costs for firms, and as the number of regulations increases the compliance cost for the private sector also increases. The costs in terms of time can be extreme. Many top executives spend up to 25 percent of their time attempting to comply with regulation.²⁶ This draws resources away from productive activities and reduces business profitability. The reduction in private sector profitability may discourage investment, reduce competition and discourage innovation which can slow the economy’s potential and actual growth rate.

Excessive or ineffective regulation may also prevent firms from entering an economy’s formal sector. This creates an indirect cost specific to many developing economies because they lack the resources to closely monitor the firms and individuals operating within the economy. Firms that remain within the informal sector in order to avoid regulation and tax remain small and uncompetitive within global markets. The reluctance to move into the formal sector restricts both tax revenues and the tax base, impeding infrastructure development and restricting potential growth. The World Bank notes that less developed economies often have higher compliance costs, in terms of time and money, associated with their regulation.²⁷

Regulatory reform is primarily focused on how effectively regulation targets market failures, and this often includes substantial deregulation. When no market failure exists there is no benefit to justify the cost of regulating. Further, regulation in the absence of market failure can create problems that may invite further regulation if the cause is misdiagnosed. This can create a growth in regulation that is focused on fixing regulatory failure rather than market failure at a cost to the government and the economy.

3.2.2 Regulatory management

Increasingly, regulation has come to be seen as having a shelf life. Regulation may need to be updated, replaced, or removed in response to ongoing changes in government objectives, the actions of firms, or the evolving external environment. Regulation, like structural reform, has come to be seen less as a one-time event rather than as an ongoing dynamic process which is responsive to the outcomes that it achieves. The OECD has labelled this process regulatory management.

The process of regulatory management and the process of structural reform have much in common. First, they both require the problem to be accurately defined if the solutions that are implemented are going to be effective. Accurately defining the problem and assessing whether it is a long-term issue is essential if regulatory inflation is to be avoided. Regulatory inflation occurs when problems are blamed on market failure when they are actually the result of regulatory failure.

Australian Government (2006), Rethinking Regulation: Report of the Taskforce on Reducing Regulatory

Burdens on Business. ²⁷ World Bank (2006) Doing Business in 2006, World Bank, Washington

However, the key similarity is that regulatory management, like structural reform, recognises that the world is constantly changing and so adopts a feedback loop that facilitates a process of constant refinement. This feedback loop is created when economies monitor how well their new regulatory arrangements are performing and then seek to repeat the process of implementing solutions for any problems that are identified. This has two benefits. First, it allows regulation to evolve alongside global changes and secondly, it builds in an ex post appraisal of how successful past changes have been.

3.2.3 Case Study: New Zealand’s Ministry of Economic Development

While New Zealand implemented an extensive and wide-ranging set of structural reforms during the 1980s, the government recognizes that structural reform is not an event but a process. Thus, the elements of structural reform must be continuously monitored and adjusted as the situation warrants. In New Zealand the ministry that oversees this function is the Ministry of Economic Development. This ministry is responsible for regulatory policy, competition policy, insolvency and financial reporting and so on. It reviews regulatory frameworks, compliance costs, the legal frameworks and penalties and fees. Importantly, this ministry engages in regular reviews and consultations, which allows the elements of structural reform to be the subject of continuous debate. In this way, New Zealand is able to be continuously looking forward, and to rapidly react to changes in the economic environment that have implications for structural reform.

3.3 Examples of APEC Work on Regulatory Reform

3.3.1 The APEC/OECD Integrated Checklist

The Competition Policy and Deregulation Group (CPDG) and the OECD have worked together to create a regulatory reform checklist which may be of use to economies as they seek to create a regulatory management system to complement their structural reform agenda. This may help economies achieve the goals which they set for themselves. The checklist explicitly recognises that every economy faces a different set of circumstances and so no one-size-fits-all reform agenda exists. Instead, the checklist is structured as a qualitative self-assessment tool that economies may use to voluntarily investigate their own regulatory management systems.

The checklist is a policy-focused tool which encourages a qualitative assessment of an economy’s regulatory management system. It provides qualitative questions which consider practical measures that may be able to contribute to the success of an economy’s reform agenda.

The first section of the checklist supports a whole-of-government approach. The remaining sections consider three broad aspects that economies may choose to consider when redesigning their regulatory management system. The three sections are: regulatory policy; competition policy, and market openness.

Regulatory policy

To be effective, regulatory policy needs to be well designed and founded in law. It should adopt an ongoing process of appraisal and reappraisal with suitable attention being given to non-regulatory alternatives. To ensure that this occurs, regulation should be situated within a wider management system that reviews the performance of existing and new regulations.

This management system, the regulations, and the organisations created to enforce and manage regulations should all be transparent.

The competitive nature of policy

Competition can produce desirable outcomes at little cost to the government, the private sector, or the economy as a whole. However, while unfettered markets are often able to provide desirable outcomes, situations do arise where it needs to be supplemented by regulation. Market failure or unfair competitive practices justify the cost of regulating as these results can create socially undesirable results. This section of the OECD regulatory reform checklist encourages consideration as to whether regulation distorts competition, is discriminatory against private sector firms, or is inefficient.

Market openness

If economies are to reap more of the benefits of globalization they need to be open to international trade and competition. The regulatory reform checklist considers regulation’s role as a potential behind-the-border barrier to trade. Economies can benefit from giving consideration to how trade-friendly their regulations are and whether they may place an undue burden on cross-border economic activity.

3.3.2 Private sector development plan

In May 2006, APEC and ABAC held a private sector development workshop that considered the ease of doing business by drawing upon the World Bank’s 2006 Doing Business: Creating Jobs report. The report was used to highlight potential ways in which the APEC regulatory environment could be improved. The World Bank Doing Business reports examine the link between the quality of business regulation and private sector business growth. The studies may be used to analyze economic outcomes and identify what reforms have worked, where and why. It provides a series of quantitative indicators grouped into 10 different categories. These categories are:

1. starting a business;

2. dealing with [building] licenses;

3. hiring and firing workers;

4. registering property;

5. getting credit;

6. protecting investors;

7. paying taxes;

8. trading across borders;

9. enforcing contracts; and

10. closing a business.

The ABAC representatives recognised that the regulatory burden was a strong inhibiting factor on their businesses. The content, transparency and administration of regulation within the APEC region could be improved to make it easier to both start businesses and reduce the compliance costs of running those businesses. ABAC specifically identified the regulatory burden associated with both tax and labour laws, as well as access to financing as prominent inhibiting factors on doing business in the APEC region. The World Bank, in analysing APEC's performance compared to the rest of the world, noted three regulatory areas where APEC could benefit from improvement: the ease of starting a business, dealing with licenses and accessing credit. APEC is currently developing a plan for further work on how the APEC business environment may be enhanced in order to encourage private sector development.

4. CONCLUSIONS

Structural reform is important for APEC. A well-implemented structural reform agenda can stimulate business profitability, encourage economic growth and boost productivity. Further, structural reform has the potential to build on the growth in prosperity that trade liberalisation has already brought to the hundreds of millions of people who live within both the developed and developing economies throughout the APEC region. By building strong and efficient markets that are capable of stable and sustainable growth, member economies may utilise resources for maximum gain.

The structural reform work agenda has already started with many of the APEC fora contributing valuable work. This work agenda is going to continue at least until 2010. The Economic Committee’s new mandate is to coordinate and cooperate with APEC’s specialist fora to produce good practice principles for economies interested in capturing the benefits of structural reform.

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ATTACHMENT

LEADERS’ AGENDA TO IMPLEMENT STRUCTURAL REFORM (LAISR)

SANTIAGO, CHILE

NOVEMBER 2004

The APEC Leaders reaffirm their sustained political commitment made in Bangkok 2003 to promote structural reform and their determination to demonstrate leadership to strengthen implementation of structural reform in the APEC region. They recognize the value of well-executed structural reform, underpinned by institutional capacity building, for achieving sustainable economic growth and supporting APEC’s goal of trade and investment liberalization.

The APEC Leaders fully recognize that structural reform improves the functioning of market in order to sustainably enhance living standards and realize the economic potential of the APEC region by raising our economic efficiency and increasing our competitiveness. They stress the importance of structural reform, which provides a crosscutting perspective and potential for greater synergy across APEC’s traditional approach to APEC’s wide-ranging economic development agenda.

With a view to advancing structural reform initiatives in APEC, the APEC Leaders commit to addressing the following agenda by priority.

• Focus APEC’s structural reform-related work on the following as possible priority areas based on its ability to add value and to build on its existing work: regulatory reform, strengthening economic legal infrastructure, competition policy, corporate governance and public sector management.

• Identify an institutional mechanism to address structural reform as a major APEC priority, in consultation with the relevant APEC fora and the Finance Ministers’ Process, in order to promote APEC’s structural reform-related activities in a more enhanced and effective manner.

• Stimulate policy-oriented discussions on structural reform with a view to providing further clear guidance on APEC work.

• Foster understanding of the benefits of structural reform among APEC economies through better reporting process and sharing of good practices.

• Promote further capacity building, including for regulators.

• Strengthening cooperation and collaboration, where appropriate, with relevant international fora, notably the OECD, to deepen and expand structural reform-related activities and measures.

For continued structural reform in each APEC economy, the APEC Leaders acknowledge the relevance to:

• Accelerate domestic efforts and enhance communication with business on priority areas to be identified by each member economy.

• Develop pioneering policies/measures with a view to encouraging the initiation of reforms and promoting domestic regulatory reform.

• Enhance transparency to realize the predictable business environment through reversing those actions that perpetuate corruption.

Chapter Two:

Structural Reform and Sustainable Development in the APEC Region – Emerging Issues

PREFACE

During its 15 years of existence, APEC has consistently worked toward its original goals and the specific objectives defined in the founding Bogor Statement. The substance of those activities reflects the central pillar and prime focus of the organization: trade liberalization and trade and investment facilitation, moving toward the achievement of trade and investment liberalization in the Asia Pacific by 2010 for industrialized economies, and by 2020 for developing economies. The APEC Work Plan on the Leaders’ Agenda to Implement Structural Reform toward 2010 (LAISR 2010) adopted by the Ministers in 2005 demonstrates a collective determination to implement structural reform in member economies along the line of Bogor Statement’s Goals. The theme, subthemes and priorities of APEC Year 2006 reflect the resolution of member economies to build APEC into a community that not only achieves high economic growth, but also ensures the required conditions for socially and environmentally sustainable development for individual economies and for the region as a whole. As such, to fully attain the goal of building a Community for Sustainable Development and Prosperity, structural reforms will need to be closely linked to the conditions that ensure sustainable development for each member economy and for the entire region.

Chapter One of the APEC Economic Policy Report 2006 introduces a policy-oriented structural reform program and clarifies the whole-of-government approach to structural reform, emphasizing the linkages between institutional reform and structural reform, and how to open the economy in an efficient manner. While Chapter One discusses relatively specific issues relating to structural reform and recommends the related policies, Chapter Two, under the title “Structural Reform and Sustainable Development: Emerging Issues,” provides deeper analysis from the perspective of the sustainable development of the region.

Chapter Two is composed of three parts as follows:

I. General Issues about the Relationship between Structural Reform and Sustainable Development in APEC Region

International integration is a continuing trend. The aim of structural reform is to facilitate trade and investment liberalization, bringing into play member economies’ respective comparative advantages while fully exploiting external opportunities. However, there is a concern that the differences in the level of economic development among APEC economies may lead to disparity in the benefits of liberalization and economic integration. Part I of Chapter II clarifies the conditions and requirements for sustainable development for each of APEC’s economies and the region as a whole.

II. Emerging Issues in Sustainable Development in the APEC Region

Moving toward trade and investment liberalization, each of APEC’s economies will face challenges, challenges which may threaten sustainable development. Part II provides a thorough analysis of the potential for unsustainable development in each of the economies, with particular emphasis on income disparities between different regions within an economy as well as those between different economies.

III. Solutions and Recommendations

Part III recommends policy measures to ensure that structural reform in favor of trade and investment liberalization does not have an adverse impact on the conditions for sustainable development.

As such, Chapter Two focuses on reconciling sustainable development with structural reform and trade and investment liberalization, ensuring that the process of structural reform can take place in an efficient and realistic manner.

I. General Issues about the Relationship between Structural Reform and Sustainable Development in APEC Region

1.1 Sustainable Development - a Goal of APEC

Sustainable development can be briefly defined as that which ensures equity in the conditions of production and welfare between present and future generations living in the same territory or between different economies in the region. Therefore, economic growth and economic development cooperation should not be pursued at any cost, and the ramifications of development should be carefully considered. International economic integration appears to be an inevitable trend, and development cooperation must bring about benefits to all parties concerned. Rich economies need to invest their capital and transfer technology overseas, especially in and to underdeveloped economies, exploiting the latter’s comparative advantages. To achieve sustainable development there needs to be an understanding of the scope of cooperation which will ensure mutual benefits to all the parties concerned. This will help bridge the development gap between economies, and more importantly, guarantee equal development opportunities for future generations while avoiding irreversible environmental and ecological harm.

Sustainable development is one of APEC’s founding principles. The goals set forth in the 1991 Seoul Statement, the 1994 Bogor Statement, the Busan Road Map and many other APEC documents stipulate the overarching objective of sustainable development for the region.

At the APEC Ministerial Meeting on Sustainable Development on 9 June 1997, the Ministers emphasized the need to maintain a balance between economic development, population growth and environmental protection, considering it a key criterion for evaluating the level to which the trade liberalization and cooperation is achieved.

The Summit Meeting, held in Phnom Penh in November 2001, put forward a general Sustainable Development Platform for the entire Asia-Pacific region, including six initiatives:

i) Poverty reduction;

ii) Organic production and sustainable use of energies;

iii) Land management and preservation of bio-diversity;

iv) Safeguarding, management and provision of opportunities for accessing fresh water

sources; v) Water resources in oceanic and coastal areas for sustainable development of small

island and developing economies; and vi) Responses to climate and atmosphere changes.

The meeting explicitly acknowledged that although APEC is a region that includes many wealthy economies it also contains many of the world’s poorest people. Cooperation between rich and poor economies in the region should therefore consider poverty eradication a primary objective and an urgent priority.

The threat of terrorism is undermining the stability of the region and adversely affecting the attainment of APEC goals. APEC Economic Outlook 2005 analyzed and quantified the impacts of terrorism on economic development cooperation in the region.

In parallel with the activities to implement the goals of the Bogor Statement and Busan Road Map, the theme of APEC this year once again reaffirms the determination of APEC member economies to advance the conditions for sustainable development for the region as a whole as well as for individual economies.

1.2 Issues Relating to Structural Reform and Sustainable Development in the Region

APEC is a large community which accounts for more than 41 percent of the world’s population

(2.64 billion inhabitants) and is composed of 21 Asia-Pacific member economies, namely Australia; Brunei Darussalam; Canada; Chile; the People’s Republic of China; Hong Kong, Indonesia; Japan; the Republic of Korea; Malaysia; Mexico; New Zealand; Papua New Guinea; Peru; the Republic of the Philippines; the Russian Federation; Singapore; Chinese Taipei; Thailand; the United States of America; and Viet Nam. This is also a community with differing natural, historical and cultural conditions, characterized by different levels of economic development and different economic structures. The APEC economies share a common commitment to the aims of structural reform, even as they take different paths to this end.

An analysis of Gross National Income (GNI) within APEC reveals also some generalized characteristics of structural reform, according to three levels of economic development.

Group One consists of high-income economies, namely the seven OECD members (Australia, Canada, Japan, Republic of Korea, Mexico, New Zealand and the United States of America) plus four non-OECD high-income economies: Brunei Darussalam; Hong Kong, China; Singapore; and Chinese Taipei.

Group Two is composed of five middle-income economies: Chile, Malaysia, Peru, the Russian Federation, and Thailand. The Russian Federation is a G8 member with advanced scientific and technological capabilities, but it is a transitional economy subject to a range of stresses. In terms of income level, this economy is classified among the middle-income economies. [9]

Group Three includes the five remaining low-income economies: China, Indonesia, Papua New Guinea, Philippines, and Viet Nam.

Table 1: Sectoral Contribution to Growth by APEC Economies by Income Group 1970–2003 (%)

Source: WB, GDP/breakdown at constant 1990 prices in US Dollars (all countries and regions) data [23]

Group One economies are industrialized or newly industrialized, highly developed and high productivity economies using advance technology. Their service sectors are mature and account for a large proportion of the overall economy and economic growth. To generalize, the structural reforms pursued by Group One high-income economies tend to focus on resolving specifics shortcomings, especially as they relate to: (1) the service sector; (2) foreign investment and foreign equity ownership; (3) educational and vocational training; (4) labor and employment; (5) the financial system; (6) the tax system; and (7) agricultural subsidies. The first two of these issues mainly involve interactions between developed economies (both within and beyond the APEC region). The issues of education and training and labour reform, however, will impinge on Group Two middle income economies as well as Group One economies, through labour migration.

Policies relating to financial and tax systems, as well as agricultural subsidies will most likely also have a considerable and direct impact on middle income economies and non-APEC developing economies. Agricultural subsidy reform is the area in which policy change can impact most seriously on developing economies.

The economic development of low and lower middle income economies is typically involves lower productivity activities such as primary production and labour-intensive industries (the Russian Federation being an exceptional transitional economy). Structural reform for this group of economies should be more comprehensive in scope, covering a range of socio-economic issues. The more affluent economies can assist in this process through support from their parallel structural reforms, or using separate assistance programs.

1.3. Impact of Structural Reform, Trade and Investment Liberalization on Sustainable Development

Structural reform is a crucial aspect of the economic development process. To ensure sustained and stable economic development, structural reform must be a continuous and comprehensive process covering all policy areas, from institutional reform to policies that effect business and industry. In the context of globalization, trade and investment liberalization have become popular targets for structural reform. This is in line with the Bogor commitment: “to continue to reduce barriers to trade and investment to enable goods, services and capital to flow freely among our economies”.

At the present stage of international economic integration, in addition to ensuring stable economic development, structural reform, especially institutional reform, is necessary for economies to comply with international trade conventions, creating a favorable investment and business climate to help achieve the common goals of the region.

Trade and investment liberalization is the immediate objective of APEC member economies. Structural reform is a necessary step toward this goal. Different levels of economic development reflect differences in labour productivity. However, with a level playing field, some low productivity economies may suffer unduly during the liberalization process. Therefore, structural reform should take into consideration differences in labour productivity. Practical experience shows that APEC member economies succeed when they gradually shift their production and business focus from low productivity activities to higher productivity activities that make a greater contribution to economic development. Industrial development is an evolutionary process, starting with the full exploitation of natural advantages to create initial savings, the development of new comparative advantages and more competitive industries (i.e. higher value-add manufacturing) and subsequently, or simultaneously, expanding the service industries.

The increased number of economies that are fully industrialized has resulted in the strong development of the capital market goods and equipment market. International trade led to the establishment of an international labour division based on differences in labour productivity between industrialized and non-industrialized economies. This phenomenon is making economies increasingly more interdependent, but may also gradually widen the income gap between economies.

Structural reforms help economies maintain macroeconomic stability, bringing into full play their comparative advantages, better mobilizing domestic savings, creating wealth, and consolidating economic potentiality, all of which contribute to accelerating economic growth and resiliency. Many APEC economies have mobilized sources of capital to achieve remarkable accomplishments, especially the NIEs during the 1970s and 1980s. However, these achievements have been interrupted by trade wars and instabilities in the regional financial system. The Asian economic and financial crisis of 1997 took a heavy toll on regional economies. It also showed that the risk of such financial turbulence is higher for underdeveloped economies and that there is a significant role for the international community to play in overcoming the consequences of financial crises. Guaranteeing a stable financial market in the region should be regarded as an important objective of structural reform and sustainable development.

Structural reform solely concerned with raising rates of economic growth is insufficient to ensure sustainable development. In conducting trade and investment liberalization, two fundamental requirements for structural reform must be met. First, the economy should ensure it is not overly vulnerable to external shocks, and able to make full use of external development opportunities. Second, highly competitive manufacturing and services industries should be gradually established.

These two conditions are also needed to ensure sustainable development for developing member economies.

The development stage that relies mainly on the exploitation of natural resources is often characterized by relatively slow structural reform, which rarely makes a great contribution to economic growth. As development progresses, the accumulation of domestic savings and application of technology helps raise productivity and speeds the restructure and transformation of the economy. A liberal free trade and investment environment may enable some economies to accelerate their rate of development, and close the gap on the more developed economies, while others continue to lag behind, resulting in widening disparity. According to a report in November 1999, conducted by the External Committee of the French National Assembly, following the spread of globalization “over 80 economies have a level of per capita GDP lower than it was 10 years ago,” and the income gap between “the lowest population quintile and the highest one has increased: the ratio was 1 to 30 in 1960, 1 to 60 in 1990 and 1 to 74 in 1997.” There are three to four APEC economies whose per capita GDP has declined or remained unchanged in the decade to 2000 (in real terms). The requirements for sustainable development that will ensure equity among different economies in the region as well as different generations should be carefully considered in the process of devising and implementing structural reform toward trade and investment liberalization.

Given this approach, there are many interrelated issues impacting structural reform and sustainable development that call for thorough study and detailed solutions, including as the direction of sectoral transformation, the system of international division of labour in the region, the exploitation of comparative advantage of individual economies, the reduction of severe competition among economies; measures to bridge income gaps between different regions within an economy; measures to build a stable financial system in the region; measures to ensure a balance between energy supply and demand; the measurement of the level to which environmental degradation harms human health and sectors such as agriculture, forestry and fishing; raising popular support for environmental protection; the establishment of an international framework for studying issues relating to the global environment, cooperation in establishing general warning systems for natural calamities, epidemics, etc.

II. EMERGING ISSUES IN SUSTAINABLE DEVELOPMENT IN THE APEC REGION

2.1 Economic Issues

The APEC region is characterized by disparities in the level of economic development.

Large populations, diversities in natural, historical and cultural conditions, and inequitable income distribution, are outward signs of many features of sustainable development in the APEC region. Structural reform among APEC member economies should not only aim to build a community with free trade and investment, but also needs to squarely address the issue of sustainable development in the region.

The per capita income gap between the high-income economies and the lower-income economies dropped from a multiple of 26 in 1995 to 19 in 2004. The composition of each of the group as ranked by income did not change greatly over the same time period, only Mexico temporarily fell from the ranks of “high-income economies” (due to the impact of the financial crisis), before subsequently regaining its position. The developmental features of the two groups are noteworthy. The high-income economies have already completed their industrialization, using different development models. In addition to economies that have a strong and long-standing industrial base

(e.g. the US and Japan), others have based their development on the exploitation of natural resources. The emerging newly industrialized economies have grown rapidly thanks to their successful adoption of an export-oriented development model. Sparsely-populated but resource-rich economies like Australia, Canada, New Zealand and Brunei have accumulated savings, and quickly shifted to high productivity manufacturing and services industries, which now contribute the lion’s share of economic growth. As a result, a high proportion of their exports still originate from the primary sector and the technologies applied are less than in other economies.

Hong Kong, China; Republic of Korea; Mexico; Singapore; and Chinese Taipei are so-called newly industrialized economies, which prospered by following an export-led development model, initially supplying light manufactured goods to the world market, before moving on to even higher vale add products. The economies of Hong Kong, China; and Singapore leveraged their geographic location as natural trading hubs and rapidly developed their services sub-sectors, achieving a high proportion of re-exports among their total exports. Some middle income economies (Chile, Malaysia and Mexico) have emulated the open-market newly-industrialized approach, but have yet to achieve the same success.

Structural reform in densely populated and low-income economies contributes to the sustainable development of the region.

Although the population density of the region is below the world average (APEC occupies 46 percent of total land area, but has only 41 percent of total world population), APEC includes many economies with high population density. In 2004, Chinese Taipei had a population density of 629 inhabitants per square km which is the highest in the region, followed by the Philippines, Viet Nam, China and Indonesia. Other member economies possess large land areas and abundant natural resources, but enjoy low population density. These economies include Australia (2.6 inhabitants per square km), Canada (3.2) and New Zealand (14.7).

While globalization appears inevitable, a considerable number of economies have been made poorer by this process. For each APEC member economy and for the community of member economies as a whole, structural reform toward trade and investment liberalization needs to ensure that member economies are able to establish and consolidate the conditions for sustainable development.

Over the past 30 years, the four APEC economies at the low-income or lower-middle income levels have been those with large populations and high population density, i.e., China, Indonesia, the Philippines and Viet Nam. Except for China, the population growth rate of other economies has been declining, but has remained relatively high, particularly in the Philippines and Viet Nam. In the meantime, the population growth rates of high-income economies have remained very low: 0.14 percent per annum in Japan, 0.9 percent in the US, and about 1 percent per year in Australia and Canada.

Table 2: Population Growth Rates of Five Low-Income Economies (%)

Source: The World Bank, Table 07 World Population and GDP [23]

In 2004, the combined population of Indonesia, the Philippines and Viet Nam made up about 15 percent of the total regional population (64 percent if China is included). Given their above average population growth rates, this proportion will continue rising in the coming years. This will constitute a challenge, both economic and social, for those three economies. The low per capita agricultural land area; limited investment available for agriculture; and low land profitability have constrained the productivity of agricultural labour in these economies. A comparison of agricultural production between sparsely and densely populated economies shows that while there are not big differences in terms of food production per hectare between them, their productivity levels measured in US$ per agricultural labourer are very different.

Table 3: A Comparison of Agricultural Productivity between Selected APEC Economies and Viet Nam in 2000

Source: Tatyana P. Soubbotina, Beyond Economic Growth, WB 2005 [9]

Clearly, to achieve further improvement in people’s living standards, the structure of densely populated economies must be shifted in favor of manufacturing and services industries, by improving the quality of human resources, and reducing population growth rates. The improvement of human resources depends on many factors, such as the rate of domestic savings, access to education, training and health care services. Of particular importance is the level of productive investment that can generate new jobs. This should be a primary target of structural reform so as to ensure the economic dynamism necessary to achieve sustainable development.

The mobility of labour between economies can bring about mutual economic benefits for the countries concerned, and for the region as a whole. In the case of temporary labour migration, labour-exporting economies benefit in terms of remittances, knowledge and skills transfer, while labour-importing economies can quickly make up for any shortfall in their labour supply, especially in respect of lower skilled workers. However, there is a tendency for highly skilled workers from developing economies to seek employment and residency in developed economies. Through their remittances, these workers may make a great contribution to their home economies’ foreign exchange earnings by choosing to work abroad. Nonetheless, in the longer term this “brain drain” could impede the overall pace of development among low-income economies.

Trade liberalization and its impact on sustainable development of the region

Currently, one obvious feature of the APEC region is the huge disparity between the high-income economies and all the other economies. Bridging this inequitable income gap will bring about benefits to all members and promote the attainment of the principle aim of “building APEC in to a dynamic community for sustainable development and prosperity.”

In the 13 years following APEC’s formation in 1990, developing member economies in the region enjoyed economic growth 1.3 times higher than the average annual GDP growth rate of developed members. Unfortunately, the developing economies’ annual average population growth rate was

1.65 times higher than that of the developed economies during the same period. Consequently, the annual average growth rate of real per capita GDP of the developing economies has been relatively low (2.8 percent compared to 2.45 percent for the developed economies).²⁸ The income gap between developed and developing economies in the APEC region has been reduced, but only marginally. Estimates based on World Bank data show that per capita GDP in current US$ term in the five richest economies was 22 times larger than that of the five poorest ones in 1970, 25 times larger in 1975, 36 times larger in 1989, 34 times larger in 1995, and 34 times larger in 2004. When purchasing power parity is applied, this ratio drops to 7.8 times in 1991 and 6.8 times in 2004. The US and Japan are the two largest economies in the region, making up only 16 percent of the total regional population, but representing 71 percent of APEC GDP.

In the context of trade and investment liberalization, there has been a tendency for low-income economies to specialize in low-income industries and high-income economies to invest in high-technology industries, making it more difficult to bridge the development gap.

Computed from World Development Indicators 2005 (WB) and Human Development Report 2005 (UNDP) The World Bank, Beyond Economic Growth, p. 152

Table 4: APEC Economies’ Ranking by Per Capita GDP

Source: UNCTAD’s database, Table “Per Capita GDP at current prices in US Dollars (all countries and regions)”

[23]

Technology is a key driver of economic growth and facilitator of structural reform. The share of high-tech exports among total export volume in APEC high-income economies is 35 percent and 36 percent for the US and the Republic of Korea, respectively; and 28 percent and 29 percent for Japan and Mexico. Economies with exports dominated by primary commodities usually have a smaller share of high-tech exports. Moreover, economies with rising proportions of high-tech exports appear better able to maintain high, stable growth rates (e.g. Korea after the 1997–98 crisis and China in recent years).

Table 5: Differences in Technology Adoption among APEC Economies

Source: UNCTAD database [23]

Hence, to narrow development and income gaps between economies, structural reform should not simply aim to achieve the goal of trade and investment liberalization, it also requires each member economy to upgrade its technology level and human resource quality, thereby ensuring competitiveness, and rapid and stable growth.

A key ingredient in the success of APEC member economies has been the opening -up of their economies. Since the late 1980s, the development of many APEC member economies has heavily relied on export performance: the ratio of exports to GDP has rapidly risen over the years, especially for the developing economies. During a period of almost 20 years between 1986 and 2004, the ratio of exports to GDP for developing economies rose from less than 50 percent in 1986 to 67 percent in 1990, and over 72 percent in 2004.

Table 6: Export to GDP Ratio for Selected APEC Member Economies, 1986–2003 (%)

Source: The World Bank’s database, Vietnam Statistical Year Book 2005 [23]

At present, the APEC region accounts for approximately 47 percent of total world trade volume. Intra-regional trade between member economies represents over 70 percent of total regional foreign trade. The APEC region now plays a leading role in international trade. In years to come, further expansion of trade relations with the rest of the world should be regarded as a common goal of the APEC community, particularly for the less developed economies.

Table 7: Commodity Export Volume in APEC and EU during 1970–2003

Source: World Bank, World Development Indicators 2005, p. 334

The level of foreign debt affects the sustainable development of some economies in APEC region

The foreign indebtedness of APEC’s developing economies has been increasing over time. In a period of 13 years, from 1990 to 2003, the total foreign debt of APEC’s developing economies rose from US$368.7 billion to US$898.1 billion. However, the foreign debt-to-GDP ratio has been gradually declining: in 1990, it accounted for about 29 percent of GDP, by 2003, the figure had declined slightly to 28.2 percent. The trend in the size of long-term debt relative to total debt was less positive; long-term debt accounted for 80.4 percent of total foreign debts of the developing economies in 1990, but declined to only 78.8 percent in 2003, indicating an increase in the proportion of short-term and medium-term debt. In the short run, this can put pressure on debt servicing for the poor economies in the region. According to the World Bank’s classification, among developing and less developed economies in APEC, only two economies fall into the most heavily indebted group, namely Indonesia and Peru, six economies are in the group of medium-indebted economies (Chile, Malaysia, Papua New Guinea, the Philippines, Russia and Thailand), and three economies can be categorized as low-indebted countries (China, Mexico and Viet Nam).²⁹

Figure 1: Foreign Indebtedness of APEC’s Developing Economies in 2003

% of export

Source: World Bank, World development indicators 2005, p. 262 [11]

2.2 Social Aspects

Poverty and inequality are non-sustainable factors for APEC’s developing economies.

Almost all developing economies that are members of APEC have recorded remarkable progress in poverty reduction and, at the same time, have maintained relatively high rates of economic growth. The proportion of persons below the poverty line in respect of national standards has been declining over time in every economy, except for Indonesia.³⁰ Moreover, the national standards relating to poverty in some of APEC’s developing economies are higher than the international norms. This means that those that are considered poor in these economies often enjoy a better standard of living than those categorized as poor in many poor economies, which apply a poverty standard of less US$1 (PPP)/day. Some economies like Chile, Peru, Russia and Malaysia have set poverty standards higher than the international norm of US$2 (PPP)/day, indicating the great strides made in poverty reduction among APEC member economies. The governments of APEC member economies have been relatively successful in implementing the policies in support of economic growth and poverty reduction.

29

According to the World Bank’s classification, economies that have foreign debts exceeding 220 percent of exports or 80 percent of GNI are considered heavily indebted; countries with more debts than 132 percent of exports or 48 percent of GNI and less than 132 percent of exports or 48 percent of GNI are considered medium indebted and low indebted, respectively (World Bank, World Development Indicators 2005)

30

National poverty lines 1 and 2 indicate the percentage of the poor of the economy according to two different surveys conducted by the World Bank.

Figure 2: Poverty in APEC Developing Economies

60 50 40 30 20 10 0

Chile

Indonesia

P hilippines

Rus sia

M exico

Papua New Guinea

Source: World Bank, World development indicators 2005, p. 64 [11]

However, progress on reducing income inequality in APEC’s developing economies has not been as successful as the accomplishments in poverty reduction. Income disparity is relatively large among APEC’s developing economies. Latin American economies have high degree of income inequality compared with the East Asian economies. Those with highest inequality in income distribution are Chile, Papua New Guinea, Mexico and Peru, all of which have Gini coefficient above 50,³¹ (the higher the Gini coefficient, the smaller the share of national income for the poorest members of society). At the same time, and with the exception of Chile, these countries’ per capita GDP growth rates have been modest at best (less than 3 percent a year). Indonesia and Viet Nam are the two economies that enjoy the lowest degree of income disparity. The poorest 20 percent of society in these two economies have 8.4 percent and 7.5 percent of total income, respectively. This is almost three times higher than the situation in Peru and Mexico, where the poorest 20 percent have only 2.9 percent and 3.1 percent respectively of income. Viet Nam is one of the few economies that enjoy both high economic growth and relatively equal income distribution.

Although there is no clear-cut threshold, economies with a Gini coefficient of over 50 can be considered as having highly unequal income distribution (UNDP-Human resource development 2005).

Figure 3: Gini Coefficient and GDP per Capita Growth Rate in 1990–2003

-0.02 -0.01 0 0.01 0.02 0.03 0.04 0.05 0.06 0.07 0.08 0.09

GDP per capital growth rate, 1990-2003

Source: World Bank, World development indicators 2005, p. 72 [11]

2.3 Utilization of Energy and Land Resource

Energy consumption in some APEC member economies requires structural reform

APEC is the largest energy consumer in the world. In addition to major industrialized economies consuming large amounts of energy, like America and Japan, the high economic growth in the remaining economies has strongly pushed up the demand for energy. APEC’s energy consumption in relation to global consumption increased from 57.3 percent in 1991, to 58.7 percent in 2003. Although the contribution to energy demand by the United States and Japan declined, these two economies still account for more than one quarter (26.7 percent) of total global energy consumption. Higher energy demand from the rest of APEC saw their share of energy consumption jump from 24 percent in 1990, to 32 percent in the same period, of which China accounts for 41.7 percent [23]. High economic growth rates and accompanying high consumption of fossil fuels have been the experience of many APEC economies. Fossil fuels are non-renewal and their exploitation can have negative impacts on the environment and ecological systems.

In the near future, with further rapid economic growth expected, the exploitation and utilization of fossil fuels in the region will continue to increase, not only to meet industrial demand but also for domestic residential use. According to a long-range forecast on energy supply and demand released by the Institute for Energy Economics (Japan), primary demand for energy in 11 economies (ASEAN, the NIEs, China and Japan) will be about three billion tons (oil equivalent), of which the demand for oil alone will be about 980 million tons [6]. According to [10], in 2020, China’s need for primary energy will be 2.5-3.3 billion tons of standard coal equivalent (including 2.1-2.9 billion tons of coal, 0.45-0.61 billion tons of petroleum as well as natural gas).

Higher and more volatile energy prices may result in the development of more sustainable energy substitutes, eventually changing the structure of energy consumption. This bright prospect will depend on many factors such as the level domestic savings by the economies as well as scientific and technological breakthroughs. Moreover, any major change in the mix of energy sources will not be immediately forthcoming. In the meantime, energy policy will continue to be dominated by issues of energy security at the economy level. In the coming years, increased energy utilization and reserve requirements by economies will add to the upward pressure on energy prices, threatening to derail socio-economic development in the region.

Trade and investment liberalization will accelerate the process of technology transfer with positive and negative effects. The importation of outdated technology by developing economies may push up the demand for energy consumption and possibly exacerbate environmental degradation. APEC’s economies need to take collective action to ensure the current massive use and exploitation of fossil fuels do not conflict with sustainable development goals.

Depleted agricultural land area is a threat to sustainable development in many developing economies

Land use is a major issue in densely populated economies with limited agricultural land per capita. The over-exploitation that sometimes results can lead to land degradation, resulting in lower yields. Deforestation has caused in landslides, flash floods and depleted ground water reserves.

Industrial development, the construction of economic and social infrastructure and urbanization are reducing agricultural land area. From 1990 to 2002, agricultural land area in many economies declined, especially in the economies with limited agricultural land to begin with: in Korea agricultural land declined by 11.3 percent, in Japan by 8.8 percent, and in Thailand, 5.7 percent [23]. As economies develop and require more land for industry and services, this tendency will spread to other densely populated economies such as China, Indonesia, the Philippines and Viet Nam. This worrisome trend represents a direct threat to sustainable development.

To combat this loss agricultural productivity needs to be increased, food security improved and the pressure on arable land reduced. The establishment of integrated programs to create the harmony between production and consumption, and among regions in each economy is required. Proper protection for various types of natural resources such as water, forests and mineral resources are also needed.

2.4 The Environment

Increased environmental pollution, especially air pollution is an unwanted byproduct of industrial development

Higher industrial output and rising energy usage by consumers will inevitably lead to increased air pollution, especially in developing economies that are more reliant on basic heavy industrial processes and that are less able to afford clean technologies. The emissions that contribute to the so-called greenhouse effect are on the increase. The volume of CO2 emissions continues to rise, even among the more affluent APEC economies: between 2000 and 2003, CO2 emissions increased by 5.4 percent in Australia, 4.2 percent in Canada and 9.7 percent in New Zealand. Among APEC’s developing economies the rates of increase have been much higher: from 2000 to 2003, CO2 emissions in China increase by 26.7 percent, in Viet Nam by 38.5 percent and in Thailand by 19.3 percent.∗

∗

Calculation based on CO2 Emission from Fuel Combustion, IEA statistics, 2003.

Pollutants like SO2 and NO2 have been declining in developed APEC economies. Between 1990– 2002, emissions in the United States fell by 35 percent and in Japan by 16.4 percent, although in some economies, like Australia and New Zealand, they continued to increase. Among the low-income economies in the region, the increase was negligible.

Estimates by the Institute for Energy Economics in Japan indicate that emissions of SO2 and NO2 from 11 Asian economies (including Japan) will increase from about 30 percent of the total global emissions of these gases (in 1992) to 50 percent and 47 percent respectively, by 2010. Almost half of global SO2 and NO2 emissions will come from the East Asian economies. APEC economies will account for about three quarters of CO2 and SO2 emissions [6]. Equipment and systems to reduce the level of polluting emissions are not used in Asia due to their high cost, nor are they likely to be in the near future. This issue needs to be included in any structural reform agenda.

Table 8: APEC Emissions of CO2

Source: CO2 Emission from Fuel Combustion, IEA statistics, 2003; World Bank, World Development Indicators 2006 (for PNG).

In each economy, different levels of industrial production and urban development result in varying degrees of air and water pollution. Underinvestment in environmental protection in low-income economies can exacerbate the effects of pollution, storing up problems for future generations. Many economies in the region have enacted strict laws relating to environmental protection, but all too often they are not fully enforced. While enforcement is important, it is equally important to educate industry and the public about the seriousness of the issue.

Cooperation between economies to resolve specific environmental problems is often complicated by the conflicting vested interests of an economy or a group within an economy. When discussing institutional reform, it is necessary, at a policy level, to reach a common position among member economies.

2.5 Natural Calamities and Epidemics

The APEC region is highly susceptible to natural calamities and epidemics, with some economies— for example, China, Japan, the Philippines and Indonesia—at particular risk from natural disasters.

The APEC region is disproportionately endangered by natural calamities

From 1900 to the present day, 3,700 natural calamities have occurred in APEC economies, accounting for 37 percent of all natural calamities around in the world. These unfortunate events have caused the deaths of an estimated 13 million people, seriously disrupted the lives of another

2.4 billion people and caused economic losses of US$888 billion. On average, the region is afflicted by 37 natural calamities annually, with heavy loss of life and property.³² These statistics indicate that the highest frequency natural calamity are storms (1,425 storms or nine per year on average) followed by floods with 910 occurrences.

Almost all the economies in the APEC community are affected by natural disasters with the possible exception of Singapore.³³ Severe natural calamities have been occurring more frequently in recent years and with more destructive force. At the end of 2004, the region witnessed a terrible tsunami that damaged 11 Asian economies, of which Indonesia, Thailand and Malaysia, all members of APEC, were among the most seriously affected. These three economies (plus Myanmar) accounted for more than 75 percent of the total loss of life resulting from the tsunami. In the period 2004–2005, the US experienced three devastating hurricanes—Ivan, Charley and Katrina—causing damage of more than US$100 billion. These three storms ranked first, third and fourth in the list of the most destructive storms ever to hit the US economy. China is also prone to storms and floods. In the 10-year period 1990-99, there were around 35 serious floods, but this number increased to 55 in just the last five years (2000–2005).³⁴ In 2005, after having swept through Southeast Asia causing 40 deaths, the storm Damrey hit the cities of Guangxi and Hainan provinces in China, causing damage estimated at more than US$1 billion. It was the most destructive storm experienced by China in the last 30 years. In the same year, three APEC member economies were unfortunate enough to be on the list of countries most affected by natural disasters in terms of human loss: the US ranked third (more than 1,300 people killed by hurricane Katrina), Indonesia ranked sixth (915 people were killed in an earthquake in March 2005); and China (771 people were killed in the flood in June).³⁵

³²₃₃ Calculated based on CRED data. [18] _{Based on CRED data.}

³⁴ Based on CRED data. ³⁵ CRED data.

Table 9: Summary of Natural Disasters that Occurred in APEC Member Economies (1900–2005)

Source: Calculated based on CRED database. [18]

Natural disasters not only interrupt production and destroy the physical infrastructure needed to facilitate trade and support growth, they can also undermine investor confidence in a region, severely impairing the prospects for sustainable development.

According to ISDR statistics, from 1993 to 2005, eight APEC member economies including Australia; China; Indonesia; Japan; Korea; Mexico; the US and Chinese Taipei were among those economies listed as most affected by natural calamities, with the total damage valued at US$880 billion (at 2005 prices). The US, Japan and China were the worst hit economies with losses of US$365 billion, US$209 billion and US$172 billion, respectively. Some natural calamities have been so severe that they have significantly reduced the productive output of economies. One case in point was the earthquake that occurred in Papua New Guinea which depressed GDP by 7.5 percentage points. The 1997 forest fires in Indonesia had a similar economic impact on that economy.

Figure 4: Economic Loss Suffered by APEC Member Economies from Natural Disasters

(1993–2005)

(US$ billion at 2005 prices)³⁶ [20]

The costs of repair and rebuilding as well as economic rehabilitation in areas affected by natural calamities place an unexpected burden on state budget expenditures, negatively influencing investment in economic development programs. In 2005, humanity witnessed hurricane Katrina, the world’s most destructive storm since 1900. The damage sustained by the US was estimated at US$75 billion; the total cost of reconstruction US$105 billion.

Most natural disasters affect places inhabited by the poorest and most vulnerable groups in society, those least able to contend with, and recover from, such calamities.

The human loss is the most serious cost to society, debilitating the labour force along with the local economy of the affected areas. ISDR^∗ statistics reveal that between 1900 and 2005, several APEC member economies were among the most seriously affected in terms of human suffering. In China,

1.3 billion people were affected; in Viet Nam 30 million; in Thailand, 29 million; and in the Philippines, 21 million. In June 2006, the Chanchu storm killed hundreds of Vietnamese fishermen most of whom were the main breadwinners in their families. These kinds of events can easily tip families and even whole communities into poverty.

According the International Committee of the Red Cross, children are often the most vulnerable. One third of the victims of the 2004 tsunami in Southeast Asia were children. This may result in a labour imbalance in the affected areas in the future. The state must take on an additional financial and social burden because of the need to care for large numbers of orphans.

With manufacturing facilities destroyed, transportation systems in collapse, raw material supplies poorer access to healthcare services). Disasters cause many people to fall into homelessness and they wreak havoc on social infrastructures such as hospitals, schools and housing.

Indeed, the negative impact of natural disasters on people’s living conditions may persist for many years. Droughts and forest fire may have destroyed arable land. Tidal surges and tsunamis may have seriously damaged coastal ecosystems, in the process making these areas more vulnerable to further damage by tsunamis and cyclones. Contaminated water supplies due to the destruction of waste disposal systems may threaten people’s health and well being. The long-term impact of the destruction caused by tsunami to coastal mangrove forests has not yet been fully evaluated. These forests have been partially destroyed, leading to the changes in the salinity of the soil and harming ecological systems and coastal aquaculture.

The Impact of New Diseases on APEC’s Sustainable Development

Despite advances in medicine, in this the 21st century, mankind continues to be threatened by extremely dangerous and highly contagious diseases. The recent outbreaks of SARS (Severe Acute Respiratory Syndrome] and avian flu have threatened APEC economies in particular.

Over the last 100 years, all 21 economies in APEC had been affected by outbreaks of various diseases, negatively impacting the lives of over eight million people.

Table 10: Impact of Epidemics in APEC Member Economies (1900–2005)

Source: Calculated based on CRED data.

In 2003, SARS spread to 30 countries, infecting 8,096 infected people and killing 774. Half of APEC’s member economies were hit by the epidemic with 8,048 infected and 772 deaths, of which China; Hong Kong, China; and Singapore were the most seriously affected.

Then came avian flu. The first case appeared in Viet Nam and then spread to neighboring economies (Thailand, China, Indonesia, Cambodia and Laos). And by October 2005, the disease had reached Europe and Africa.³⁷ The spread of the disease may be due to the migration of wild water-birds and seabirds. The results of a WHO investigation into the case of seven members in one family who died of the H5N1 strain in Sumatra indicate that the disease had mutated to become communicable from person to person. While the WHO says that avian flu is not yet an epidemic, if an epidemic does break out, it could kill two million to seven million people within a 12month period. At present, the fatality of this virus is relatively high (over 50 percent).³⁸

Epidemics such as SARS and avian flu can have an immediate impact on economic growth. SARS lowered GDP growth in the APEC economies by 0.5-1 percentage points.³⁹ But the economic fallout varied by economy. Economic growth in Hong Kong, China; Singapore and Indonesia dropped by 1.8, 1.1 and 0.9 percentage points,⁴⁰ respectively.

So far, the impact of avian flu on affected economies’ GDP growth has been relatively minor as poultry farming in these economies accounts for a negligible percentage of economic output. Viet

³⁷ FAO. ³⁸ Based on WHO data. ³⁹ APEC. ⁴⁰ ADB statistics.

Nam was the first to be hit, and is the most seriously affected economy. The FAO estimated that the economic growth rate of Viet Nam dipped by about 0.12 percentage points as a result. In the case of Thailand, the biggest poultry exporter in Asia, its poultry exporting industry suffered a loss of US$500-700 million, leading to a loss of 0.1 percentage point off economic growth.

Epidemics most severely impact industries that involve the movement or gathering of people, industries such as tourism, aviation, retailing, etc. The airlines of many economies in the APEC region faced a massive drop in demand for air travel resulting in many flight cancellations. The World Tourism and Travel Corporation (WTTC) conducted an analysis of SARS-affected economies (China; Hong Kong, China; Singapore; and Viet Nam). According to its findings, impacts by SARS on tourism earnings were most serious in the case of China, while Hong Kong, China; and Singapore suffered from the biggest reduction in GDP.

Source: WTTC, 2003.

The impact of SARS on air travel was catastrophic. Singapore, Korea and Viet Nam reported sharp declines in passenger traffic in the early months of 2003, with many international and domestic flights cancelled. In China, official statistics reveal a massive 81.2 percent slump in the number of airline passengers in the first 10 months of 2003, in comparison with the same period of the previous year. In Hong Kong, China it has been estimated that if SARS had persisted for three more months, one third of the city’s 10,000 restaurants would have been forced to close. In Chinese Taipei, as elsewhere, the hotel occupancy rate during the SARS epidemic fell by half.

Trade shows, exhibitions and conferences also suffered a huge loss of business. In Guangzhou, business was only one fifth of that of the previous year and the value of contracts signed was 26 percent down on 2002. In Hong Kong, China only 460 companies took part in an exhibition on appliances and gifts in comparison to 5,000 the year before. On the first day of the exhibition, there were only 3,000 buyers, and most of them were locals. In 2002, the number of sellers had been 80,000, and more than 50 percent of them were foreign buyers.

The ever-present risk of a new epidemic can undermine the confidence of investors, resulting in the reduction of foreign investment and capital inflows. Moreover, delay in the transportation of components and finished products can create obstacles to cross-border trade.

Though the contribution of poultry farming to GDP is small, it nonetheless plays an important role in the economy. In many economies, this industry is a major source of protein, and it creates jobs and incomes for farmers. Because of avian flu, people stopped eating poultry in fear of contracting the virus. Many governments ordered a cull of poultry in order to stop the spread of H5N1. WHO indicates that more than 140 million birds were either culled or died as a result of the virus. This placed an enormous financial strain on many poultry farms, especially smaller ones. Moreover, treatment costs are always a major burden for poor households. Thus, not only was the spread of bird flu a serious danger to the poultry industry, it also undermined efforts to reduce poverty in some Asian economies.

Avian flu also adversely affected the environment because of the ways in which dead poultry was disposed of, the most common of which in many economies were burying and/or burning. However, technical safety standards could not always be met, leading to environmental problems. Burial pits were located too close to surface water sources and roads. Protective clothing was not always adequate and sometimes insufficient soil was used to cover the birds. These problems contributed to water and air pollution. In future, if these problems are not dealt with in a timely manner, surface and underground water sources may become seriously contaminated.

Another concern relates to the treatment of fecal waste from poultry farms; if there is no processing of these wastes prior to their being used on crops, the risks of environmental pollution and disease will persist.

III. SOLUTIONS AND RECOMMENDATIONS

3.1 Closer Coordination of Structural Reform and Sustainable Development Policy is Required

Trade and investment liberalization promotes economic growth, but it may also widen income disparities, both within and between economies. If this imbalance becomes too great, the risk of social instability will rise, leading to the need for corrective policy prescriptions. Developing economies are struggling to narrow income disparities, but face many challenges.

Implementation of structural policy reform in favour of a free trade and investment area remains a priority. However, any policy change should be compatible with the aims of sustainable development. In parallel with maximizing the competitive advantages released through trade and investment liberalization, governments should implement the necessary reforms to integrate its development programs, and adopt appropriate technological advances in order to rapidly create new advantages and enhance national competitiveness.

3.2 Strengthening International Cooperation for Sustainable Development

International cooperation in the region can make a strong contribution to sustainable development; cooperation can be achieved through various bilateral or multilateral fora; or between sectors and individual businesses.

The APEC forum is held annually and in the meetings of subcommittees, socio-economic and environmental issues are discussed. This is a good opportunity for economies to exchange their experiences with structural transformation policies for sustainable development.

Business fora for specific sectors should exchange information on market, investment and business environment conditions; to strengthen the mutual understanding among businesses, governments and to jointly implement common solutions for sustainable development.

If the largest APEC member economies maintain their high economic growth rates, the energy demand of the region could quickly overwhelm global supply. Thus, it is vital to restrict energy demand through energy saving and recycling, as well as through policy constraints on overall economic growth. The concept of energy demand management has been applied in the United States’ electricity industry and has attracted interest in Japan. It will be more difficult for APEC’s developing economies that need to generate jobs and create employment opportunities to accept the concept of slower growth as a general principle. Nonetheless, it is a subject of increasing concern in the next 10–12 years.

Energy is a key industrial input and a significant determinant of living standards. A stable and cheap supply is an important target of any energy policy. In an economy with rapidly increasing demand, energy security requires large investments. As energy sectors are liberalized, energy planning becomes more complex. Thus, energy consumption in the APEC region should be considered a priority agenda item for APEC.

3.3 Enhancing Awareness of Sustainable Development Issues

The rural population of APEC’s developing economies account for a large share of the total population in APEC member economies. The awareness of issues around sustainable development differs from region to region within an economy as well as between economies. For lower income per capita economies, their priority is high economic growth, leading to a relatively lower regard for social and environmental issues. But in the context of globalization, environmental protection is no longer solely the responsibility of individual economies. It is necessary to increase the awareness of issues relating to sustainable development—as they affect individual economies and the region—of every citizen and enterprise. Recently, people in many regional economies have become more aware of the problem of pollution and have actively participated in anti-pollution programs. This suggests that simply enhancing people’s awareness can make a difference. Dialogue between governments, ministries, enterprises, NGOs and individuals to ensure environmental protection is also beneficial.

The program to encourage the private sector to implement environmental protection measures on a voluntary basis, through the adoption of international standard ISO 14000, has been quite successful. The success of ISO 14000 derives from its ability to create enhanced international competitiveness by taking advantage of the market mechanism.

3.4 Improving Sustainable Development Management Systems

Many APEC economies have established Agenda 21 programs. Provinces and industries have also launched Local Agenda 21 or Sectoral Agenda 21 programs. Many economies now have a set of sustainable indicators for monitoring sustainable development. APEC economies should be supported in realizing their initiatives with respect to the implementation of sustainable development goals or Agenda 21 program.

3.5 Supporting the Establishment of Information Systems to Monitor Sustainable Development in APEC’s Member Economies

Regional financial instability (e.g. the Mexico crisis in 1995, and the crisis in South East Asia in 1997–1998), disasters, epidemics and terrorism recently have demonstrated that these largely unforeseeable external shocks affect the whole region as well as individual economies. Their impact is potentially devastating, especially for low-income economies. In accordance with the theme of APEC 2006, establishment of information systems to monitor sustainable development for APEC’s member economies is recommended. Through such an information system, economies in the region could receive early information of impending external shocks from a regional alert center.

Financial risks could be reduced through greater information exchange among major international financial centers, especially on the inflow of short-term loans to developing economies. Enhanced information exchange on the outbreak and transmission of diseases on a regular basis is needed. Centers for monitoring the risk of epidemics should be established across the region. Greater coordination of action and financial support to combat epidemics is also needed.

Coordination in the setting up of early warning systems for natural disasters such as tsunamis, earthquakes, hurricanes and landslides, especially in the most vulnerable areas, is necessary. Developed APEC member economies should provide financial support to build this system, which would supply predictive data and analysis in a timely manner.

Past experience shows that regional cooperation is very important for establishing effective early warning systems for the following reasons [8]:

• Cooperation combines the best knowledge, skills, technologies and practices; it helps to promote knowledge sharing and the dissemination of best practices; and

• Integrated national systems promote redundancy and reliability, and increased information flow for accurate analysis and decision-making.

Effective regional cooperation requires the political and financial commitments of national governments; donor assistance is important, but regional and international cooperation is more critical for long-term sustainability.

REFERENCES

1. Aaditaya Mattoo and Antonia Carzaniga, 2003. Moving People to Deliver Services, The World Bank, Washington, DC.

2. ADB, 2005. Asian Environment Outlook, Philippines.

3. APEC, 2005. Summary Report of the APEC-OECD Symposium on Structural Reform and Regulatory Reform, Korea.

4. APEC Economic Committee, 2005. Follow-up Study on the Impact of APEC Investment Liberalization and Facilitation, Singapore.

5. Ernesto Guevara, Ministry of Foreign Trade and Tourism (Peru), Biodiversity and trade: a way for sustainable development, paper of APEC symposium on Structural Reforms and Sustainable Development in the APEC region: Emerging Issues, Hanoi, Viet Nam, 30 August 2006.

6. N° 1963, Rapport d'information de M. Roland Blum, La Commission Des Affaires Etrangères sur la mondialisation, Assemblée Nationale Française, 1999.

7. Ministry of Planning and Investment, 2004. The Strategic Orientation for Sustainable Development in Viet Nam. Hanoi, Viet Nam.

8. Orestes Anastasia (USAID), Regional Cooperation for Disaster Early Warning Systems, a paper of the APEC Symposium on Structural Reforms and Sustainable Development in the APEC region: Emerging Issues, Hanoi, Viet Nam, 30 August 2006.

9. Tatyana P. Soubbotina. World Bank, 2005. Beyond Economic Growth.

10. Wang Xianlei: On China’s Reform and Sustainable Development, a paper of the APEC symposium on Structural Reforms and Sustainable Development in the APEC region: Emerging Issues, Ha Noi, Viet Nam, 30 August 2006.

11. World Bank, 2005. World Development Indicators, Washington, DC.

12. UNDP. 2005. Human Development Report 2005, Washington, DC. UNDP. 2004). Reducing Disaster Risk - A Challenge for Development, Washington, DC.

13. World Bank, 2003. Sustainable Development in a Dynamic World: Transforming Institutions, Growth, and Quality of life. Washington, DC, USA.

14. Youngjae Lim, Korea Development Institute, Structural Reforms and Sustainable Development: Recent Experiences in Korea, paper of APEC Symposium on Structural Reforms and Sustainable Development in the APEC Region: Emerging Issues, Ha Noi, Viet Nam, 30 August 2006.

15. Asian Development Bank

16. Asia-Pacific Economic Cooperation

17. Food and Agriculture Organization

18. Center for Research on the Epidemiology of Disasters

19. Institute for International Studies and Training

20. International Strategy for Disaster Reduction

21. Natural disaster

22. United Nations Development Program Viet Nam

23. United Nations Statistics Division

24. World Health Organization

25. World Travel and Tourism Council

26. Vnexpress

Chapter Three:

Individual Economy Reports

AUSTRALIA

Australia has undergone major macroeconomic and microeconomic reform over the course of the last two decades, which has contributed significantly to strong and sustained economic performance since the early 1990s. Notable areas of reform have included the introduction of a medium-term fiscal framework and monetary policy framework, competition reform in many product markets, labour market reform, significant changes to taxation arrangements, financial sector reform, welfare reform, reducing tariffs and opening Australia to international trade, as well as reform in energy, communications and transport.

1. Improving the Efficiency of Capital and Labour Markets

Improved efficiency of capital markets in Australia is attributable to a series of reforms undertaken over two decades. Australia experienced significant financial “deepening” in the 1980s and 1990s, a result of financial deregulation, liberalization and reform. This included the floating of the exchange rate and the removal of exchange controls in 1983. It also involved changes directed at financial intermediaries to increase competition.

Reform in the second half of the 1990s focused on strengthening regulatory regimes to increase competition and improve the efficiency of the financial system, while preserving its integrity, security and fairness. A central aspect was the move to a functional objectives-based framework rather than a sectoral-based regulatory framework. There are three peak regulators under the functional objectives framework—a single prudential regulator (Australian Prudential Regulation Authority), a regulator for conduct and disclosure (Australian Securities and Investment Commission) and an institution responsible for systemic stability and payments systems (the Reserve Bank of Australia).

The Financial Services Reform Act 2001, established within the Corporations Act 2001, provides an improved regulatory regime for the financial services industry. It includes a harmonized licensing, disclosure and conduct regime for providers of financial services such as banks, insurers and advisers. In May 2005, the government released a proposals paper containing a number of refinements to financial services regulation. It is anticipated that further regulatory amendments will follow, particularly in relation to disclosure-related issues.

Effective from October 2006, new measures were introduced for governance and “fit and proper” requirements for Approved Deposit-taking Institutions and insurers. Further prudential standards were also put in place for general insurers.

In terms of the labour market, Australia has pursued a range of initiatives over the past two decades to improve the flexibility of wages and conditions of employment and to improve the connections of the unemployed with the workforce.

Since the early 1990s there has been a shift away from centralized wage fixation and industrial arbitration. The primary responsibility for determining matters affecting wages and conditions was placed with the employer and employees at the workplace level, with the introduction of registered agreement-making between an employer and individual employee. The role of awards was redefined with the intention that they act as a safety net of minimum standards. The reforms also provided a framework of rights and responsibilities for employers, employees and their organizations, ensured freedom of association and enabled employers and employees to choose the most appropriate form of agreement for their particular circumstances.

Australia introduced further changes in 2006 to improve the flexibility of employer-employee agreements about wages and conditions, with a simplified safety net of minimum standards, and to reduce unwarranted barriers to further employment.

In mid-2006, Australia also implemented a range of initiatives to encourage people to participate in the labour force and move into work, which involves tighter work testing of welfare benefits, improved financial incentives and enhanced employment assistance tailored to the labour market needs of the jobseeker concerned. This builds on previous reforms to labour market assistance in the mid 1990s, including the development of the Job Network, a system of non-government job placement agencies.

The regulation of workplace relations remains complex. In part, this is due to a lack of harmonization of regulations across the six different state jurisdictions applying in Australia. The Australian labour market will need to have greater flexibility to respond to the challenges of an ageing population.

2. Investing in Human Capital

Australia continues to pursue its National Reform Agenda in the area of human capital. This is a long-term and integrated agenda to increase the nation’s productivity and workforce participation. The Australian government has made significant investments in the nation’s human capital, including increased funding for schools, increased numbers of places at universities and vocational training centers, and increased flexibility for universities in setting course fees and improved access for full-fee paying students.

Work continues on specific reform proposals in four initial priority areas of early childhood, diabetes, literacy and numeracy, and child care.

3. Improving Regulatory Quality and Enforcement

In response to business concerns about compliance burdens, the government commissioned the Taskforce on Reducing Regulatory Burdens on Business in October 2005 to identify areas of government regulation that impose undue costs on business. While the report raised no fundamental concerns about the financial sector regulatory framework, it did raise concerns with the compliance burden of some regulations and suggested ways to improve scrutiny and cost-benefit analyses of regulatory proposals. In August 2006, the government announced that it will take steps to address the recommendations relating to financial sector regulation through a package of financial services and corporations law reform proposals. These reforms are aimed at ensuring the policy objectives of regulation are met while reducing compliance costs for financial sector participants.

For those areas where the regulatory burden is imposed by different levels of government in Australia, they have been placed on the National Reform Agenda (agreed by the Council of Australian Governments in February 2006) for comprehensive and integrated solutions to the problems.

4. Ensuring Competitive Markets

In April 1995, Australia agreed to promote enhanced competition through the National Competition Policy (NCP). The NCP provided for extension of the Trade Practices Act to previously excluded businesses and reformed government businesses to make them more commercially focused and more exposed to competitive pressure. The NCP also provided for arrangements to secure third-party access to essential infrastructure services and it incorporated reforms for the electricity, gas, water and road transport sectors. Furthermore, competition assessment and, where appropriate, reform were carried out on approximately 1,700 pieces of legislation across all levels of government. The report prepared by an independent commission, the Productivity Commission, indicates that Australia’s real GDP increased by 2.5 percent due to the NCP reforms.

Notwithstanding these achievements, there are still inefficiencies and performance gaps which, if removed, could yield substantial benefits.⁴¹ A new competition policy agenda, as part of the National Reform Agenda, is aimed at providing a supportive market and regulatory framework for productive investment in energy, transport and other export-oriented infrastructure, and for its efficient use by improving pricing and investment signals and establishing competitive markets.

5. Enhancing Macroeconomic Stability

Australia has been well served by a combination of stable and robust macroeconomic policy frameworks, along with continuing microeconomic reform programs.

Reform has continued since the floating of the exchange rate in 1983, which has acted as a critical absorber of economic shocks. An essential development in Australia’s macroeconomic policy regime was the monetary policy agreement by the government and the Reserve Bank in August 1996, which endorsed the medium-term inflation targeting regime, which targets consumer price inflation of between 2-3 percent on average over the course of the economic cycle. This reform has helped contribute to low and stable inflation in Australia.

The Charter of Budget Honesty Act, introduced in 1998, laid out the principles for sound fiscal management, including a key objective to maintain budget balance over the economic cycle. The government’s fiscal strategy has a number of supplementary objectives, including: maintaining budget surpluses over the forward estimates period while growth prospects are sound; not increasing the overall tax burden as a share of GDP from 1996-97 levels; and improving the Australian government’s net worth position over the medium to longer term. The government’s sound fiscal management has resulted in the elimination of net debt and the prospect of positive net worth.

Australia’s macroeconomic policy settings are well placed to deal with current and expected medium-term developments. Australia is well advanced in its preparation to meet potential longer-term fiscal challenges arising from increasing healthcare costs and population ageing through a broad range of reforms, including the establishment of a Future Fund to cover future public-sector pension payments.

6. Improved Corporate Governance

Australia's corporations law has been substantially modernized since the launch of the Corporate Law Economic Reform Program (CLERP) in 1996. In particular, the CLERP 9 Act 2004 (Audit Reform and Corporate Disclosure) enhances the financial reporting framework by improving regulations relating to auditing, financial disclosure and shareholder participation. The Act contains significant reforms in the area of auditor independence and covers other

⁴¹ The 2005 Productivity Commission report noted that further reforms were required in Australia. The Productivity Commission is the Australian government's principal review and advisory body on microeconomic policy and regulation.

audit-related issues such as standard setting, oversight and liability. It also deals with aspects of the disclosure framework for shares, debentures and financial product advice which improves the quality of information that market participants use in making investment decisions. Most of the reforms took effect in the latter half of 2004, with some commencing in early 2005. From 1 January 2005, Australia also adopted International Financial Reporting Standards for financial reporting purposes.

Continuing reform proposals include reducing the regulatory compliance burden, corporate social responsibility and the treatment of corporate groups.

7. Improving Public Sector Governance

In November 2002, Australia commissioned a review of the corporate governance of statutory authorities and office holders (the Uhrig Review). The main objective was to identify issues surrounding existing governance arrangements and to provide options for the government to improve the performance of statutory authorities and office holders.

The review was asked to develop a broad template of governance principles and arrangements that the government could extend to statutory authorities and office holders, and potentially to a wider range of public-sector bodies. The governance templates were developed to delineate between statutory authorities whose major activities were commercial and those undertaking regulatory and service provision operations. Both templates detail measures for ensuring that the boundaries of responsibilities are better understood and that the relationship between Australian government authorities, ministers and portfolio departments is clear.

Australian government ministers are assessing the governance arrangements of 160 Australian government statutory authorities and office holders within their portfolios against the report’s governance templates and principles. Assessments have been prepared on a rolling basis throughout 2005 and have continued in 2006.

8. Strengthening Economic and Legal Infrastructure

In 2007, Australia is expected to implement law reforms to improve its domestic framework for corporate insolvency that have been developed through a comprehensive review process. It is also expected to adopt the UNCITRAL (United Nations Commission on International Trade Law) model law on cross-border insolvency.

CANADA

Structural Reforms in Canada, 1989–2006

The need for structural reform in the Canadian economy was evident by the early 1990s. As in other industrialized countries, GDP growth had slowed considerably, reflecting a downturn in productivity growth that began in the 1970s and persisted until the mid-1990s. As a result, growth in real household income stagnated. Unemployment increased from an average of 4.9 percent during the 1960s to 9.4 percent during the 1980s, and over 10 percent by the early 1990s. Inflation exploded following the oil shocks of the 1970s and years of chronic deficits, used to finance current spending, had pushed Canada’s debt-to-GDP ratio to levels above the G7 average. By 1992, net lending in Canada had reached over nine percent of GDP and net financial liabilities⁴² had reached 68 percent of GDP (compared to the OECD average of 49 percent). The impending retirement of the baby-boom generation gave added impetus to fiscal reforms lest both current debt and unfunded liabilities be passed on to future generations.

In the early 1990s, decisive action was taken to stop the vicious cycle of deficit and debt accumulation and to improve economic fundamentals. Trade liberalization, tax reform and inflation targeting were supplemented by pension reform spending reallocation and labour market policies designed to foster income growth and job creation. The following provides an account of some of the key structural reforms over the past 15 years that contributed to the improved economic environment Canada has today.

1. Improving the Efficiency of Capital and Labour Markets

1997 PENSION REFORM

Inaugurated in 1966, the Canada Pension Plan (CPP) underwent a major set of reforms in the mid-1990s to place the plan on a long-term sustainable path. Contribution rates—shared equally between employer and employee—were increased over six years from the 1998 rate of

5.85 percent of contributory earnings to 9.9 percent in 2003.

The year’s basic exemption—the first $3,500 of earnings in any year on which no contributions are paid—was maintained and frozen. Effective April 1998, an arm’s-length investment board was created to increase plan returns, tighten the provision of benefits and keep contribution rates down. The reserve fund is invested prudently in a diversified portfolio of securities and managed by a new Canada Pension Plan Investment Board, acting at arm’s length from government.

Financial Sector Reforms

The financial sector framework has undergone significant reform in the last two decades. The move to allow foreign bank branching in the late ’90s and to open the banking sector to small, closely-held entrants for the first time in 2001, has contributed to making the Canadian financial services sector more competitive, while enhancing choice for consumers. The demutualization legislation in 1999 has made it possible for Canada’s largest insurance companies to significantly increase their share value and become some of the largest life insurance companies in North America. In addition, the 2001 legislation introduced increased flexibility in

⁴² Net lending and net financial liabilities are the measures of the deficit and debt commonly used by the OECD.

terms of investments and structural organization for Canadian financial institutions and established measures to ensure that Canadian consumers and SMEs were appropriately served and protected.

The government’s commitment to conducting regular reviews of the financial sector framework has been key to Canada’s success in ensuring that its financial services sector is efficient, competitive and poised for growth.

As part of the 2006 legislative review of the financial institutions, which is currently underway, the government is making selective changes aimed at enhancing the interests of consumers, increasing legislative and regulatory efficiency and adapting the financial sector framework to new developments, while maintaining the safety and soundness of the sector. The government has proposed several changes such as developing a new consumer disclosure regime, limiting cheque-hold periods, raising the loan-to-value ratio requiring mortgage insurance from 75 percent to 80 percent, simplifying the foreign bank entry framework and reducing regulatory burden by narrowing the framework to focus on real foreign banks, streamlining certain regulatory approvals and allowing financial institutions to use electronic cheque images in the cheque clearing system. Legislation will be introduced this fall to implement these refinements to the legislative framework.

Currently, efforts are underway to simplify securities regulation in Canada.

Canada has taken steps to ensure confidence in Canadian markets in the wake of the Enron affair and subsequent corporate scandals. The Canadian Public Accounting Board (created July 2002) administered and enforced a new system of auditor oversight. New draft guidelines by the Accounting Standards Board (AcSB) and securities regulators aim at improving the transparency of financial statements.

1996 Labour Market Reform

In the early 1990s, labour market policies contributed to a high level of structural unemployment and a pattern of repeat use, particularly among seasonal workers. The Unemployment Insurance program underwent a series of major reforms during the 1990s, which made the program less generous. The 1990s reforms increased the number of weeks required to qualify for benefits and reduced weeks of benefit entitlement. The replacement rate was reduced from 60 percent to 57 percent, and those who left their jobs voluntarily were disentitled to benefits. The 1994 reforms increased qualifying weeks, reduced benefit durations and further adjusted replacement rates.

With the 1996 Employment Insurance Act, income benefits were redesigned to promote greater labour force attachment and to introduce stronger insurance principles into the system. Eligibility was changed to hours of work rather than weeks worked, a new benefit structure was introduced and eligibility requirements were tightened.

2. Improving Regulatory Quality and Enforcement

2003–2006 Regulatory Reform

The Government of Canada established the External Advisory Committee on Smart Regulation (EACSR) in May 2003 to provide advice on how it could redesign its regulatory system to better serve the needs of Canadians in the 21st century. In September 2004, the Advisory Committee released its report entitled Smart Regulation: A Regulatory Strategy for Canada. The report recognized that good regulation is essential to a robust economy, and an appropriate regulatory framework should help to protect the health and safety of Canadians and the environment, at the least possible economic cost. The report called for a regulatory system, from the design stage to compliance and enforcement, that was effective, cost-efficient and timely, as well as transparent and one where the regulators were accountable for their performance.

The government launched its Smart Regulation initiative in March 2005 to strengthen regulatory management through the development of new policies and tools, including an open, consultative lifecycle approach to regulation, and building capacity and expertise within the regulatory community. Canada is also improving coordination on regulation development and management, both within the federal government as well as working with other governments, both nationally and internationally. The goal is to create a regulatory system that is highly responsive to the dynamic nature of the domestic and global economies, and provides Canada with a competitive advantage.

The federal government’s Smart Regulation initiative has already yielded concrete results:

• The review backlog for pharmaceuticals has been eliminated and review times substantially reduced, improving access to safe and effective new drug therapies.

• Development of a faster and more efficient system for assessing new chemical substances while maintaining environmental and human health standards.

As part of the Smart Regulation Initiative, the government has also created the Paper Burden Reduction Initiative, whose mandate is to develop a plan for measuring and reducing administrative costs. The final results of the first small business survey of administrative compliance costs will be released in late 2006. The government is also reviewing and updating the 1999 Government of Canada Regulatory Policy. The new Government Directive on Regulating will strengthen federal regulatory governance by making clear commitments regarding how the government will regulate, and by outlining clear analytical and process responsibilities for departments and agencies at all stages of regulatory management, including development, implementation, evaluation and review.

3. ENHANCING MACROECONOMIC STABILITY

1991 Inflation Targeting

Low inflation facilitates long-term planning and encourages business investment that ultimately boosts productivity. In 1991, the Bank of Canada and the Government of Canada agreed to a targeting framework in order to bring inflation down to low and stable levels. In 1991, inflation stood at 5.9 percent. The targets sought to bring inflation first to 3 percent, then to 2.5 percent and ultimately to the mid-point of the bank’s 1-3 percent target range. Despite a run up in year-over-year total inflation recently due primarily to energy price increases, core inflation and inflation expectations remain firmly anchored at 2 percent.

1995 Fiscal Consolidation

During the mid-1990s, the Finance Committee of the House of Commons held hearings across Canada and subsequently recommended to parliament that immediate and decisive action be taken to halt the government’s fiscal deterioration. Canadians accepted that the process of fiscal consolidation would involve difficult decisions but felt that the continued accumulation of debt to fund current programs was unacceptable.

In 1995, the government implemented Program Review, a year-long, top-to-bottom review of all departmental programs, covering about C$52 billion in spending. The main objective of the program was to review all categories of federal government spending—except certain statutory programs—in order to bring about the most effective and cost-efficient way of delivering programs and services to Canadians. In 1994, current expenditures of the federal government stood at 16 percent of GDP, by 2002, after several major reinvestments, current expenditures stood at 12.7 percent. Programs that were deemed inefficient or no longer relevant to current conditions were eliminated or drastically cut, and funds were reallocated toward those programs that worked well and would foster economic growth and job creation.

As part of Program Review, subsidies were reduced to limit distorting effects on economic activity. Furthermore, the government’s interest in Cameco, Canadian National Railways, Petro-Canada, the Air-Navigation System and Canada Communication Group was privatized or commercialized.

Together with spending reductions, deficit targets were established, and a prudent approach to budget planning was implemented to ensure that targets would be met. In the space of four years, the federal government eliminated a deficit of C$42 billion and placed the federal debt on a permanent downward track. To ensure continued balanced budgets, the government uses prudent economic assumptions to develop fiscal projections for budget-planning purposes. Economic prudence, which rises over time, is built in to the five-year fiscal projections to provide further assurance against falling back into deficit. Finally, the annual Contingency Reserve is set aside to guard against unforeseen circumstances. If it is not needed, the Contingency Reserve is applied against the federal debt.

In 1990, debt charges absorbed 35 percent of federal revenues. By 2002, interest payments on the federal debt took less than 20 percent of federal revenues, freeing revenues for other priorities of Canadians.

Sustained budgetary surpluses finally put the debt burden on a downward track. In 1997, the federal net public debt-to-GDP ratio recorded its first significant decline in 25 years, falling to

64.7 percent from 68.3 percent in 1996 (National Accounts Basis). Federal net public debt stood at 38.7 percent as of the end of the fiscal year 2004-05.

2003 Expenditure Review

Following the success of the 1995 program review, the government launched an ongoing review of all non-statutory programs in 2003 to ensure they continue to be relevant, effective and affordable. Over a five-year cycle the treasury board will examine the programs of federal departments and agencies, to determine systematically whether the program is still relevant to the needs of canadians and whether the program’s resources are being used in the most efficient and effective way to deliver appropriate results.

2006 EMS Reform

In 2006, the government launched a review of its expenditure management system. The three guiding principles for this review are that government programs should focus on results and value for money; that government programs must be consistent with federal responsibilities, and that programs that no longer serve the purpose for which they were created should be eliminated. The objectives of this review are to ensure that the growth of program spending is sustainable and that the federation works better for all Canadians.

4. Other – Trade

1989 CANADA-US AGREEMENT ON FREE TRADE

In 1989, Canada signed a free trade agreement with the United States to promote productivity improvements, full employment and encourage foreign direct investment. The agreement would also promote competitiveness and ultimately boost living standards in Canada.

Although there were some inevitable job losses during the transition period, trade with the United States has increased substantially, as has productivity, direct foreign investment and growth in Canadian living standards. Exports to the United States, as a share of total exports, increased from 73 percent in 1988, to 84 percent in 2005.

1994 NAFTA

In 1994, the Canada-US Free Trade Agreement was expanded to include the phased elimination of tariffs between Canada, the United States and Mexico. The agreement created, at the time, the largest free trade area in the world. As a result, Canadian exports to Mexico have grown by almost three-fold between 1994 and 2005.

1995 Domestic Trade Liberalization

With a view to removing internal barriers to trade and investment within Canada, the federal and provincial governments are partners under the Agreement on Internal Trade (AIT), which came into effect on 1 July 1995. The signing of the AIT led to important strides in liberalizing trade and factor flows, especially with respect to labour mobility. However, some barriers remain, particularly with respect to trade in energy, government procurement and business regulations. In recent years, provinces have recommitted to addressing remaining internal trade barriers, with the strong support and participation of the federal government. Progress includes recent bilateral agreements between the states of British Columbia and Alberta, and between Quebec and Ontario, addressing long-standing trade irritants between these provinces.

Continued Trade Liberalization

As of January 2003, all products from the Least Developed Countries (LDC) became eligible for duty and quota-free entry, with the exception of certain dairy, poultry and egg products. Further, in 2004 Canada completed implementation of its Uruguay Round tariff reduction commitments and eliminated all quotas on textiles and apparel.

5. Other – Tax Reform

1988 Personal Income Tax Reform

Fundamental reforms to the personal income tax system were undertaken in 1988, at which time seven of 10 tax brackets were eliminated, most deductions were converted to nonrefundable credits (an approach that is more progressive because it gives the same tax benefit to all taxpayers regardless of their income), the tax base was broadened (e.g., mainly through increased taxation of capital income) and certain tax preferences were reduced or eliminated (e.g., elimination of the C$1,000 annual deduction for interest income). The second phase of the 1988 reform—the introduction of the Goods and Services Tax (GST) in 1990—addressed many of the distortions of the Manufacturers’ Sales Tax it replaced, by removing taxes on capital inputs, and providing a more neutral treatment in the taxation of goods and services.

1991 Sales Tax Reform

In January 1991, the GST replaced the outdated Manufacturers’ Sales Tax (MST), which had been in effect since 1924. The MST was highly complex in that it was subject to no fewer than 22,000 special provisions and administrative arrangements. The GST, a multi-stage, value-added tax, is simpler, fairer and more visible than its predecessor.

Businesses are entitled to receive a fully refundable credit (i.e., an input tax credit) for the GST they pay on the goods and services they purchase as inputs into their production and distribution processes. To offset the regressive impact of a broader taxation base on low-income Canadians, the GST credit, a refundable income tax credit, was introduced along with the tax.

The replacement of the MST by the GST has helped to make Canadian manufacturers more competitive. The GST applies to all imported goods and services, but does not apply to Canadian manufactured goods and services that are exported to other international markets. The GST has also made consumption tax rates more equal across commodities, thereby reducing relative price distortions in the economy.

On 1 April 1997, three of the Atlantic provinces—New Brunswick, Nova Scotia, and Newfoundland and Labrador—combined their provincial sales taxes with the GST to create a single harmonized value-added tax structure. In partnership with the Government of Canada, these three provinces introduced a new 15 percent joint federal-provincial Harmonized Sales Tax (HST).

Recent Tax Initiatives

As federal finances were placed on a healthy and sustainable track in the late ’90s, the government began to reduce taxes on individuals and businesses, to reduce distortions in the economy and to foster job creation and economic growth.

For individuals, this included certain structural reforms to the federal personal income tax system such as the restoration of full indexation and the elimination of the deficit-reduction surtax in 2000. Foremost, however, significant personal income tax relief was provided, largely within the prevailing tax structure, through higher credit amounts, lower tax rates and higher tax brackets.

More recently, in 2006, broad-based tax relief was provided by a one-percentage point reduction in the GST, increases in the basic personal amount—the amount that all Canadians can earn without paying federal income tax, and a reduction in the lowest federal personal income tax rate from 16 percent to 15.5 percent.

A number of targeted personal income tax measures were also introduced in 2006 to reduce barriers to paid employment and support a more skilled and educated workforce. These include:

• The introduction of the Canada Employment Credit (CEC) in recognition of work-related expenses incurred by employees.

• A commitment to developing a Working Income Tax Benefit (WITB) —an earned income tax credit—which will enable more low-income individuals to become self-reliant by improving their incentives to work.

• A new deduction of up to C$500 for trades people for the costs of tools in excess of C$1,000 that they must acquire as a condition of employment.

• A new tax credit for the cost of textbooks.

• The elimination of the current dollar limit on the amount of scholarship, bursary and fellowship income a post-secondary student can receive without paying federal income tax.

• For business, significant action has been taken since 2000 to improve the competitiveness of the federal corporate tax system, especially vis-à-vis the U.S. These actions include:
• Reducing the general corporate income tax rate to 21 percent from 28 percent, which will be followed by a further two-percentage point reduction, to 19 percent, by 2010;

• Eliminating the corporate surtax for all corporations in 2008, and

• Fully phasing out the federal capital tax in 2006.

As a result of these actions, Canada established a solid corporate statutory tax rate advantage over the U.S. in 2004 and set the course to increase that advantage to over five-percentage points by 2010. These measures will also achieve a slight overall tax advantage for business investment over the U.S. by 2010, as measured by the marginal effective tax rate on investment.

Important steps have been taken to support the growth of small businesses since 2000. In particular, the amount of small business income eligible for the reduced federal tax rate was raised to C$300,000 from C$200,000 in 2005, and will be raised further, to C$400,000, by 2007. The rate that applies to this new threshold will also be reduced to 11 percent from 12 percent. These steps will help to ensure that Canadian small businesses continue to face lower tax rates on income above C$85,000 than their counterparts in the U.S.

6. Other – Social Assistance Reform

Social Assistance Reform

During the 1980s reforms to provincial social assistance programs generally made the system more generous and tended to encourage repeated and long-term use. Major and far reaching changes were subsequently implemented motivated by a desire to counteract the dramatic increase in program expenditures that occurred during the early 1990s (between 1989 and 1994 real social assistance expenditures in Canada doubled). These reforms represented a systematic change from those in the 1980s, involving not only changes in program parameters such as benefit levels, but also measures aimed at restricting eligibility through tightened administrative procedures.

Results