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Companions Abroad: and New Zealand’s participation in global flows

February 2015

Authored by Living in remote nations, and have long had an intuitive

David Pralong understanding that being open to, and connected to, the rest of the is important for James Manyika the of their economies. There is hard evidence that they are right. Connectedness Sree Ramaswamy accelerates GDP growth, both in the short and long term. Recent research by the McKinsey Ben Fletcher Kate Yang Global Institute (MGI) finds that global flows of goods, services, finance, people, and data and communication contribute between 15 and 25 percent of world GDP.1 The country most connected to these flows—and inflows matter as well as outflows in the form of exports— will reap 40 percent more benefit than the least connected country. In short, connectedness is a virtuous circle—the richer the networks of connectivity and the more diverse the of flows and bilateral relationships, the more a country benefits.2 So how connected are Australia and New Zealand to the burgeoning landscape of global -border flows?

Shifts in the global-flows landscape The past 25 years have borne witness to four dramatic shifts in global flows.

The first of these has been robust growth in the global scale and value of all five types of global flows. Cross-border flows of goods, services, and finance reached $26 trillion in 2012 or 36 percent of global GDP—1.5 times the level in 1990.3 Today, 35 percent of goods cross borders and one in three of financing comes from a foreign creditor or investor. People flows have soared with 1 billion border crossings in 2011. Data and communication flows have grown the fastest. Cross-border Internet traffic has grown 18-fold since 2005; international call volumes have doubled. And these trends show no signs of abating. Flows of goods, services and finance are predicted to reach $85 trillion by 2025, people flows to reach 2 billion short-term travellers, and global online traffic potentially to expand another eightfold.

Second, existing routes of flows are broadening and deepening, and new ones 1 Global flows in a digital are developing as many more countries participate in the —especially age: How trade, finance, emerging economies that are becoming important as consumers and producers in the people, and data connect the world economy, global economy. Emerging economies now account for 38 percent of global flows, McKinsey Global nearly triple their share in 1990. South-to-South goods flows between emerging Institute, 2014. economies have grown from just $200 billion or 6 percent of total goods flows 2 Ibid. in 1990 to $4.4 trillion—25 percent—in 2012.

3 Unless otherwise specified, all figures in this paper are quoted in US dollars.

1 Third, there has been dramatic growth in the value associated with knowledge-intensive—as opposed to labour-intensive or capital-intensive—flows.4 Today, knowledge-intensive flows are worth $12.6 trillion a year. That’s half of total flows and more than the combined GDP of and in 2012. Knowledge-intensive flows are growing faster than many other types of flows. For instance, trade in knowledge-intensive goods is growing 1.3 times as fast as trade in labour-intensive goods such as apparel and toys. The same is true in services.

Fourth, digitisation is transforming and enriching all flows by reducing the marginal costs of production and distribution. We are seeing the creation of purely digital goods and services, the increasing use of “digital wrappers”—sensors that track flows and produce information about them that can be used commercially, and a proliferation of online platforms that are facilitating cross-border activity. Cross-border e-commerce has grown from almost zero in 2005 to 13 percent of global goods trade in 2013. Skype went from nothing to four percent to 39 percent of the level of international voice calls in just a decade. On eBay, more than 90 percent of commercial sellers to customers in other countries, compared with 25 percent of small businesses in the offline world. In the past, governments and multinationals were the only actors involved in cross-border economic activity. Today, even the individual entrepreneur or the “micro multinational” is able to participate courtesy of digital technologies.

A special connection The economic relationship between Australia and New Zealand has been the subject of much discussion and study.5 Today, the two economies are highly connected to each other in all five types of cross-border flow. Relative to the size of their economies, the two countries have more exchanges than most pairs of countries (Exhibit 1). Remaining obstacles to connectedness between Australia and New Zealand have been well researched and their removal is unlikely to be transformational for the relationship.

Exhibit 1 Australia and New Zealand are deeply connected economies 4 Knowledge-intensive Depth of relationship flows include R&D intensive-goods such Share of total flows between the pair, % Connectedness score 1 as pharmaceutical Country pair Goods Services Finance People Data Index drugs, chemicals and Australia-New Zealand 3 5 6 27 25 13 electronics, high-skill services such as - 13 7 7 18 10 11 professional services and financial services, and - 5 2 4 36 4 10 foreign direct investment (FDI) flows (since they United States-Mexico 11 4 2 13 6 7 are associated with management expertise). United States- 2 7 11 3 8 6 5 For a comprehensive bibliography of -Germany 5 4 5 6 9 6 publications on this topic, see Strengthening France-United Kingdom 3 4 5 7 10 6 economic relations between Australia and -China 6 3 3 4 10 5 New Zealand – Joint research report, United States-Japan 4 5 5 3 6 5 Productivity Commission United States-China 7 3 1 1 7 4 and New Zealand 1 Finance is the total of foreign direct investment (FDI); people is the total of international tourist arrivals; data is the total of cross-border Internet traffic. Productivity Commission, SOURCE: Comtrade; IHS; World Trade Organization; Telegeography; World Development Indicators, ; McKinsey Global Institute analysis December 13, 2012.

2 Standing together The McKinsey Global Institute Connectedness Index ranks Australia 17th for its participation in the five types of global flow out of 131 countries assessed, and New Zealand ranks 43rd.6 These rankings have fallen slightly since 1995 (Exhibit 2).

These rankings and their evolution may appear counter-intuitive, given the strong export-oriented nature of both economies, and the recent strength in commodity prices. However, the reality behind the slight declines in connectivity rankings is that Australia and New Zealand are not participating fully in the fastest-growing global flows: global value chains, emerging markets, and knowledge-intensive flows.

In comparison, Germany has increased its rank to become the most connected country in the world. Its rankings across all flows are in the top seven. Germany has a strong manufacturing sector, good participation in knowledge-intensive goods flows, and a central position in the This strong position has been bolstered by good infrastructure, supply of labour, and government policy.

Exhibit 2 Australia and New Zealand rank 17th and 43rd on global connectedness Rank of global connectedness, in total and by flow

Rank Flow Rank Country change Goods Services Finance People Data intensity %1

1 Germany 1 3 5 7 5 2 110 2 Hong Kong2 1 4 3 14 546 3 United States -1 8 9 5 1 7 35 4 Singapore 1 2 3 4 18 5 436 5 United Kingdom -1 13 6 9 7 3 60 6 Netherlands 2 6 7 15 29 1 157 7 France -1 9 10 36 15 4 60 8 Canada -1 16 22 13 9 18 76 6 The McKinsey Global 17 Australia -1 32 34 14 11 30 53 Institute Connectedness Index ranks 131 countries 21 Japan -1 14 24 10 82 15 44 on their connectedness 25 5 5 21 6 93 33 62 by looking at both the size 30 China 16 27 13 26 47 64 61 of inflows and outflows relative to their GDP or 43 New Zealand -3 61 59 58 25 47 63 population, and its share 49 South 4 43 50 49 56 73 63 of global flows, drawing 56 -3 31 49 39 113 65 56 on a methodology developed by Jay Squalli 1 Flow intensity is proportion of goods, services and finance to GDP; 2 Data unavailable for data flows SOURCE: Comtrade; IHS Global Insights; UN WTO; Telegeography; World Development Indicators, World Bank; McKinsey Global Institute analysis and Kenneth Wilson. See Global flows in a digital age: How trade, finance, people, and data connect 1. Strong in resource exports, less so in global value chains the world economy, Australia and New Zealand’s global flows show a bias towards the export of primary McKinsey Global Institute, April 2014; and resources. The resource-intensive exports of both countries nearly doubled in value Jay Squalli and Kenneth between 2008 and 2012, from $138 billion to $248 billion. However, even that growth Wilson, A new approach to measuring trade was not as rapid as the goods exports increases achieved by other countries including openness, Economic China and India. These two emerging economies, which gained five places and 16 places Policy Research Unit, respectively in their connectedness ranking between 1990 and 2012, have not only been Zayed University, Dubai, working paper number increasingly strong exporters but have simultaneously experienced significant growth in 06 - 07, May 2006.

3 their imports. These economies have become more connected through both growing participation in global value chains and via increasing consumption power. In contrast, Australia’s imports were static over the past decade and New Zealand’s imports declined by 0.3 percent per annum.7

This asymmetry between exports (outflows) and imports (inflows) has led to a comparative decline in connectedness, hampering overall GDP growth.8 Strong two-way flows of partially finished goods, services, people, and data promote the efficient allocation of resources, increase competition, and give domestic markets access to ideas and .

Geography puts Australia and New Zealand at a disadvantage in terms of participating in global value chains that now constitute more than half of the value of world exports.9 However, geography does not fully explain why the same imbalanced growth in services has been observed over the past decade. Australia’s services flows fell by 0.6 percent per annum and New Zealand’s by 1.6 percent a year in contrast to global growth of 2.1 percent per annum in this time period. Their performance on services element can be stronger given the technology available to both countries.

2. High exposure to China, less so with other emerging economies China is an important trade partner for both economies, accounting for 28 percent of Australia’s overall goods trade and 20 percent of New Zealand’s. China remains the primary focus of many Australian and New Zealand corporations seeking growth in —and for good reason. China accounts for nearly one-third of total emerging-markets trade and 12 percent of global goods exports and 10 percent of imports. Six of the top 20 trade routes in the world involve China. However, the strong focus on China means Australia and New Zealand may be missing opportunities for growth in other emerging markets in Asia, and for strengthening connections between them (Exhibit 3).

Exhibit 3 Most of Australia and New Zealand’s trade growth has come from China Australia and New Zealand goods trade by partner , 2002-13, % of total, $ billion

Emerging economies Goods trade value, 2013 157182 223 262 294 339 429 352 443 562 567 549 $ billion 100 LatAm 9 7 Adjusted for GDP; 90 Middle East & Africa 28 data sourced from Other Asia 26 80 ASEAN 76 Commodity Trade 70 Statistics Database, 60 China region 152 Statistics Division. 50 8 Global flows in a digital Others 58 40 age: How trade, finance, Intra-region 14 people, and data connect 30 NAFTA 43 the world economy, EU 61 McKinsey Global 20 Institute, April 2014. 10 Northeast Asia 84 9 Interconnected 0 economies: Benefiting 2002 2004 2006 2008 2010 2012 2013 from global value chains – synthesis report, NOTE. Numbers may not add up due to rounding. SOURCE: International Trade Commission; McKinsey Global Institute analysis OECD Publishing, 2013.

4 3. High commodities flows, low knowledge-intensive flows Over the past decade, Australia and New Zealand have experienced a decline in knowledge- intensive flows into and out of the region. Globally, knowledge-intensive flows have been growing at 1.3 times the rate of labour-intensive goods and gaining on their share of all flows, as we have noted. Yet knowledge-intensive flows in Australia and New Zealand have fallen from 36 percent of all flows in 2002 to 31 percent in 2012. While this trend reflects the comparative strength of primary resources exports in both countries, Australia and New Zealand now lag behind several major economies on their flows of knowledge-intensive goods, including the BRIC quartet of , Russia, India, and China; Mexico; and some Southeast Asian countries.

This is a missed opportunity. Countries that have high knowledge-intensive flows have strong R&D-intensive industries in their home economies or via companies active in other countries. India, for instance, manufactures pharmaceuticals for German and American markets.

Furthermore, data flows in and out of Australia and New Zealand remain comparatively small. In 2013, cross-border data flows per capita in Australia and New Zealand were less than half of those of and one-seventh of those of Western .

Getting in the flow Long-term economic growth will partly hinge on the two nations’ full participation in global flows. They can strengthen their performance in the three areas of opportunity identified above. There have been successful efforts to boost flows and connectivity in each of these areas—some in Australia and New Zealand—that can point the way ahead.

Global services value chains Australian and New Zealand economies have scope to raise their participation in cross-border service flows, especially to and from the rapidly growing consumer and business markets in neighbouring Asia. to increase connections to global value chains have historically been government-led, mostly in the form of infrastructure spending, new standards to stimulate innovation, and tax credits and grants. Some governments have set up state-owned enterprises to create a domestic supply chain that attracts international investment, such as the Taiwanese semiconductor firm TSMC, and state-owned car makers in China. However, the private sector is increasingly taking the lead in removing barriers to participation.

Emerging markets There is scope for both economies to engage more fully with emerging markets, especially in neighbouring Asia. Collaboration with partner nations has already proved effective, whether that collaboration has been focused on joint trade agreements, joint marketing, or collaboration to remove behind-border barriers. The role of the private sector is central as companies often spearhead development before seeking government’s support. Success in growing flows with emerging markets has taken various forms. Examples include Japan’s collaboration with India to create industrial corridors (and double the number of Japanese firms investing in India), and Morocco’s use of free-trade agreements with Europe, Arab countries, and the African Union to develop its connectedness. Power Africa, a private- sector led between the United States and several African countries to increase access to electricity in sub-Saharan Africa, was initiated by an investment of $9 billion 10 Fact sheet: Power Africa, from the private sector. The government of the United States has committed to provide The White House Office technical assistance, risk mitigation, and to leverage its relationships to bolster this financial of the Press Secretary, 30, 2013. commitment, all of which should benefit the ’s participation in global flows.10

5 Knowledge-intensive flows In a world being transformed by digital technologies, increasing the degree of digitisation of an economy is important not only to enhance knowledge-intensive flows but to promote economic growth. There are several instances of successful collaboration between business and governments to increase digitisation. In Australia, for instance, the growth of technology businesses in has been bolstered by support from the state government, which put in place an A$80 million information and communications technology strategy and initiatives such as the Technology Innovation Fund. Melbourne is now home to half of Australia’s listed technology companies and an increasing number of digital start-ups including Envato, 99designs, and SitePoint that generate a significant proportion of their revenue overseas.11 Elsewhere, Google and other tech firms have made a number of joint investments with local governments to fund start-up centres and accelerators such as Le Camping in Paris or Berlin’s Factory.

Digitisation is also opening up opportunities to take part in global flows for the small and medium sized enterprises (SMEs) that account for the majority of companies in both Australia and New Zealand. As we have noted, digital platforms facilitate cross-border interactions and make exports accessible to SMEs, only 2.5 percent of whom export to other markets.12 Increasingly large businesses are exclusively using digital technologies to, for example, advertise tenders, and it is therefore vital that SMEs embrace the digital world. In the United Kingdom, for instance, companies are increasingly posting tenders on online contracts-finder portals that can only be accepted through the government’s eSourcing platform.

New avenues of collaboration There is often an implicit expectation that it is largely up to governments to ensure that their economies are as connected as possible to the global economy. It is their job to facilitate access, remove barriers, and ease the path to international collaboration for its domestic champions. The governments of Australia and New Zealand have, of course, been playing this role from the original Closer Economic Relations trade agreement to more recent free-trade agreements. Given the economic imperative to participate fully in global flows, now may be the time to join forces across the , working together on efforts to boost connectedness with the rest of the world—in effect, being “companions abroad”. Collaboration could include joint sector-development agendas, stronger combined products and services, and concerted efforts to remove barriers to trade, finance and other flows.

However, the increasingly dispersed and digital nature of the global economy means that governments are important, but are no longer the primary actors. This a world in which even 11 J. Lim, “Australia’s Victorian government the individual entrepreneur can use digital technologies to build a global presence. This new is a model of innovation,” era requires different economic collaborations, not only between countries but between the Forbes Asia, December 2014. full range of actors in the private and public sectors. Large private enterprises, in particular, have an important role to play in rallying their industry sectors to concerted action. When 12 Ali Saleh and Viet Le, A review of SME export they do so, enterprises often find ready and effective government support. Cross-border barriers: The case of innovation and consolidation have also given rise to global champions in other and Australian small and have been value-creating for all countries involved. It is time for the private sector to lead. medium-sized exporters, paper presented at the 6th International Business and Social Science Research Conference, Dubai, January 3-4, 2013. Copyright © 2015 McKinsey & Company. All rights reserved.

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