Report: How global medtech & pharma corporates engage with Australia (MTPConnect)

Pharmaceutical and medical technology corporates increasingly rely on external innovation to supplement and bolster their innovation pipeline. BioPacific Partners and MTPConnect recently undertook research, including a series of interviews with key personnel within the largest multinational companies, to uncover current trends and their attitude toward accessing external innovation from Australia. Download the report here to read more.

Pharmaceuticals

The size of the global pharmaceutical industry is estimated at US$1.2 trillion. The cost of research and development for new drugs, the high risk of failure, and the significant exposure many large pharmaceutical multinational companies have to patent expiry of blockbuster drugs means big corporates are increasingly looking for external innovations to fill product pipelines.

“Innovation does not have a boundary. There is no border limit, wherever there is good science, we go for it,” says the head of business development from a top 5 pharma company.

Pharmaceutical corporates are very positive about the Australian industry. “Australia has a lot going for it because it has great education, great science, a similar regulatory environment, and a great market,” says an external innovation director from a top 10 pharma company. “If something is making headway there, there’s a whole lot of hurdles it has overcome and it makes me think I can pick it up and run with it elsewhere.”

Pharmaceutical multinationals are often not embedded within the Australian environment – they see the logistics and cost of maintaining a scout in the region as an unjustifiable expense. However, the distance from the USA and Europe reduces the frequency and ease of engagement, and these delays are a significant barrier.

“One really needs to scour the world for innovation. But unfortunately, isolation adds a barrier for people – the time difference is inconvenient to make calls, travel distance – it is reality, and although that’s kind of silly with modern communication, it is still reality,” says a BD boss from a top 5 pharma company.

“You need to go and smell the place, interact with people, and get a feel for how far along the technology is. That’s where feet on the ground is useful,” says a top 10 pharma BD executive.

“Geography means the bar has to be higher,” say an external innovation boss from a top 10 pharma company. This lack of presence means that these companies are unable to explore innovation opportunities through informal interactions, and are therefore less likely to be aware of potential opportunities.

Some corporates suggest that Australia is a ‘nice to have’, rather than ‘cannot leave out’. “But innovation wise, the region deserves to be in the place of being critical rather than being nice to have,” says the head of external innovation from a top 10 pharma company.

Australian innovators can overcome these barriers by attending international industry events with partnering platforms such as BIO – considered a necessity by multinationals for identifying innovations of interest and catching up with those they have been paying attention to.

“We can’t justify spending resource in Australia when we barely have enough resource to cover China and Japan…. We have to rely on chance meetings at BIO or research conferences,” says an external innovation director from a top 10 pharma company.

Another barrier raised by corporates is the perception that Australian innovators struggle to translate science into commercially attractive propositions. A lack of understanding regarding the risk, global regulatory requirements, and data required by multinationals means technology is often not packaged with a value position aligned to the requirements of a multinational.

“Technology transcends geography – but business culture does not,” says an open innovation director from a top 5 pharma company. “I would put Australia in the bucket of there is some technology available but the business friction is high.”

“You’ll get university professors that think it’s okay to work on the development of their company while keeping their full-time academic job, whereas here in San Francisco, people will leave their full-time job,” says an external innovation director. “It wouldn’t be a question, they’d just leave.”

Medical technologies

The medical technology industry – which includes medical devices, diagnostic and medical imaging equipment – is estimated to have a global market size of US$350 billion.

Like their pharmaceutical counterparts, medical technology corporates look externally for new technology. They say they have no hesitation accessing world-class innovation from Australia, but suggest it is easier to hunt for medical technologies in their own geography – they point to Australia’s relatively small number of companies compared to the United States and Europe to evidence this.

In contrast to the pharmaceutical industry where partnering with innovators at an early stage of product development is now the norm, most medical technology multinationals prefer to wait until a technology has regulatory approval and can demonstrate strong sales. This mitigates the challenge of registration and the considerable work involved convincing physicians and surgeons that an innovation is worth considering (and often retraining for) over existing alternatives.

“[We] will not acquire companies that do not meet all our criteria. And the universe of buyers is not bigger than it was last year, or the year before – it is smaller. That’s the biggest issue,” says a VP from a top 5 medtech company. “You could beat your head against the walls wanting to be acquired – instead, companies should be focused on building their business.”

Medical technology innovations are increasingly being developed for a consumer market, including mobile phone sensors, smartwatches, fitness trackers, apps – and data. This movement is causing great concern in the industry over where revenue will come from.

Explains BD VP from a top 5 medtech company: “I joke that I’m glad I am closer to the end of my career than the beginning because I’m not inherently wired to think this way. Belonging to the older generation of medtech, I had a gut feel, and it was pretty good. I don’t have that for the future… I think it is incredibly naïve to think that technology and digital won’t fundamentally change the sector.”

These changes, as well as disruption from advances in China, mean corporates are being forced to adapt their business models. Along with this, global tech giants including Google, Apple and Amazon have begun a move into medical devices.

Explains a BD director from a top 5 medtech company: “Someday I am going to need a new hip. I’ll go onto Amazon, where there will be a base one, and then ones with extra features… I’ll select my hip, pick my doctor, choose a hospital (after checking their reviews), and take my basket to the checkout. Somebody is going to figure it out.”

Unlike the pharmaceutical sector, medical technology events are far less partnering-focused than in the pharmaceutical industry. Most corporates attend these events for corporate responsibility, government affairs, meeting vendors, and for recruitment purposes.

In part, this is because the niche areas of interest to medical technology corporates mean that most are aware of developments in their space. “In certain spaces we know the activity so well – we are rarely surprised,” says a business development VP from a top 5 medtech.

But for Australian innovators, they encourage a direct approach. Says one executive: “95% of opportunities come from companies that have called us. We can quickly and easily gauge the pros and cons of technologies and companies.”

 

 

Capital Markets: The Direct approach – an interview with Direct Capital’s Ross George (NZ Herald)

Originally published in the New Zealand Herald

Direct Capital’s Ross George is a pioneering veteran of the New Zealand private equity market. Now, 25 years after raising Direct Capital’s first fund, George is still going strong. He talked with Capital Markets about how he got started here as a 32-year-old, the dynamics of the market and some of his standout transactions.

Herald: You were very young when you came back to New Zealand to raise the first fund for Direct Capital — which you listed.
Why did you make that decision to list and how did you have the confidence to do that at such a young age?

George: I was 32 when I came back. I did come back to raise the first fund for Direct Capital but it didn’t actually work on its first go. That was the early 1990s. New Zealand was quite depressed. There was huge distrust for investment professionals after the party of the 1980s and the private equity industry didn’t exist in New Zealand. There were a couple of venture capital funds including a Government one called Greenstone. We had to educate investors what private equity was. It was called direct investment back then.

I then convinced my varsity mate Mark Hutton to come back from Monaco to join Direct Capital and Bill Kermode, who I knew from school, to do the same. It got off the ground once the three of us teamed up. We were all young but we had confidence because I came from the industry, Mark was in a senior financial position in Monaco and Bill was well known in Wellington where all the institutions were.

The listing was a happenstance. We planned a private fund of $50m which was quite a lot at the time. The listing came about in a funny way actually. I was doing a presentation to about eight people in AMP in Wellington in the middle of which they all started talking amongst themselves and then gradually one by one got up and left. I did the second half of the presentation with a couple of analysts who were over compensating by nodding a lot. Towards the end the big bosses came back in and said “if you can write us a good proposal and agree to list it, we will put $25m in”. That was enticing but it put at risk the only money we did have at the time which was from the Bell South Pension Fund whom I knew from Hong Kong. We actually lost Bell South as a result of the listing decision. But AMP were quite a bell cow for other institutions and we listed with over 10 institutions on board which was a great effort. The other positive of the listing route was we appointed Rob Morrison and Ord Minnett as brokers who did a fantastic job for us.

Herald: In the last few years Direct Capital has transitioned from the three tight partners — Mark Hutton, Bill Kermode and yourself — that ran the fund over the first 20 years. What made you decide to continue after their exit?

George: Yes, it was a great partnership and we are still joined at the hip in a number of investment vehicles.

While Bill left, Mark is still an owner, a director, and on the investment committee. He is not a full time executive but remains actively involved.

It’s actually been a continual succession process since we started through Gavin Lonergan, Tony Batterton, Simon Plowman through to the current owners, Travis Sydney, Heath Kerr, and Andrew Frankham. Hugh Cotterill, our new partner joins in June. We have got very good at succession because we have watched it in a lot in companies we invest in.

I have continued on because I enjoy the work. It is like a university course where continual learning is the norm. You can be dealing with a pharmaceutical company one year, then a logistics company, a retirement village operator, an internet market place and an engineering firm the next. The commonality between them all is growth which is our focus. The rules of growth seem to be the same no matter what industry you are in. The easiest growth we have found to be is in Australia. For the last 20 years about 50 per cent of our revenues have been derived in Australia. Once you know it, it is a very good and successful market to be in.

Herald: Looking back over 25 years, what has been your stand-out performer?

George: We don’t typically highlight individual companies but we’ve listed some of our companies and their performance is public record. Ryman Healthcare has been an obvious highlight. We invested in it in 1996 when it had a small number of South Island retirement villages. The industry wasn’t that understood at the time as it was in its infancy. The people however were the best we had seen. John Ryder and Kevin Hickman had almost all of the bases covered between them. They had different skills but they were good mates and a great business combo. It wasn’t a popular investment at the time as people thought of it as property development. The drivers of this industry are far from it and we think they still are. Building the villages is a short period within a retirement village’s life. It is a people and healthcare industry once it is up and running.

John and Kevin wanted additional capital so they could accelerate what they knew to be a successful business model. It worked almost immediately. Ironically we had trouble listing it and there was reluctance at an institutional level to invest. Fortunately we knew all the institutions at the time and after a series of one-on-one meetings we got a sufficient number on board to proceed. Once it was on the market it didn’t turn into a darling for its first two or three years. We invested at an equity value of $23m! Its market cap hovers around $5 billion to $6b now.

We are very proud of Ryman and to complete the circle John Ryder is now non-executive chairman of Direct Capital, and just to complete another circle, we have re-invested into the retirement village sector alongside John in Qestral Corporation.

Herald: Scales Corporation is absolutely booming. You scooped it up from the South Canterbury Finance receivership in 2011, later listing it on the NZX — which paid off very well. Was that investment always a no-brainer?

George: We knew Scales very well for 5 — 10 years before we got to invest in it. In fact, our offer to invest in 2011 was our fourth attempt. We could never get the (Allan) Hubbard Group over the line.

It was put up for sale through the South Canterbury Finance (SCF) receivership and ironically (again) we absolutely struggled to get into that sales process.

The receiver had high valuation ambitions and Goldman Sachs thought we had insufficient money to buy it. Although that wasn’t completely true we understood their view so teamed up with ACC and NZ Super in a consortium and were then allowed into the process. We knew Scales was not a straight forward investment for anyone unfamiliar with it and we knew it had been tied up in the South Canterbury Finance group which would scare others off.

We didn’t really scoop it up because we think 28 parties were approached and one by one they fell away through the process. Commentators also tend to ignore the high level of debt in the business at the time which we reduced over time. It wasn’t “scooped up” on an enterprise value basis. In any event, we clearly had the most attractive offer at the end which was well financed. I also think we were attractive to Andy Borland and his management team because a number of other bidders only wanted one division of it and our offer was for the whole lot.

Scales is a great company which again has a great group of managers and that is why it’s successful. The investment was in no way a no-brainer in fact it was a very difficult investment to make for all of the reasons above.

Herald: Which company has been the biggest turnaround challenge?

George: It’s one of the most common questions we get asked and we always disappoint by not answering it but the simple truth is that we are always investing into private companies alongside other shareholders, often family groups, and management and our partners are usually quite private individuals. They expect their privacy to be respected and we honour that. In fact, many owners tell us that is the reason they prefer private equity over other options.

But of course very few businesses travel in a straight line of success. Private companies are just as subject to economic and business cycles as anyone. When business gets difficult it is often due to changes in industry structure or risks that do in fact eventuate. Occasionally you have to accept that what you invested in is different to what you thought it was. Thankfully we have delivered very good returns to our investors for 25 years because those situations are the exception, not the norm. When these situations do occur you have to ensure you have the right information to evaluate whether more capital will solve it, or more time. And sometimes it is neither. Investment is rarely a binary “good call or bad call,” it is managing identifiable risks and being patient when required.

One of the reasons private company investment is so successful is the alignment of interest between shareholders and management. In private company investment you invest alongside the owners and management.

Everyone has skin in the game. Both we and they have a vested interest in solving business issues when they arise, rather than management just moving on to the next career assignment. In our view this alignment of interest is one of the most powerful drivers of value in private company investment.

Herald: What have been the lessons you have learnt from an investment that hasn’t gone so well?

George: We invested in a people based company with five owners. We only discovered after we made the investment that only three of them were keen on expanding the partnership to include us.

It was difficult for those five and us but we managed our way through it. It wasn’t a financial success and it shows the value of a harmonious partnership. It’s easier to run a company when all the owners are on the same page.

The lesson out of this was to spend a lot more time with all the owners before investing to find out everyone’s motivations. Nowadays, we ask our prospective partners what their objectives are and we can handle almost every variable we are faced with — ie do they want to stay in the business for ever, do they want out, do they want to be part-time or more flexible, do they want to change roles etc. We can accommodate all of this as long as we know it.

Herald: You hold a retreat every two years where you get all the companies you have invested in together. What’s the rationale behind that?

George: We have held 13 of them and I think they look forward to them as much as we do. Direct Capital doesn’t buy a business, it invests into a company with other shareholder owners so you get quite close to the people you are in business with. Fortunately in a growth company it is also quite good fun and over time you get to like each other and since you have dealt with a myriad of issues in the trenches you know each other really well. The most extraordinary thing is that the people we invested alongside in the early 1990s still come, and they become mates with all the other companies.

Our partners are a group of similar people who enjoy catching up with each other.
We try to make it mostly educational during the day with drinks and dinner and some form of entertainment at night. They never know where they are going and just agree to meet in the morning at a café.

Part of the rationale is that companies we have invested in in the past are our best form of marketing to other company owners. In New Zealand everyone checks each other out and if you don’t check out well you don’t have an enduring business here. They all speak well of us and this conference is also to say thank you for that.

Herald: How has the New Zealand private equity market changed over 25 years?

George: The market has come a long way and is now professionalised with funds being run by experienced and proven management teams. In 1994 it wasn’t really an industry. In addition to the NZ-based managers we see Australian and international funds also active in the New Zealand market.

There’s also been the development of Limited Partners — institutional funds who now allocate capital to the private company market as a matter of course. And it’s not just the evolution of General Partners and Limited Partners — we’ve seen the banking, legal and advisory community grow enormously to service the industry.

And a huge benefit of this is that company owners have also become much more familiar with private equity and understanding of the benefits a financial partner can bring to their business. This was something we used to have to explain to them. Today, a sell down or introduction of a financial partner is a common and accepted (and often preferred) option for business owners thinking about growth or capital.

The operating standards of private equity firms have also advanced through the influence of Limited Partners, who are all part of global networks. Direct Capital operates to international standards in terms of reporting, governance, identifying and managing environmental, social and governance issues (ESG). We were the first New Zealand private equity manager to become a signatory to the United Nations Principles of Responsible Investment (UNPRI).

Herald: You’ve said previously that the private company market is at least 10 times bigger than the listed company market in New Zealand. What does the NZX need to do to build confidence for public listings?

George: We are involved in the Capital Markets 2029 Taskforce currently underway and are very supportive of NZX initiatives to deepen our public markets. We don’t see private equity as a competitor to the NZX.

We are complementary to each other. We have led the IPOs of several of our companies — Ryman, Nobilo Wines, Scales, and New Zealand King Salmon and would expect to list others over time.
I think the first thing to acknowledge is that not every private company can be listed or indeed wants to be listed. As I mentioned, private company owners are often family groups or comprise a small number of shareholders and are quite private people.

Company owners often have strategies that will take several years to execute. When listed there is a natural focus on more immediate performance.  Owners often express a concern about their ability to remain focussed on longer term growth initiatives in a public environment. It’s a common issue in the US and around the world.

Beyond that, a broader market of public market intermediaries would be helpful. We have seen the benefit of that in the private company space and I believe the same would be true for the listed sector.

Herald: What are your predictions for the private equity market over the next five years?

George: We are 25 years old this year and have invested in 75 companies. In the larger mid-market area that we operate in we know there are close to 1000 private companies that are of a size that we could invest into. We’ve barely scratched the surface. Of course those companies need a catalyst to introduce a financial partner — whether it is to fund growth or succession. I think the next five years will be a continuation of the past 25 years.

Capital will continue to accelerate growth. In our 25 years, the benefit of new capital into business has been clear.

Our companies, in aggregate, have grown their employee numbers by 44 per cent and revenue by 64 per cent. Inevitably we will see a cyclical correction — probably sooner than later. But we’ve been through a number of those periods in our 25 years and good businesses with good management teams, and that are well-capitalised will continue to thrive. Indeed, investing in cyclically difficult times has proven to generate the greatest value in our experience.

We’ll see second generation managers emerge and that will be a healthy sign of a continuing maturity in our market. I’d like to think we’ll see more institutional investment into private companies.
KiwiSaver is the obvious elephant in the room for its lack of investment despite the positive international evidence of pension funds in the space and the natural compatibility of the investment timeframes.

KiwiSaver is now at a scale where issues such as the requirement for liquidity and pricing on a daily basis, for example, are not that credible for what would be a small percentage of overall asset allocation.

There is no doubt, New Zealand’s private company sector continues to provide excellent opportunities for experienced managers to accelerate growth and generate investor value. This is confirmed by an array of institutional investors continuing to consider increasing mandates targeting private capital in New Zealand.

Capital Markets: A new role model for growth (NZ Herald)

Read more

Capital Markets: EY monitors record activity (NZ Herald)

Read more

Capital Markets: Fintech revolutionises finance (NZ Herald)

Read more

Reflections from MCing the China Business Summit

Newshub Nation Panel: April 13, 2019

China Business: 2019 – a year of challenges (NZ Herald)

Read more

China Business: 2019 – Exchange securing a future (NZ Herald)

Tim McCready talks to James Fok, Head of Group Strategy at the Hong Kong Exchange

Herald: What sets the Hong Kong Exchange apart from other exchanges around the world?

Fok: We’re one of the top several exchanges in terms of market capitalisation in the world. We have been number one in IPOs in six of the last 10 years. In many ways, we have a fantastic business — particularly leaning on mainland China and helping Chinese companies from the 1990s onwards raise capital from international markets. Unlike many other cash equity exchanges around the rest of the world, we have quite a lot of growth in our core business. While in New York you’re seeing the number of listed companies fall year-on-year, we’re seeing the number of listed companies go up.

Going back almost 10 years now, we recognise that mainland China is also changing in the way in which it operates and is structured. The first H-share company [companies incorporated in mainland China that are traded on the Hong Kong Stock Exchange] to IPO on the exchange was Tsingtao Brewery Group in 1993. At that time there wasn’t a lot of capital in China, so if Chinese companies wanted to raise capital they had to come out into international markets, and Hong Kong was a place that enabled them to do that.

Herald: With China opening up over past decades, how has the Exchange’s relationship with China changed?

Fok: Today there is a huge surplus of capital in China — notwithstanding the economy slowing down. There is over US$25 trillion sitting in Chinese deposit accounts that has not been deployed into capital markets. We still see a big opportunity with China, not necessarily with Chinese companies coming out to raise capital — although they are continuing to do that — but to try and find a way for Chinese investors to be able to diversify their investment in international markets.

Chinese financial market needs are also becoming a lot more complex. Chinese companies and individuals are doing a lot more things internationally, and supply chains are such that they are making sure they squeeze every bit of margin out of everything. That means they have to hedge a lot of the input prices such as metals and commodities. China is rich in many ways, but in terms of natural resource commodities it is generally having to import to supplement its own domestic production. On top of that, doing more business internationally means that there is foreign exchange risk, interest rate risk on foreign currencies, etc.

The role Hong Kong needs to play going forward is a much more comprehensive one. Not just the capital formation centre that we have continued to be, but we need to become a wealth management centre and a risk management centre for China as well. International investors coming here continue to come here for the Chinese exposure. They now have the option of going to the mainland directly, but many still find challenges in going directly onshore.

Now, as well as bringing Chinese companies here directly to list, the exchange is helping to provide a channel in which investors on both sides of the border can access each other’s market without the product or company being directly listed there.

We are providing a gateway for people to go in using their broker in Hong Kong — without having to open new accounts onshore — allowing access to the onshore market in as frictionless way as is possible, where we manage the differences in market structure.

Equity is still a large piece of the business, but more and more we have been shifting towards different asset classes as well — the most obvious was our acquisition of the London Metal Exchange in 2012.

Herald: How are new advances in fintech reshaping how you’re operating?

Fok: Stock exchanges are the original fintech businesses. Technology has driven our business for a very long time. But what seems to be happening at the moment in the technology space is that we have a confluence of factors that are forcing a huge acceleration in the pace of change.

That change, in many ways, has been hugely disruptive. You only have to look at retail businesses and what Amazon has done to those to understand that. When you look at stock exchanges and you look at the fundamental business model — providing a centralised place for people to buy and sell securities — generally that model is very efficient. But in every other facet of our business — ranging from clearing and settlement, the ways companies communicate with their investors, through to the day-to-day operational processes — that is now disrupted.

When you look at the ability of robotics and artificial intelligence to replace a lot of fairly menial — and actually relatively sophisticated but process-driven jobs — it’s phenomenal. We have had to, like everyone else, look at how we adopt technology into our business to drive efficiency.

Many businesses do this as a way to cut costs. There is an element to which that is true for us, but actually it goes much beyond that. Because everyone investing in our market has to use us, if we are inefficient as a market and as an infrastructure, it imposes a significant cost on all the market participants which ultimately affects Hong Kong’s competitiveness.

Herald: How is the exchange helping to attract smaller start-ups to Hong Kong?

Fok:  Last year we undertook the largest set of listing reforms we have done in 25 years. We launched three new chapters of our listing rules — all of which were targeted at new economy companies, but two in particular:

We launched a segment of our main board that caters to pre-revenue biotech companies. Many R&D companies when they come to market don’t have revenue, let alone profit. The biotech board allows companies from the biotech sector to come here and list. Prior to these changes companies had to at least have revenue.

The second component is to allow weighted voting rights. These allow founders to maintain control even if they are diluted below 50 per cent of the shareholding of the company. We didn’t offer these kinds of governance structures here, so we saw a lot of Chinese companies in the tech space find themselves in the US market.

We were number one for IPOs last year for the amount of money raised, and 32 per cent of that money raised came from companies listing under the new chapters.

Herald: The Hong Kong Exchange signed a Memorandum of Understanding with the NZX early last year. What was the purpose of this for the HKEX?

Fok: The long-term ambition for us is to develop the product offering in Hong Kong more widely. It is largely an equities market still today, and when you look at trading and market capitalisation, something like 80 per cent of turnover is on mainland Chinese companies. While this is precisely what attracts international investors, as we open up to more direct mainland China investors who already have a lot of China product to invest in onshore, we need to diversify our offering.

New Zealand isn’t the only country we have signed an MoU with.

Of course, on the stock side, New Zealand is not one of the highest priority markets — most Chinese investors looking to diversify will look to the US market. Instead, the purpose is to bring a more diverse range of products to the exchange. New Zealand has done very well in the agricultural milk future space — something that is potentially of relevance to mainland Chinese consumers, particularly given their consumption.

Promoting confidence

The NZX and Hong Kong (HKEX) exchanges signed a Memorandum of Understanding in January 2018 to further promote confidence and co-operation in Asia-Pacific markets. Under the terms of the memorandum, the exchanges seek to promote market development by considering opportunities in a range of areas, including foreign investment, derivatives, depository receipts, listed debt, dual listings and exchange-traded funds.

The NZX says:

  • This global alliance supports NZX’s commitment to increase its international presence, and our desire to expand the reach and connection of the New Zealand market, because growth in New Zealand’s public markets will come from having a wider range of listed products and increased market activity. Global alliances we initiated and are continuing to build with the Hong Kong, Singapore, Shanghai and Nasdaq exchanges support this.
  • NZX and HKEX have continued to work together since the memorandum was signed in January 2018. In April, NZX Regulation recognised the regulatory regimes and requirements for the Hong Kong, Singapore and Toronto exchanges. This allows companies listed on these exchanges to seek a secondary listing on NZX.
  • Seeking new ways to retain and attract customers has been a priority for NZX. It is vital to growing New Zealand’s public markets. Over the past 12 months, we progressed alliances with global peers to ensure that an NZX listing connects New Zealand issuers with the world.
  • Our relationships with the Nasdaq, Singapore, Hong Kong and Shanghai exchanges, and the transformation in our service offering to issuers, ensures we are developing a product that is relevant and competitive.

China Business: Why you can’t contain China (NZ Herald)

We’re in the midst of important structural shifts, says former World Bank President Robert Zoellick. Tim McCready reports

“China has had enormous progress over 40 years. It has had the most historic reduction of poverty in humankind,” says former World Bank President Robert Zoellick.

Zoellick, who led the World Bank through the global financial crisis and served as a US trade representative under President George W. Bush, points out that while Asian growth rates have been healthy, they have not been able to return to the levels they had before the 2008 financial crisis.

At the recent Asian Financial Forum he sent a message that the Asian growth model that was so successful for many decades would need to change.

Zoellick says  Asian economic policymakers have traditionally had a longer time-horizon.

“The old model began by relying on manufacturing at the low end of supply chains. It then integrated upward — adding efficiencies, learning, productivity — but relied on the assistance of exports to developed economies.

“I think that perspective is especially valuable today because we’re in the midst of some very important structural shifts.”

Though Asia has accounted for two-thirds of global growth in recent years, markets are nervous as major shifts are taking place: the end of the quantitative easing experiment and transition to a tightening cycle, slower growth in real trade over the past decade compared to the 20 years before the financial crisis, productivity increases in Asia, and the ongoing trade dispute between China and the US.

“Trade policies and rising economic nationalism around the world have disrupted commerce and created a great deal of uncertainty,” says Zoellick.

“Traditionally, governments put tariffs on final goods, but from 2010 to 2016 they focused on temporary trade barriers, targeting cross-border supply chains for raw materials and components.”

But while President Donald Trump’s hefty tariffs may have been intended to help US manufacturers by making foreign goods comparatively more expensive,  in reality, import taxes imposed on intermediate goods like steel and aluminium are pushing up prices of products manufactured in the US.

Belt and Road part of a new era

Zoellick says Japan, South Korea and Taiwan all offer cautionary tales — a bias towards incumbency and instrumentalisation has slowed the innovation process — and a rapidly ageing population and lower population growth are changing the dynamics. “We can see some of those trends in China today as well.

“One of the main challenges is: will Asia grow old, before it grows rich and wealthy?” he asks.

He says the new Asian model will need to focus on new and different types of supply chains, to meet the changing needs — first off — of the region itself.

He points to the Greater Bay Area as an example of how this transformation has already started in Hong Kong and China.

The Greater Bay initiative, established by the Chinese Government, links Hong Kong, Macau, and nine other cities within the Guangdong Province into an integrated economic and business cluster.

The 11 cities have a combined population of close to 68 million people — greater than the world’s largest city cluster of 44 million in Tokyo — and a GDP of around US$1.4 trillion (NZ$2.06 trillion).

The 55km Hong Kong-Zhuhai-Macau bridge-tunnel system which opened last year cut the drive time between the cities from up to three hours, down to just 30  minutes.

Zoellick sees the Greater Bay Area as a huge opportunity, but says the challenge for Hong Kong will be not only the hard infrastructure — railways, bridges, roads — but some of the soft connectivity to move capital, information, and people.

“Policies will have to focus on new cross-border logistics networks and the barriers that impede them, such as new infrastructure to facilitate trade, services, environmental conditions, energy access, standards, rules and a whole series of soft infrastructure issues, such as customs and tax procedures,” he says.

Zoellick says China’s Belt and Road Initiative could be an important part of the new Asian model — if it is correctly developed.

“Frankly, the world is still unclear about the real purpose of Belt and Road. Is it a move for geopolitical dominance across Asia?

“Is it a plan to export overproduction from some of the materials industries in China? Or is it a new corridor for development? How will other countries benefit?”

He says although it is important to focus on the new regional opportunities and obstacles of the Belt and Road Initiative, Asia must stay global in outlook. “For example, even with President Trump’s protectionism, consider the US economy.

“The private sector will continue to be the engine for innovation in the United States — whether it is big data, different business models, or biologics in medicines — Asia must keep linked into that to remain competitive and adaptive.”

A trade leadership vacuum

Zoellick says another important factor shaping trade in Asia is the way President Trump has seen the US abandon its previous role as a key player developing new rules for global trade.

“After some 70 years of a US-led system, I suspect that much of the world has taken the public good aspect for granted,” he says.

“People sometimes reacted against US behaviour and didn’t always agree with it, but because the United States is an innovative economy working at the cutting edge, US officials had to press for new norms and rules to help adapt the international system — in areas such as services, intellectual property rights, transparency, anti-corruption, investment, and even currency manipulation.

“When you consider developments in big data, along with things like personal sensors and innovation in medicines, they can have huge effects on health and are significant business opportunities — but only if the world develops the appropriate legal framework.

“Traditionally, the World Trade Organisation could help do this. But today the WTO is adrift.

“It will not be able to negotiate new rules unless the United States, European Union, China and others can reinvigorate the WTO.”

Zoellick says China might offer an alternative system, but if they do, the world is more likely to end up with a managed trade system.

“The big powers will emphasise national champions, political priorities and sovereign protections over a rule of law framework in which markets will operate relatively freely,” he says.

“That has very large implications for the small and medium-sized economies that have benefited enormously from a rules-based system over past decades.”

The ongoing trade war

Zoellick says that for the near term, he expects to see friction, accusations, and negotiations between China and the US become a fact of life and add to ongoing uncertainty.

But some of the tensions between the two economic giants go beyond Trump and are concerns held across the American political spectrum and among voters.

“A transactional deal would not address the fundamental issues which are causing widespread concern in the United States — including questions about the Belt and Road Initiative and the ‘Made in China 2025’ strategy, which has created anxiety that China intends to dominate advanced technology.

“These concerns are part of the political debate in the US,” he says. “The US cannot decouple from or contain China, but it can work together with China to make sure the rules are followed.”

Zoellick says that although Trump is a protectionist by nature, he will be sensitive to the market.

As he begins to think about his re-election — and particularly if the US economy slows down — he is more likely to do a deal.

“However, if there is a deal, I think we have to recognise that it is more  likely to be a truce than a solution,” Zoellick says. “Part of my concern is that I’m not sure President Trump thinks in systemic terms.  He thinks in deal-making transactional terms.”