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Cybercrime is fundamentally adver- users while they’re interfacing with When the process for sarial. A lone wolf or criminal outfit your services. Are they hesitating too verification is unified will probe every weakness in your veri- long when asked to make decisions? and data-driven, fication system and will stop at nothing Does their cursor move robotically? passive authentication to breach your defences. You need to 4. Public record: Publicly available becomes a reality. cover all your bases and ensure they information on the customer. Are have no place to hide. they accessing their services from a customer tries to sign-in or access their registered address? Does their a service, an orchestration platform At the same time, however, you given age match what’s on their should be set up to collect all the desired mustn’t go too far in the other direc- driver’s license? data points before sending them to a tion. You have a duty to protect your 5. Group and risk analysis: Wider data decision engine. The solution can then customers, but also to provide them from analysis of the market and analyse the data and evaluate if entities with the best experiences – something threat landscape. Is the email address are the customers they claim to be. an endless loop of authentication the entity is using part of a known methods can never deliver. fraud cluster? When the process for verification is unified and data-driven, passive authen- The 5 senses of security Organisations don’t have to imple- tication becomes a reality. The customer When you meet someone for the first ment every data type into their enjoys a real-time, seamless experience time, you make use of all your senses verification process. Yet every new – no password required – while the to get a first impression of them. The segment they do adopt vastly increases decision engine rapidly confirms iden- same principle should be applied to their chances of detecting and stopping tity in the background. This is security online interactions with customers. fraud in progress. and customer satisfaction all in one. Why wouldn’t you use all the informa- tion channels available to you to find Time waits for no one There is no silver bullet that will out if the user is being honest? However, data alone won’t protect protect your organisation from cyber- you or your customers. Once you have fraud in every event. However, when The problem is that credit, fraud and the data and a process in place for you have access to the right data and risk managers and their staff too often discovery, you have to do something the capability to interpret and act on make the call based on incomplete insight. with it. While models do an outstanding it in real time, you achieve the best of This is because they only collect and job predicting fraud, rules stop it. At both worlds. analyse some of the data that’s on offer. the same time, you need to act quickly. Customers won’t wait around if you John Watkins is an Industry If you don’t consider every possi- spend more than 10 seconds weighing Consultant for SAS Institute bility, you’re only leaving blind spots to up their credentials. The process has to who partners with financial be exploited. For example, an authen- be seamless and instantaneous. services companies to drive tication system may approve a request analytical and operational from cybercriminals simply based on Yet the industry’s approach to authen- solutions to prevent losses, reduce the device they’re using. Yet if the tication has sadly become segmented. compliance risk and minimise customer system had checked the device’s loca- There are thousands of point solutions impact. John’s 20+ years of financial tion and the customer’s behaviour, the that cover only one part of the verifi- services experience fuels a passion for hacker would likely have been exposed. cation process. They are rarely joined combining operational data and up and only waste customers’ time and processes with cutting edge analytics to The main data points to consider are: patience. It’s critical that the process identify and mitigate emerging fraud 1. Experiential information: The organ- begins and ends with the customer and risk trends. experience in mind. isation’s previous interactions with and knowledge of the user based Turning insight into authentication on an existing profile. Has this user To turn insight into an authentica- been denied access before, and why? tion decision, organisations should 2. Channel information: The channel consider an end-to-end solution. When or device the entity is using. Has the user accessed your services with a certain device before? 3. User behaviour: The behaviour of europeanfinancialreview.com 51

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Risk Management Managing Risk in a threats, this approach becomes even Modular Economy more important as many firms rely on shared cloud resources, such as Amazon BY KAMIL J. MIZGIER Web Services or Microsoft Azure. These services are often used to outsource The business world is constantly activities, however there is one aspect even the most critical business processes. changing, at a pace which humans of outsourcing and automation which The associated concentration risk is hard are not able to catch up with. The requires special attention, i.e. third to identify and manage if you don’t look premise of machines taking over the party risk management. It is becoming beyond your own organisation. most tedious, low value-adding business an ever increasing problem for Chief processes is very attractive from a budget Risk Officers of global organisations In the age of modular economy, and cost cutting perspective, which is so operating in a modular economy, financial services and manufacturing prevalent in the current low interest rate in which the majority of business firms are buying more and more new environment. From Boston Dynamics’ processes are executed beyond organi- technologies than ever before. By doing robots replacing humans in physical sational boundaries. so, they can offer enhanced services to activities to medical nanobots correcting their clients without having to develop human bodies through to financial How to assess and mitigate them in-house (and later on maintain the bots taking care of human’s investment third party risk? costly IT infrastructure). However, the decisions – automation and artificial intel- In my previous article1, I have intro- reliance on external service providers ligence are taking the world of commerce duced the concept of economic supply bears supplier risks that include facil- by storm and it is unstoppable. chain risk capital (ESCRC) which is a ities in geographical locations prone useful tool that helps managers to quan- One of the earliest adopted trends tify and mitigate (or transfer) their third The associated – robotic process automation – allows party risk exposure. In the wake of cyber concentration risk is hard firms to reduce the cost of outsourced to identify and manage if you don’t look beyond your own organisation. europeanfinancialreview.com 53

Risk Management Supplier development is an important business practice that can help to bring your suppliers to the next level, however, it is costly and time consuming. to disruptions, incompatible cultures, of purchasing volume). A focus on their risk management strategies can be activities being further outsourced to most critical business case was enough evaluated by the digital risk manager unidentified suppliers, wrong business to assess the company’s third party risk of the future. practices or even costly law breaches in profile and help to decide what it can countries that have very different local afford to lose in the most conservative Machine learning is another potential labour laws. worst case scenario (and hence helped to avenue to be explored for even more define the firm’s risk appetite). comprehensive model formulation that Supplier development is an important predicts future supply chain disruptions business practice that can help to bring The study revealed several surprising based on similar events happening else- your suppliers to the next level, however, and important insights: where in the business ecosystems. For it is costly and time consuming. In that 1. Procurement managers normally this to happen, both vast amounts of new reality, ESCRC is a tool that can internal and external data and computing help you to make the decision on which focus on stock keeping units with power is already available and ready to suppliers to develop and which business the highest spend, but a low-volume be applied to assess third party risk in relationships to wind down. component actually had the biggest complex supply chain network that your impact on profit-at-risk. organisation is inevitably part of. A practical example of using ESCRC 2. Alternative or backup suppliers do As an example, think of an SME not guarantee business continuity. Kamil J. Mizgier works as managing a global complex supply chain Normally companies do not look at Group Manager, Model for high-tech manufacturing with its all the different risk types and their Development in the area of factories and supplier base exposed to differentiated impacts. Only the statis- Enterprise Risk Analytics in disruptions in Thailand and Japan. For tical modelling of ESCRC revealed the the financial services industry. this manufacturer and auto supplier, busi- impact of these very real effects. Until 2016, he was a Senior Researcher ness continuity and loss of profit must 3. Further testing revealed trade- in Supply Chain Management at ETH be managed as top priority. The firm had offs and identified which suppliers Zurich. Prior to this role, he gained only limited information about its first tier were worth keeping based on their professional experience in risk mode- suppliers, not to mention sub-suppliers individual reliability. ling at Credit Suisse, UBS and Aduno further in the supply chain. But even Group in Zurich. He has published with this partial information, the compa- A forward looking approach to third several academic and practitioner arti- ny’s management did not have to waste party risk management cles on supply chain and operational resources on mapping the entire supply As the above case study shows, risk management, supply chain chain. The company selected their most third party risk can be understood, networks and economic risk capital. critical products and began to collect measured, owned and mitigated in He obtained a Master's degree in Applied data on products, suppliers and trajec- a forward looking fashion if statis- Physics from the Warsaw University of tory. In the second step, the firm polled tical risk measurement techniques Technology and a PhD from the its staff about historical occurrences like ESCRC are carefully applied Department of Management, Technology of disruptions, likelihood and times to with enough high quality data. Future and Economics at ETH Zurich. recovery. Based on this data, ESCRC was development of this methodology computed, revealing aggregated informa- includes macroeconomic variables References tion about expected losses and profit at and scenario consistent simulation of 1. Mizgier, Kamil J. (2018): On Economic Supply risk in the next year’s time horizon. future states of the world, in which Chain Risk Capital, The European Financial Review, value added activities are becoming August/September 2018. Furthermore, several strategies to more and more fragmented and minimise impact of systemic risk could performed in locations where they can be tested (such as the relocation of the be done most efficiently. From this factory, supplier switching or reallocation even more sophisticated third party 54 The European Financial Review December - January 2020

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Risk Management The Challenge of the ‘Shifting Sands of Model Risk Management’ for Banks BY TONY BETHELL Model risk management (MRM) sits at the The significance of MRM at the heart of Operational Resilience heart of the Bank of England’s Operational MRM has grown in Resilience (OpRes) initiative. OpRes raises yet recent years as the In 2019, the Bank of England has considerably further the expectations around risk manage- reliance on models – picked up the pace on its Operational Resilience ment at financial institutions. Driven by and the knowledge (OpRes) initiative. While still not a regulation, none- regulatory expectations and scrutiny, MRM theless regulators are expecting their regulated firms and governance are fast finding their place as and insight they to demonstrate enhanced resilience across every the top agenda items in banks today. provide – has grown. aspect of the business. In essence, regulators are insisting that banks’ business processes are resilient It was perhaps around 2000 when the first to any event that has the potential to cause disrup- regulatory demands – OCC 2000-16 from the tion or have a profound impact on the business over US Office of the Comptroller of the Currency an extended period of time – it could be anything (OCC) – were introduced for financial institu- from a power outage, a fire, the failure of a key tions, covering Model Validation. Developed business counterparty, or an economic shock. The jointly with the Federal Reserve System, this significance of MRM has grown in recent years as regulation provided guidance for effective risk the reliance on models – and the knowledge and management when using quantitative models for insight they provide – has grown. Whereas models decision making. were used in certain niche areas – foreign exchange, derivatives, and other core functions in the trading Fast forward to 2018 – and the scale and tone of book, now they are used more broadly in the MRM regulation has changed significantly globally. In banking book and broader business management – the US, SR 11 7 has updated previous regulations, and even budget management. is now in serious adoption. In the UK, the Prudential Regulatory Authority’s (PRA) standard for MRM for This pushes MRM to the heart of OpRes. Stress Testing (SS 3/18) – with its broader remit than Nicholas Edge, Principal, Prudential Policy at just Model Validation – encompasses everything from UK Finance, recently reiterated this view too, “As model definition through to evidencable governance, OpRes becomes a central theme of the regulators, risk management, as well as validation and review. disciplines like MRM too will become a core tenet of ensuring a good operational resilience outcome.” Internationally also, there is a vast number of regulations that emphasise the need for effective MRM – Basel III, MAS 637 in Singapore, BAIT, 56 The European Financial Review December - January 2020

TRIM and MAIT in Germany, CECL their Board and the regulators. While iterations published, often unless the in the US, and the list goes on. continuing to deliver business as usual. executives dig deeper into the legislation, they wouldn’t even notice the relevance MRM challenges Senior executives aren’t off the for MRM. The Bank of England’s Stress With most regulations now including hook either. The Senior Managers Testing and Basel III’s Fundamental MRM as a key requirement, the scrutiny & Certification Regime (SM&CR) Review of the Trading Book (FRTB) is increasingly getting intense – espe- demands model oversight – executives are perfect examples. To then meet cially as models are becoming more need to be aware of the assumptions new regulatory requirements, additional complex, the regulations continue to made in the material models. Not models are routinely required. evolve, and newer ones routinely being everyone fully grasps that the SM&CR introduced. With so many and different is a catch-all regulation – a bank’s An automated, management frame- types of models in play for day-to-day non-compliance with another regula- work approach will help replace a siloed, business operation, gaining full oversight tion can lead to breach of the SM&CR. model validation-only approach in favour and control of the model landscape is This regulation aims to hold senior of one that is holistic, robust and govern- proving difficult. Often there isn’t trans- executives and the C-suite accountable ance-led. This will deliver model oversight parency of how models are developed individually and means business. – complete with a full inventory that and used across the business. includes all enterprise models, Shadow IT A practical framework for MRM and and end user computing tools (that can The shifting sands of MRM means governance is the way forward be models in their own right), all catego- that model governance must be at the MRM efforts have increased expo- rised and tier-based on their criticality and core of financial institutions’ business nentially in institutions, driven by the materiality. This will provide the ability operations. However, different insti- expectations of the regulators of course, to identify risks associated with method- tutions are at different stages in their but also by business challenges that ology, data, implementation and model journey of model governance. Nicholas lie ahead. Many are appointing Heads usage by individuals. At a more advanced Edge added, “As regulators are becoming of Model Risk, and there is a push to level, the framework will enable model more interested in, and demanding of, the centralise the model inventory for visi- risk assessment with the ability to even MRM discipline, the end journey for insti- bility of the landscape. The focus is also quantify its impact on P&L, capital and tutions is at a different place today than on model testing and validation – i.e. similar parameters. Last, but not least, the it was a few years ago. The standards for ensuring the models assumptions are organisation will be able to institute stand- model risk and governance are constantly accurate, the model is stress tested and ardised reporting with controls built-in to being pushed, which is further challenging overall, works as expected. However, mitigate risks. organisations in terms of how they must things like data quality and change manage their models.” management and model lifecycle Breaking this approach down, as management are severely lacking. With financial institutions consider an MRM The pressure on model risk teams the intricate interconnection of models framework, these are some key compo- is enormous and has spread from across the environment, potentially one nents to consider: some specialist models teams, to now inaccurate change and the entire busi- include most of the senior managers ness model could be in disarray. Policy – This will help determine of the Operational, Financial and which business entities fall within scope, Regulatory Risk groups. Short on staff Financial institutions will do well to which models within these entities and resources, they need to defend establish a core foundation and structure should adhere to the policy, definition every rationale they use for the models, for MRM so that this function is imple- of model risk, the difference between evidence all actions and provide visibility mented systematically in the business. a model and a tool, criteria for model of every change they make in the models With so many new regulations being tiering, processes for risk reporting and to satisfy internal and external auditors, regularly launched, and their numerous crucially, which models fall under policy exceptions and escalations procedures. The shifting sands of MRM means that model governance must be at the core of financial institutions’ business operations. However, different institutions are at different stages in their journey of model governance. europeanfinancialreview.com 57

Risk Management Model inventory – This underpins the quality of an which is a step in the right direction. Care should MRM framework. Many institutions are challenged be taken to clearly define and differentiate between by the lack of visibility of the model landscape. At the responsibilities of model owners, developers an insurance company, 5000 files were being added and users. And it is best practice for the Board of every quarter, making visibility and control difficult. Directors to be involved not just approving the Determining the model inventory components (e.g. MRM framework, but also reviewing and challenging name and owner, risk classification, complexity) the highest risk tier of models in the business. helps alongside categorisation based on things like purpose of the model, and risk and criticality tiering. Reporting – Processes for reporting should be This is especially important so that where needed commensurate with the financial institution’s appropriate governance can be applied to specific model risk appetite. Some commonly used metrics models, per the requirements of individual regula- by financial institutions are number of models tions. This will go a long way in enabling the bank to used in exception, un-remediated models, high risk easily defend the model inventory and models them- models as a percentage of total model landscape, selves, should it be challenged by external bodies. models yet to be validated and so on. Here again, automation can facilitate dynamic reporting and Generally, most institutions put their model should be a consideration. inventories together manually utilising standard Microsoft Office tools such as Word, Excel and More broadly too, underpinning MRM with SharePoint or GRC systems. Due to the size of automation can provide institutions with a single, the model inventory, the number of users, and real-time view of the function, based on the type complexity of the model estates, automation will of models in the business, policies, processes, prior- deliver material benefits in terms of efficiency, ities, usage, geography, activity status, data flows and accuracy and overall management capability for interdependencies and risk appetite. workflow, validation, attestation, testing and policy adherence. Anecdotal evidence shows that financial insti- tutions are including Model Risk on Board Risk Roles and responsibilities – Especially with the Committee agendas on a quarterly basis. Some even SM&CR, the clear definition of team structures, mention the specific high-risk models and new roles and responsibilities is key to ensuring owner- models that are under development. This indicates ship and compliance. There is an emergence of that MRM is making its way up to be among the top Chief Model Risk Officers in financial institutions items of institutions’ operational agenda. Yes, MRM (especially in the US) to oversee MRM reporting, requires an investment, but in the current regula- tory, financial and socio-economic environment, it is essential to mitigating business risk and ensuring operational resilience. Tony Bethell is VP of Strategic Alliances at CLusterSeven with global responsibility for developing and driving the partner channel. He is focused on identifying new partnerships and enabling existing part- ners to build successful propositions and creating new routes to market for ClusterSeven. He brings to ClusterSeven an extensive skill set having been respon- sible for managing Sales, Channel, Product Management and Professional Services organisations. 58 The European Financial Review December - January 2020

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China and the World From Follower to Leader: extensions across varied places and China’s Development of Special boundaries around the world. The Economic Zones and Its Global article below takes the trans-local Impact and Lessons dimension of “China and the World” further by tracing how China has BY XIANGMING CHEN evolved from a follower to a leader in building special economic zones A Preamble and growing body of published (SEZs) within its boundaries earlier I published my first article “China scholarship and media commen- on and extending this experience and Latin America” in The tary. Through 13 articles published and expertise to other developing European Financial Review in 2012 in this series thus far with a variety countries more recently. to launch this magazine’s “China of co-authors, including a number & the World Series”. Since its offi- of undergraduate students at Special economic zones (SEZs) cial inauguration in 2013, the Belt Trinity College in Connecticut, I have been used as an important and Road Initiative (BRI) has have taken the reader to see China’s national development instrument turned “China and the World” into presence and influence in all around the world for the past several a globally significant topic of public regions of the world. More impor- decades. China stands out not only in attention, academic research and tantly, I have attempted to shed having created the largest number and policy debate. The topic has stayed light on “China and the World” by variety of SEZs but also in building some constantly and prominently in the drawing meaningful connections SEZs in other developing countries. In headlines, only magnified by the between local and regional devel- this article, I first trace the evolution of US-China trade war over the past opment and transformation deep SEZs into both distinctive and overlapped year and a half, and generated a large inside China and their echoes and types over the past four decades, showing how SEZs have changed and continued in their own existence and in roles in fostering development. Second, I focus on China’s transition from a national follower to a global leader in creating the world’s largest number of SEZs, diversi- fying its SEZs domestically and extending them internationally. Finally, I draw critical lessons from China’s development experi- ence with SEZs for developing countries. 60 The European Financial Review December - January 2020 Pedestrians walk under red lanterns which were installed as Chinese New Year decorations, at Pudong Financial Area in Shanghai, January 24, 2014. REUTERS/Aly Song

An Age-old Story Through the industrial upgrading from the takeoff and extra-territorial SEZs are the 21st Century of labour-intensive and export-oriented newest type, of the largest geograph- manufacturing to knowledge-intensive ical scope, and truly border-intensive The Economist (4 April 2015) dated the innovative manufacturing. Since hosting and transnational in function. This first free trade zone (FTZ) to ancient much earlier services such as ware- table aims to remap SEZs as subna- Phoenicia about 3,000 years ago. Keller housing for duty-free goods in FTZs, tional units of economic development Easterling (2012) traced it to the Roman free service zones (FSZs) have diver- with varied roles onto the develop- port of Delos in the Aegean Sea, which sified over time into broader coverage ment ladder of climbing or sliding flourished in the first century B.C. From of more modern and high-end services national economies based on shifting the FTZ-like Hanseatic League during such as logistics. While overlapping comparative advantages. the 13th to 17th centuries, we could somewhat with FSZs, sector-specific fast-forward to find the first modern zones (SSZs) have a shorter history and China’s Experience with SEZs zone, created at Shannon airport in feature more specialized economic China’s experience with SEZs has Ireland in 1959. This was followed by functions and activities that increas- largely tracked the global trend over the South Korea and Taiwan using export ingly herald the future. Cross-border last four decades, with Shenzhen being processing zones (EPZs) in the 1960s and early 1970s to jump-start their Table 1: The Evolution and Differentiation of SEZs: A Typological Framework export-oriented industrialization. China raised the SEZ approach to devel- Zone Type by Stage I Stage II Stage III opment to a new level in 1980 when Stage and Time 1980s 1990s-2000s 2010s it established four SEZs (Shenzhen, Zhuhai, Shantou, Xiamen) along its 1. Free Take off Upgrading Innovating southeast coast which were much larger Manufacturing • Enclave-like • Extra-zone spillover • Within-zone refocus than the earlier EPZs and sited in or Zones (FMZs) • Labor-intensive • Capital-intensive • Knowledge-intensive near existing cities. • Masan EPZ • Export-oriented • Balanced export- • Domestic-oriented (S. Korea) • Incentive-heavy • Upgraded incentives From an estimated 500 in 1995, the • Kaohsiung EPZ • Experimental import • Clustering effect number of SEZs has risen to 5,400 (Taiwan) and catalytic • Broader incentives • Integration zones operating in 147 countries • Narrower focus • Spread effect (UNCTAD, 2019). Given the large • Diversification numbers and varied types of SEZs, their success varies widely. China is 2. Free Service Limited Expanding Dominant a global leader in SEZ development Zones (FSZs) • Trade • Finance • Finance having operated the largest number • Warehousing • Back office • Logistics and most varied types of SEZs with • Shipping • Real estate • Other professional overall success. By comparison, SEZs in India and Africa have generally not 3. Sector Rare Growing services like done as well, for various reasons such Specific Zones ᵒ Trade ᵒ High-tech engineering design as weak infrastructure connections, (SSZs) ᵒ Shipping excessive bureaucracy, and resistance to industry Emerging and land acquisition (ADB, 2015; UNDP, ᵒ Call center Future-Oriented 2015). Timing of establishment and ᵒ R&D labs governance structure loom among ᵒ Digital media other determining or facilitating factors ᵒ Tourism that shape the differential performance of SEZs. I update my early typology of 4. Transnational Beginning Growing Multiplying SEZs (Chen, 1995) to a dynamic view (cross-border) and > Maquiladoras > Growth triangles > Forest City (China- on the new SEZ landscape today. Extraterritorial (US-Mexico border) (ASEAN) (enclave) Zones > China-Kazakh built in Malaysia) Table 1 shows four types of (ETZs) > SEZs in Africa and SEZs over three broad stages. Free border coopera manufacturing zones (FMZs) mark tion center Middle East (Chi na-built) >Boten SEZ in Laos (China-built) Source: Author europeanfinancialreview.com 61

China Table 2: Types of China’s SEZs by Time Periods called high-tech industrial development zone started in the 1990s. The fourth type, heralding a new phase Type of zone by 1980s 1990s 2000s 2010s of China’s SEZ development that reflects its more Time period Uneven success in open economy, appeared with the official unveiling upgrading of the Belt and Road Initiative (BRI) in 2013. 1. Special • Shenzhen Industrial Uneven • Kashgar Economic • Zhuhai upgrading success in • Horgos While starting out as a SEZ for low-end and Zones (SEZs) • Shantou began upgrading labor-intensive manufacturing SEZ around 1980, • Xiamen Shenzhen in the early 1990s entered a new stage • Hainan of development characterized increasingly by more (province) capital- and technology-intensive manufacturing in response to rising land and labour costs and wors- 2. Economic & 14 coastal cities Began industrial Transition and Fully ening environmental degradation. The focus during Technological including upgrading diversification to institutionalized this stage was on Shenzhen to become a center for Development • Shanghai high-tech and stable high- and new-tech manufacturing, finance services Zones (ETDZs) • Ningbo manufacturing and logistics. In 2003, a cultural industry focus • Nantong and service was added. In 2009, Shenzhen added a new focus • Others on becoming an international innovation center. The successful Shenzhen model has recently been 3.High and New Special zones Growing and Uneven success extended to China’s far western cities of Kashgar Technology spread to coastal, spreading and Horgos in Xinjiang (Chen, 2018). Zones (HNTZs); central and nationally Border SEZs western border Focused more on industrial innovation a regions few years ago, Shenzhen designed a set of very 4. New Free • Ruili generous financial incentives for attracting R&D Trade Zones • Mohan labs of national, provincial and municipal grades (FTZs) and (Yunnan) ranked by a sliding scale of importance and Overseas prestige, as well as labs set up by multinational Economic and Growing gap “Go West” and Belt & Road corporations. National- and provincial-level labs, Commrcial between coastal “Go Global” Initiative (BRI) especially those certified as “excellent”, would each Cooperation and inland/ policies began launched receive financial support of up to RMB10 million Zones border regions • China-built • Shanghai Free ($1.5 million), while each municipal level lab would (OECCZs) SEZs in Africa be granted 5 million RMB ($750,000). Shenzhen Trade Zone would also provide 5 million RMB for offsetting Source: Author • Forest City, the cost of constructing each of these labs. In Johor, addition, Shenzhen has built new R&D lab spaces Malaysia that are available to new-tech firms without rent • China-Laos for the first two years and at a discount of half of (Mohan-Boten) the rent for the next three years. These new incen- tives have fuelled the dense emergence and rapid Economic expansion of high- and new-tech firms that have Cooperation placed Shenzhen at the forefront of global techno- Zone (ECZ) logical innovation today (Chen and Ogan, 2017). the most successful and well-known case. As Table 2 Except for Shenzhen’s singular success, China’s shows, the first two types of zones started in the experience with SEZs varies broadly. Despite their 1980s, a few years apart from each other, with the shorter histories than the SEZs and ETDZs, the economic and technological development zones HNTZs have since around 2000 become quite (ETDZs) launched in 1984. All the early ETDZs productive, in parallel with China’s overall effort to built by the 14 established coastal industrial cities move to higher valued-added manufacturing and were sited some distance away from the central knowledge industries (Table 2). By 2009, China had cities as greenfield development projects. They were approved 54 HNTZs occupying a total area of 962 similar to Shenzhen in that the new location and construction would keep the zones less connected and thus influenced by the old system. While both the SEZs and ETDZs experienced their transitions through industrial upgrading, China unleashed a wave of high- and new-technology zones (HNTZs) across much of the national economic space starting around 2000, although an earlier variation 62 The European Financial Review December - January 2020

sq kms. Although this is only 1/10,000 of China’s build a variety of SEZs abroad as part of the By 2009, China had total territory, it produced 10.4% of China’s total infrastructure-led development strategy under approved 54 HNTZs industrial output that year. Of these HNTZs, 16 the BRI. In 2014, a Chinese company started occupying a total produced over 20% of their cities’ total output, constructing Forest City, a private, gated, luxury area of 962 sq kms. up from eight that did so in the previous year mega-development for 700,000 people on four Although this is only (Yu, 2011). Productive as they are, some HNTZs reclaimed islands in Malaysia’s Johor state near 1/10,000 of China’s have run into the land bottleneck and acquired Singapore. But this project has been halted since total territory, it some surrounding areas without administra- the second election of Prime Minister Mahathir, produced 10.4% of tive approval by the higher authorities. In some who is more critical and cautious about China’s China’s total industrial cases, the areas around the originally approved heavy investment in Malaysia. In the meantime, output that year. HNTZs have been developed into residential Alibaba has helped Malaysia launch the Duty- and commercial zones, which has pushed up Digital Free Trade Zone (DFTZ), a warehousing land prices. This has restricted and diluted the facility close to Kuala Lumpur’s international original purpose and focus of building high- and airport. The DFTZ is designed to serve as a new-tech industries. regional logistics hub to help small and medi- um-sized businesses better connect to global This process also reflects another critical commerce. These cases mark the most recent factor in China’s SEZ success – local leadership. phase of China’s SEZ development featuring a Most of the zones of various types are led by a “go global” strategy (see the lower right corner vice mayor or Party secretary of the cities where of Table 2). It is a logical extension of China’s the zones are located. These leaders tend to do cumulative strength and experience in building quite well early on because they can leverage and SEZs at home and provides new opportunities utilize the autonomy granted to the zones and for countries that are relatively late in coming to their new momentum, with some institutional SEZs. These countries can learn useful lessons separation from their municipal administrative from China’s uneven success with SEZs that anchor. Some of the leaders were innovative may or may not transfer easily and successfully and led the HNTZs to varied levels of success. to other contexts. I present two sets of cases in However, as these zones have become more Laos and Ethiopia respectively below. integrated with their host cities through mixed-use development and inertia, some of A China-Laos economic cooperation zone their leaders have become more conservative China’s extension of SEZ development to Laos and content with the status quo. The leadership has taken place between the Chinese border factor exposes a fundamental dilemma facing city of Mohan in Yunnan Province and the Lao China’s SEZs. Since they are not special political border town of Boten. In 2015, the governments zones and ultimately governed indirectly by the of China and the Laos signed the Agreement for larger system, they carry a strong built-in limit Joint Construction of the China–Laos (Mohan- for sustaining their vitality. Boten) Economic Cooperation Zone (ECZ) as the BRI gained momentum into Southeast Pushing SEZs Overseas Asia. While this bilateral plan was predated by Partly pressured by its domestic overcapacity in the establishment of the Boten SEZ in 2009 cement and steel, as well as the overall saturation directed by the Lao government, little had of the construction market, China has begun to Partly pressured by its domestic overcapacity in cement and steel, as well as the overall saturation of the construction market, China has begun to build a variety of SEZs abroad as part of the infrastructure-led development strategy under the BRI. europeanfinancialreview.com 63

China happened through 2015. The ECZ became China’s The Boten ECZ offers a set of familiar finan- way to jump-start and scale up the Boten SEZ by cial incentives accorded to the Boten SEZ and building a new and much larger city where the Boten other SEZs. These include: 1) the exemption of zone is located, on the Lao side of the border. The import duties for all goods and materials used, sold construction has been undertaken by Haicheng, a and served in the zone; 2) tax reduction or exemp- private real estate development company based in tion for 2-10 years for factories in the zone; and Kunming. The signing of another joint develop- 3) tariff-free exports to third countries and quali- ment master plan for the ECZ in 2016 accelerated fication for most-favoured-nation status relative to the construction, with the vision and goal of advanced economies. The ECZ also benefits from turning the zone into a comprehensive and inte- being located at the crucial cross-border point of grated city for 300,000 people characterized the China-Laos Railway and at the connecting hub by four functions: international commerce and for both rail and road lines linking China, Laos and finance; duty-free logistics; culture, education and Thailand that will eventually extend to Malaysia and health care; and tourism and vacation. It recalls Singapore. It also serves as the distribution and Shenzhen’s functional expansion into a real city connective hub for cross-border trade and tourism. from its early years of industrial dominance. Moreover, the ECZ, in the heart of four concentric circles with travel radiuses of one to seven hours, Figure 1: The China-Laos (Mohan-Boten) Special Economic Cooperation allows easy and quick access and travel to a number Zone in Larger Regional Contexts of major cities and their hinterlands that span the connected adjacent border regions of China, Source: The sales office of Haicheng Corporation (the Chinese builder of the Boten SEZ), Boten, Laos. Myanmar, Laos, Thailand and Vietnam (see Map 1). The ECZ’s ultimate success is most likely to depend on the completion and operation of the China-Laos Railway that runs by the Mohan-Boten border zone. Although the idea for the China-Laos Railway project germinated in 2010, the official agreement was not signed until November 2015 and ground for construction broken in Vientiane in December 2015. The line starts in Kunming and travels southward to Jinghong and Mohan until it enters the Laos through the Lao border city of Boten. It will then move past Luang Prabang and Vang Vieng before arriving in the Lao capital of Vientiane. Designed to carry both passen- gers and cargo, the railway will run at an average speed of 160 kms per hour, which qualifies it as a high- to medium-speed train, and 60% of the line will be bridges and tunnels.1 The Lao govern- ment expects roughly 4 million Lao passengers a year to use the railway’s 420-km route through the country at first, with the figure growing to 6.1 million passengers in the midterm and 8.1 million passengers in the long run.2 This is a rather opti- mistic scenario. The China-Laos case reflects the dominance of Chinese state capital and a narrower focus on cross-border transport infrastructure in the China- Laos Railway, although the new China-Laos ECZ in Boten is being built up rapidly as a hub for 64 The European Financial Review December - January 2020

anchoring cross-border regional development. It China’s has recently further is also too early to gauge the prospect of manu- strengthened its role in building facturing-oriented SEZs being built and planned industrial parks for Ethiopia by agreeing near some stations of the China-Laos Railway such as the China-Laos cooperative Saysettha to start building a new, $300 million industrial park before the end of 2019. Development Zone (SDZ) located only 1.5 km from the railway’s terminal station of Vientiane. Laos’ SEZs are expected to host labour-inten- sive industries, some of which have left China for Southeast Asia due to its more expensive labour and land and upgrading to high-tech manufacturing Chinese city of Dongguan and a major global in new zones. Being built by Yunnan Construction shoemaking center, to open a factory in Ethiopia. and Investment Holding Group Co., a large SOE Three months later, in 2011, Huajian entered the specialized in constructio n from Yunnan, to host Eastern Industrial Park (EIP) and began producing more than manufacturing to include logistics, footwear for giants such as Nine West, Guess and, commerce and other associated functions of a new later, Ivanka Trump’s fashion line (before it closed city, the SDZ is larger version of the Mohan-Boten later).3 Located 35 kms southeast of Addis Ababa in ECZ and also stands to benefit from being on the the town of Dukem, EIP is Ethiopia’s first indus- outskirts of Laos’ capital of Vientiane (see Map 1). trial park and has helped spearhead the country’s Building industrial parks in Ethiopia export-oriented industrialization since 2011 when it was built with Chinese investment and is currently Powered by the same internal push of high produc- owned by the Jiangsu Qiyuan Group, a private tion costs, Chinese companies, both state- and Chinese investor (Zhang et al, 2018). Dukem is privately-owned, have brought SEZs to Africa, located on the Addis Ababa-Djibouti highway and Ethiopia in particular. The establishment of an SEZ the Addis Ababa-Djibouti Port railway, which was in Ethiopia was reportedly linked to Chinese econ- built by China with a loan of $3 billion from the omist Lin Yifu, a former chief economist for the Export-Import Bank of China and started operation World Bank, who had convinced former Ethiopian on January 1, 2018. This rationale is similar to building Prime Minister Meles Zenawi of the value in SEZs SEZs along the China-Laos Railway discussed earlier. (Pairault, 2019). The then Prime Minister called for Like land-locked Laos, 95% of Ethiopia’s trade Zhang Huarong, Founder and CEO of Huajian passes through Djibouti and accounts for 70% of the Group, a huge shoemaker based in the southern activity at the Port of Djibouti. Now shoes made by Huajian’s factory in EIP can be easily shipped by rail Photo 1: Ethiopian Workers at Huajian Shoe Factory in the Eastern Industrial Park for export to the US and European markets. After opening a second factory in 2016 in an industrial park of its own near Addis Ababa, Huajian now employs over 7,000 local workers (see Photo 1) and churns out 5 million pairs of shoes for export every year, earning $31 million in foreign exchange earn- ings for Ethiopia in 2017 alone.4 In 2019, Huajian stepped up further in cooper- ating with Ethiopia on manufacturing by acquiring the right to operate Ethiopia’s Jimma Industrial Park (JIP) for 40 years. Located in Oromia Regional State in western Ethiopia and 350 kms from Addis Ababa, JIP was constructed by China Communications Construction Company (CCCC) Source: CNN; accessed from https://edition.cnn.com/interactive/2018/08/world/china-africa-ethiopia- with an investment of $61 million. Stretched manufacturing-jobs-intl/. on 75 hectares of land with 35 hectares already europeanfinancialreview.com 65

China developed, JIP aims to attract clothing China’s Impact and Lessons The second lesson, with an unde- and shoe factories. Huajian has already sirable twist, pertains to many local taken the lead in leasing 9 factory build- Global SEZ development over the governments competing to build iden- ings covering 39,000 sq meters and past four decades (Table 1) has tical SEZs and ending up with wasteful committed to invest $100 million to been accompanied and reflected by investment, unfair competition and build more shoemaking facilities. This China’s own SEZ development for partial failure. The combination of production plan is expected to create a comparable period of time (Table these two lessons points to the critical 12,000-15,000 jobs. Huajian also plans 2). Around 1980, China adopted the importance of vertical and horizontal to develop the other 40 hectares in main elements of the early generation policy coordination and operational JIP to build a coffee-processing plant of EPZs through its experimental sensitivity in creating truly needed taking advantage of being in Ethiopia’s version of SEZs, crystalized in SEZs for clear and achievable devel- coffee-growing region and add other Shenzhen. China then expanded the opment goals from and beyond most agricultural production activities that “learned” SEZs geographically to favourable locations. may create additional jobs through scale up export-oriented manufac- larger and more varied exports.5 turing based on its low-cost labour The Chin-Laos (Mohan-Boten) and land advantages by building phys- SEZ, being built by a regional private China has recently further strength- ical and transport infrastructure for Chinese company under a bilateral ened its role in building industrial parks all forms of SEZs. As China upgraded agreement at the national level, offers for Ethiopia by agreeing to start building its low-cost manufacturing, heavily two quick lessons, one likely positive a new, $300 million industrial park before concentrated in industrial zones in and one potentially negative. First, the end of 2019. Located in Adama the coastal region, towards the end of taking the form of an integrated city city, 99 kms southeast of Addis Ababa the 1990s, it created more SEZs in its in a border region like Shenzhen with in central Ethiopia, this industrial park, inland and border regions and began a large scale and diverse activities, this which will focus on equipment manu- to “export” SEZ development, notably SEZ is capable of stimulating broad facturing, is funded at 85% through to Laos and Ethiopia. Starting out as regional development in northern Chinese government concessional loans a follower or learner of SEZs with its Laos where development has lagged. while the remaining 15% will come from adaptations, China has recently become The potential downside of heavy the Ethiopian government. This park a global leader in developing SEZs. Chinese involvement poses a risk that follows from the first Adama industrial this zonal development will produce park, which was built by China Civil Regarding China’s own SEZs, two exclusive spaces only for Chinese Engineering Construction Corporation main policy lessons can be drawn. investors, workers, and residents while (CCECC) at a cost of $146 million and The first lesson, of a positive nature, marginalizing Laotian citizens. This inaugurated by Ethiopian Prime Minister has to do with a national government scenario is likely since the Chinese Abiy Ahmed in October 2018. The commitment to using SEZs of various private development company is also two parks combined can create around kinds and locations to achieve multiple heavily involved in local governance. 25,000 jobs as an important part of goals: driving industrialization, creating In this kind of large-scale develop- Ethiopia’s grand plan to transform its jobs, promoting exports, inducing ment driven by a powerful outsider, largely agrarian economy into an indus- technology transfer and innovation, local “others” can be excluded and trialized one by 2025.6 and stimulating broader regional devel- lead to the erosion of political and opment to reduce spatial inequality.

territorial sovereignty and governance of Laos or other professor at Fudan University, Shanghai. He has published countries hosting China-built SEZs. extensively on urbanization and globalization with a focus on China and Asia and conducted policy research for the World China’s venture to build SEZs in Africa invokes two other Bank, the Asian Development Bank, UNCTAD and OECD. policy lessons that harken back to its domestic experience. The first lesson reinforces the two-sided trend that SEZs Endnotes can continue facilitating economic development and that 1. “China, Laos sign railway deal”, Zhao Lei, The China Daily, 14 the successful aspect of China’s SEZs can be transferred to November 2015; http://www.chinadaily.com.cn/business /2015- other developing countries with necessary adjustments. The 11/14/content_22456633.htm. growing number of special manufacturing zones in Ethiopia 2. “Laos and China come to terms on loan interest rate for railway built by China have shown expected results in inward invest- project”, Radio Free Asia, 4 January 2016; http://www.rfa.org/english/ ment, job creation and exports. This contradicts earlier news/laos/laos-china-come-to-terms-on-loan-interest-rate-for-rail- studies that had showed the China-sponsored SEZs in Africa way-project-01042016163552.html. to be largely unsuccessful (UNDP, 2015). Secondly, with 3. “Employed by China,” Jenni Marsh, CNN, August, 2018; accessed multiple actors including the state and private firms involved, from https://edition.cnn.com/interactive/2018/08/world-china-afri- China-built SEZs in Ethiopia point to the challenges such ca-ethiopia -manufacturing-jobs-intl/. as ensuring high-level political commitment and support for 4. “Chinese firm signs agreement to manage Ethiopian industrial park,” effective inter-ministerial collaboration and integrating SEZ Xinhua, May 31, 2019; accessed from http://www.xinhuanet.com/ programs into national development strategies and plans. english/2019-05/31/c_138103636.htm. These features not only define China’s more successful SEZs 5. “Huajian takes over management of Ethiopia’s state-owned Jimma but also reflect Ethiopia’s commitment to using them to Industrial Park and plans to build shoemaking and coffee-processing accelerate industrialization. plants,” Sina.com, June 5, 2019; accessed from http://www.timedg. com/2019-06/05/20836228.shtml. At this critical time for evaluating China’s growing role in 6. “Ethiopia, China to partner to build new 300 million USD industrial the global economy, we are only beginning to understand China’s park,” Xinhua, August 13, 2019; accessed from http://www.xinhuanet. leadership in global SEZ development. In spite of China’s com/english/2019-08/13/c_138304130.htm. success with SEZs at home, often inflated by the singular prom- inence and reputation of Shenzhen, we should be cautiously References optimistic that certain elements and practices of China’s SEZs • ADB (Asian Development Bank). 2015. Asian Economic Integration may be adapted to some developing countries, either inter- country policy mobility or China-foreign cooperation zones. Report 2015: How Can Special Economic Zones Catalyze Economic As this potential grows from the further implementation of the Development? Manila: Asian Development Bank. BRI, it alerts us to fully assess the policy lessons of China’s SEZs • Chen, Xiangming. 1995. “The Evolution of Free Economic Zones that can inform and foster sustainable economic development and the Recent Development of Cross-National Growth Zones.” through South-South cooperation. International Journal of Urban and Regional Research 19 (4): 593-621. • Chen, Xiangming. 2018. “Globalization Redux: Can China’s   Inside-Out Strategy Catalyze Economic Development Across Its This article was adapted from the author's recently published Asian Borderlands and Beyond.” Cambridge Journal of Regions, Economy much longer paper “Change and Continuity in Special Economic and Society 11(1): 35-58. Zones: A Reassessment and Lessons from China,” Transnational • Chen, Xiangming, and Taylor Lynch Ogan. 2017. “China’s Emerging Corporations 26 (2): 49-74 (2019). Silicon Valley: How and Why Has Shenzhen Become a Global Innovation Center.” The European Financial Review (December/ Xiangming Chen served as the founding Dean January): 55-62. and Director of the Center for Urban and Global • Easterling, Keller. 2012. “Zone: The Spatial Softwares of Studies at Trinity College in Connecticut from Extrastatecraft.” Places Journal, June. Accessed 25 May 2019. https:// 2007 to 2019. He has been Paul E. Raether doi.org/10.22269/120610. Distinguished Professor of Global Urban Studies • Pairault, Thierry. 2019. “China in Africa: Phoenix Nests versus Special and Sociology at Trinity College and a distinguished guest Economic Zones”, Working Papers hal-01968812, HAL. • UNCTAD. 2019. World Investment Report 2019: Special Economic Zones. New York and Geneva: United Nations. UNDP (United Nations Development Programme). 2015. Comparative Study on Special Economic Zones in Africa and China. Working Paper No. 6, jointly with the International Poverty Reduction Center in China. • Yu, Liang. 2011. “Land Constraints on the Development of High and New Technological Development Zones.” Science and Technology Forum 206 (3): 49-53. • Zhang, Xiaodi, Dejene Tezera, Ciyong Zou, Ciyong Zou, Jie Zhao, Eneyew Abera Gebremenfas, and Jaidev Dhavle. 2018. Industrial Park Development in Ethiopia Case Study Report. Inclusive and Sustainable Industrial Development Working Paper Series WP 21. United Nations Industrial Development Organization. New York: United Nations. europeanfinancialreview.com 67

Executive Compensation Why Do So Many People Think That CEOs Earn Too Much? BY RAINER ZITELMANN In the public debate on executive compensation, measured primarily based on the number of hours it is repeatedly claimed that it is impossible for someone works or how much effort they put into a manager to work 100 or 300 times longer or their job. In their opinion, salaries are a form of harder than a regular employee, and therefore such direct compensation for time spent on the job or high salaries are unjustifiable. In an Ipsos MORI a “blood, sweat and tears premium.” And because survey in 2018, 39% of American respondents said a top-tier manager doesn’t sweat 100 times more or it was inappropriate for managers to earn 100 times work 100 times longer, adherents of the “employee more than regular employees because they don’t mindset” naturally conclude it is “unfair” for CEOs work 100 times longer or harder. In Germany, as to earn so much. many as 63% of respondents expressed the same opinion, even though German CEOs earn far less Employees are thus projecting their own than their American equivalents. C-suite managers performance and remuneration benchmarks onto with Germany’s 30 largest companies (listed on the top managers and believe that there must be a DAX stock market) earn an average of just €7.5 close relationship between how hard or how many million per year. hours someone works and their remuneration – and they do not see this type of direct corre- The fact that more Germans than do Americans lation when they read stories about top managers believe that top-tier managers’ salaries are far too pay packages. That’s why regular workers think high, despite the fact that German executives earn that managers’ salaries are excessive, because no significantly less than their U.S. counterparts, proves manager works 100 times longer or harder than that the level of remuneration alone cannot be the an average employee. reason for the criticism. On the other hand, the fact that manager salaries are determined by supply and demand The Harder You Work, the More You Should Earn? The richest people in the world are those who have the best ideas and invent or market products People who claim that executive salaries are too high and services that satisfy the needs of hundreds of because there is no way CEOs work so much longer millions or even billions of consumers. or harder than average employees are demon- strating what I refer to as an “employee mindset.” They believe that salaries should be determined or 68 The European Financial Review December - January 2020

on the market for top executives is not at all But this world, where rare skills and good It is not the number of widely understood. Only 23% of the Ipsos ideas are rewarded, is out of the reach of hours they work that MORI survey’s United States respondents most workers and employees, who, based on earns them their very agreed that companies could only get the best their experience, believe that someone with high salaries. It is how managers by paying very high salaries, because better qualifications deserves to earn more. much value they add otherwise top-tier talent would move to other And anyone who works 50 hours deserves to to their companies. companies that do pay more or set up their earn more than someone who works 40 hours. own businesses. This “employee mindset” is largely alien to Image source: top managers and entrepreneurs, who know designsrock.org Although time input and qualifications typi- that nobody pays them by the hour or based cally play a major role in salary considerations on the volume of sweat they produce. A large in other occupations, they are not particularly proportion of a CEO’s salary is linked to the relevant in determining the remuneration of performance of their company’s share price. top-tier managers. Rather, CEOs negotiate It is not the number of hours they work that their salaries within the very narrow market earns them their very high salaries. It is how for top executives. C-suite remuneration is much value they add to their companies. determined by supply and demand, just like the pay of elite athletes. Dr. Rainer Zitelmann is a histo- rian and sociologist. He is also a The basketballer Stephen Curry earns more world-renowned author, successful than $40 million a year – and the reason is not businessman and real estate that he sweats a hundred times more during a investor. His most recent book, The game or that he trains a hundred times harder Power of Capitalism (http://the-power-of-capi- than a less talented basketball player. He earns talism.com/), was released in 2019. so much because he has a rare ability. The analogy between an elite athlete and an elite executive can be taken even further. When a company or basketball franchise signs a top manager or top athlete, they base their remu- neration on their new hire’s past performance. Their forecasts could prove to be right, but they could also be wrong. Ideas are the True Source of Incredible Wealth For entrepreneurs, who usually earn far more than top-tier managers, high earnings are usually a reward for particularly good ideas. The richest people in the world are those who have the best ideas and invent or market products and services that satisfy the needs of hundreds of millions or even billions of consumers. Just think of Larry Page and Sergey Brin, who invented Google, Amazon founder Jeff Bezos or Bill Gates of Microsoft. Of course, Jeff Bezos hasn’t worked a million times longer or harder than the average employee, but he has had great ideas that have been especially beneficial to hundreds of millions of people. Ideas that others didn’t have or couldn’t implement. europeanfinancialreview.com 69

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Family Business Portrait of Darius Forbes BY DENISE KENYON-ROUVINEZ A portrait of a special man was very eager about life and polite enough to answer From left to right: my questions in a humble and yet precise manner. Naushad, Darius, Writers and dramatists have a saying: ‘Show, don’t I was curious to learn more about the life journey and Farhad tell.’ It means to convey a thought or emotion of this man who had co-founded a trading company Forbes through dialogue or action, rather than telling the more than seven decades earlier, that had evolved to audience directly. The same principle applies to the become a world-class company specializing in instru- most impressive leaders, especially those with strong mentation, steam technology and energy efficiency, values and philanthropic achievements. as well as a wide range of community initiatives and other philanthropic activities. I first met Darius Forbes, founder of the Indian family firm Forbes Marshall, in 2017. The occa- Darius Forbes was born in 1926 to an Indian sion was a conference speech by his son Farhad, a Parsi family. The Parsi religion is Persian in origin, successful engineer and business leader in his own and little known. It is shaped by the principles Good right. The speech was about to start, and the audito- Thoughts, Good Words, Good Deeds. Mr Forbes rium was getting dark, when my eyes were drawn to lives these principles, without preaching them. the arrival of an old, pale man, very slim and elegant, When he was just 19, he was invited by his uncle who took his seat in the front row, near the stage. to work at the trading company JN Marshall. They A few people were helping him. There was a lot of soon developed the business, forming partnerships deferral and respect around him. You could immedi- with British companies to import their goods, prin- ately understand he was someone of importance, and cipally in steam technology. They formed successful I was intrigued; there was something special about partnerships; in one case so successful that the firm him. His presence conveyed a certain aura, that I have in question, Spirax, suggested that they start manu- learned to associate with an individual who combines facturing their own. This led to the foundation of high achievement with humility: a rare and extraordi- the first factory, in the city of Pune, western India. nary combination that has the power to enrich many Development of a manufacturing firm in post-colo- lives. I later learned that it was Darius Forbes and nial India presented challenges. Governments were decided to approach him at the break. following protectionist, nationalist policies with The initial impression was deepened in a conver- sation we had in the conference hall lobby. This straight-backed, elegant, refined gentleman declined to accept an offer of a seat. Another individual joined us in the conversation and, after Mr Forbes had left us, informed me that he was 91 years old. His eyes shone; there was so much life – a spark, so much energy. He europeanfinancialreview.com 71

Family Business very high tariffs and many bureaucratic In the 1980s, when they took over start our own little medical facility and restrictions. Yet, with his intelligence, leadership, they saw how high-tech- our own hospital. That’s how we first got pragmatism and spiritual calmness, Mr nology products were changing, and the idea of starting our hospital.” Forbes rose above these challenges, becoming so sophisticated that devel- even turning them into advantages. opment in one country was becoming The hospital continues to this day, more and more difficult. They began and serves the local area, not just The difficulty in importing compo- a program involving closer work with employees. The charitable founda- nents encouraged him and his team to overseas partners, bringing the tech- tion, currently run by Rati, Farhad’s display ingenuity in developing their own. nology up to world-class standards. wife and Mr Forbes’ daughter in law, And bureaucratic restrictions on forming Their modernization initiatives were prioritizes education; but their social joint ventures with foreign companies helped enormously by the liberaliza- initiatives have also included ensuring meant that he forged many partnerships tion of the Indian economy that began clean water, sanitation and electricity based on honesty and trust without formal with Prime Minister Rajiv Ghandi’s for local homes. Forbes Marshall set up contracts; a high-risk approach, but one reforms in the late 1980s, followed by a Provident Fund for employees, even with high rewards. On one occasion, bolder reforms in 1991 introduced by before Tata, the much larger philan- Mr Forbes was no longer able to import Manmohan Singh, Finance Minister thropic corporation, did so. a crucial component required for the and later Prime Minister. manufacture of a pH measuring instru- The ethos of the company has always ment. After much research, Mr Forbes The 1990s saw the elevation of been egalitarian, long before the ‘flat’ identified a Swiss company run by Dr. Forbes Marshall to an enterprising, inno- hierarchy and informality became fash- Werner Ingold, inventor of the relevant vative international business at world ionable in the workplace. Mr Forbes technology, and the two of them worked class standards. Yet this came with rejected the colonial ‘master and servant’ out a plan to produce in India, after challenges: with the opening up of the culture. “I always propagated [the importing the technology. According Indian economy to international trade, notion] that whoever we employ, we to the Indian government, they could competition intensified. The company will not employ them as an employee,” not do this, because the technology rose to the challenges, learning to play to he says. “They’ll be members of the was already developed by a Calcutta- its strengths, increasingly specializing in company. I used to keep on insisting that based organization. When Mr Forbes steam technology for industrial units and we never called person an employee … contacted this agency, they confessed process control and instrumentation. I feel that, that made a big difference in that they did not possess the expertise, people’s relationship with us.” but did not want to acknowledge this, as For Mr Forbes and his sons, social they would lose their funding. responsibility is part of the way of life He encouraged individual and team for the company; as integral as the manu- autonomy, and flexible job descriptions Dr. Ingold devised a generous and facturing and trading business itself. One – again, long before it was a business ingenious solution: He provided the major development began decades ago, trend. Suitably qualified members proprietary technology for free, and after Mr Forbes was shocked that people have the freedom to take an ingenious Forbes Marshall technicians learned injured in a road accident had to wait for approach to a technical or sales-based how to produce it themselves, after the police to arrive before being cleared issue, without going through a time-con- being trained in Switzerland. to be taken to a public hospital. He inter- suming approval process. He adds: “I vened himself to make sure the people think the main reason of success is Mr Forbes married Maharookh received medical attention. He adds: that nothing was impossible to make Forbes, a long and happy marriage, or, do. It was always that if we applied which has given them two sons, Farhad “When I left them afterwards, I was our minds we could get around what- and Naushad. Both their sons are bril- thinking that … if I have some [accident] ever problems we faced. I would always liant engineers and businessmen, trained in my own factory, what will happen? encourage people, never to worry about at Stanford University in California, and I said to myself: ‘I can’t depend on the a problem and to feel that the problem present-day leaders of Forbes Marshall. hospital here.’ I decided that we would is something which gives us a challenge. For Mr Forbes and his sons, social responsibility is part of the way of life for the company; as integral as the manufacturing and trading business itself. 72 The European Financial Review December - January 2020

“My way of working [was that] if I saw a product, to doing business correctly, honorably, honestly and An individual which I thought would be very useful to us, I would sticking to one’s knitting, deciding what you’re good will be always encourage people to make it. They always at and specializing in it.” disciplined, felt that, this is so difficult, we don’t have the draw- and potentially ings, we don't have this, we don’t have that. I would During a later period of unrest, activists held dismissed, for always encourage them to see that they use their demonstrations outside many Pune workplaces; but conduct that own resources, their own ideas, their own thoughts Forbes Marshall was spared the indignity. Curious, is unethical to develop. Whatever modifications we had to the Forbes Marshall HR Director Bobby Kuriakose and contrary to make, we would make it, but make certain that we made inquiries, and learned that a planned protest the company’s succeeded with it.” was called off when one of the leading protestors, values, such a local mother, declared that they could not demon- as theft. Honest mistakes are not punished, even if they are strate outside the Marshall Forbes campus because expensive. But an individual will be disciplined, and it was at their hospital that her baby had been born. potentially dismissed, for conduct that is unethical and contrary to the company’s values, such as theft. The family togetherness is also striking. The All these values and ways of working have been event at which I first met Mr Forbes was held in continued by Farhad and Naushad, and into the third Hyderabad, several hundreds of miles from the generation, who are starting to make their way in the family home in Pune. He had travelled by air, at working world. The company has frequently reached the age of 91, to hear his son talk for 30 minutes. a high placing in the Great Place to Work rankings in Similarly, when his son Naushad was President of India, reaching the number one place in the manufac- the Confederation of Indian Industry for the year turing category. The ethos extends to the customer; 2016-17, the whole family travelled to Delhi for his the Forbes Marshall way is to empathize, and try to final address as President. see the problem from their point of view, and then work back to the solution. It can be a time-consuming It is easy to forget that history is shaped by the exercise in the short-term, but leads to high levels of good guys, as well as the bad. All that is creative, satisfaction, loyalty and repeat business. innovative and socially valuable is the product of the efforts of enlightened people, who combine Mr Forbes has maintained his aura of calmness strong values with hard work. When you have and sense of fairness through the most testing times, been in the presence of Darius Forbes, and his such as the wave of trade union militancy that swept amazing family, you feel a little better about through India in the late 1970s. Throughout the most humanity, and its prospects. significant dispute, a politically motivated strike of over 100 days, he declined to respond to extreme Prof. Denise H. Kenyon-Rouvinez is provocation, and even still permitted strikers to use the former Wild Group Professor and company resources. The only point he held firm Director of the IMD Global Family on was not paying for days not worked. One of the Business Center at IMD. For more than strikers later recalled: “I feel ashamed to remember 25 years she has worked extensively with that during that entire period we came to the factory very large family businesses in Europe, Asia, the in the bus that the company was paying for … [and] Middle East, North and South America and is used to the canteen was giving us meals at company expense. deal with complex governance and wealth situations. I know that Mr Forbes always really cared for our Denise is also author and co-author of many well-being and did his best for us.” That individual books, including Governance in Family Enterprises: later became an advocate for the company. Maximizing Economic & Emotional Success, (Palgrave Macmillan, 2014). Her work in collaboration with the Ashok Desai, a former member of the World Economic Forum over the past three years has Supervisory Board at Forbes Marshall, describes Mr culminated in the publication of a white paper in June Forbes’ presence: “He seldom says much but when 2019: Responsible Ownership: Reshaping Business as he does say something, it is worth listening to. He a Force for Good. often reminisces in meetings; he reminds us of a certain way of doing business … If you ask me to define it, it is unbending commitment to goodness, europeanfinancialreview.com 73

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Leadership If Transformational Leadership Comes First, Knowledge Management and Financial Performance Will Follow BY MOSTAFA SAYYADI A prominent scholar that is well known in the Corporate structure departments, but most importantly, through manip- Academy of Management, one of the largest can be reshaped by ulating organizational factors. Also, transformational leadership and management organizations in transformational leaders contribute to financial performance through the world by the name of Peter Senge says that leaders when they improving knowledge management performance that successful organizations enhance their competi- develop knowledge will increase the rate of responses to environmental tiveness and financial performance by focusing sharing and inspire changes. Transformational leaders know that finan- on knowledge management. This article indi- employees to create cial aspects of firm performance include return on cates the indirect impact of transformational assets, return on sales, earnings per share, and stock leadership on knowledge management as an new ideas for a price performance. Armed with these tools, trans- important component of financial performance. better environment. formational leaders can effectively increase financial performance for companies. Introduction The key function of knowledge management is Structural Change That Sticks to help executives use it for goals achievement. Corporate structure has been defined as a pattern Knowledge management has been, therefore, a focal by which companies can divide their activities and point of executive span of control but has not been tasks as well as control them to achieve higher associated with transformational leadership enough degrees of coordination.1 Corporate structure, to make it an integral part of business success. One therefore, refers to the bureaucratic division of tool for executives to use when considering on less- labor accompanied by control and coordina- ening the gaps between success and possible failure, tion between different tasks in order to develop is to adopt transformational leadership and become a communication within companies. transformational leader. Corporate structure can be reshaped by trans- Transformational leaders can positively impact formational leaders when they develop knowledge knowledge management through enhancing the sharing and inspire employees to create new ideas dynamic relationships among employees and for a better environment among business-units and departments.2 An informal structure could facilitate new idea generation to build a more inno- vative climate within companies.3 Transformational europeanfinancialreview.com 75

Leadership leaders can implement organizational changes that knowledge management processes such as knowl- develop better collaboration among subordinates edge acquiring, creating, and sharing among both and managers. managers and departmental units.8 On the contrary, a more decentralized and flexible structure may Centralized versus decentralized decision making enable companies to identify best opportunities that is a topic that transformational leaders must deal can potentially lead to improve knowledge utilization with. More emphasis on formalized and mechanistic process. Ergo, transformational leaders can positively structures can negatively impact the transforma- contribute to organizational knowledge manage- tional leader’s ability to exert such changes. On the ment through building more decentralized structures contrary, a more decentralized and flexible structure within companies. And if corporate structure is may improve departmental and managerial inter- not completely in favor of supporting knowledge actions. The mechanical or centralization at the management, companies cannot effectively imple- commanding level of leadership impairs the oppor- ment knowledge management projects to improve tunity to develop relationships among managers, financial performance and they may become obsolete business units, and departments. Transformational or taken over. leaders inspire followers to generate new solutions and a better environment. A highly centralized Strengthening Corporate Culture structure has a negative impact on transforma- Corporate culture is a “pattern of shared basic tional leadership practices, while decentralization assumptions that the group learned as it solved its positively contributes to transformational leaders problems of external adaptation and internal integra- in developing a more innovative climate. This tion that has worked well enough to be considered is enhanced by the crucial role of decentralized valid and, therefore, to be taught to new members as structures in facilitating the exchange of ideas and the correct way to perceive, think, and feel in relation the implementation of more innovative solutions to those problems”.9 Corporate culture is, therefore, based on stipulating the power of decision-making reflected in shared assumptions, symbols, beliefs, at all levels of the company. Furthermore, highly values and norms that specify how employees under- formalized structures are more bureaucratic, and stand problems and appropriately react to them. this negatively contributes to the effectiveness of transformational leadership in changing the existing Scholars have proven that transformational leaders situations and creating a better environment. Thus, can build a strong corporate culture to improve transformational leaders reshape corporate struc- customer satisfaction through acquiring additional ture to be more effective when the command center knowledge from customers, developing better rela- of companies can disseminate information in a tionships with them, and providing a higher quality of decentralized and organic way as opposed to the service for them.10&11 Executives, today, are focusing mechanical and centralized command center. on corporate culture. Corporate culture is to gather, evaluate, and disseminate information throughout Transformational leaders that implement struc- the companies. Transformational leaders can build an tural changes may improve knowledge management. effective culture to acquire knowledge from various For example, decentralized structures shift the sources such as suppliers, customers, business part- power of decision-making to the lower levels and ners, and competitors.12 subsequently inspire organizational members to create new ideas and even implement them while Corporate culture includes three dimensions of centralized structures may negatively impact interde- collaboration, trust and learning.13 A collaborative partmental communications and inhibit knowledge culture enhances communications in companies. And exchange.4&5&6&7 Recent research affirms that the this cultural aspect can be critical for transfor- there is a negative impact of centralization on various mational leadership practices, which are strongly Corporate culture is to gather, evaluate, and disseminate information throughout the companies. Transformational leaders can build an effective culture to acquire knowledge from various sources such as suppliers, customers, business partners, and competitors. 76 The European Financial Review December - January 2020

based on developing relationships with subor- in enhancing the effectiveness of knowledge dinates. Moreover, a transformational leader’s management practices. For example, collabora- ability to build a more innovative environment tion provides a shared understanding about the is highly dependent on the extent to which their current issues and problems among employees, subordinates trust them. Therefore, a culture that which helps to generate new ideas within compa- instills trust in subordinates enables transforma- nies.22&23&24 Trust towards their leader’s decisions tional leadership practices through mobilizing is a necessary precursor to create new knowl- their support toward the transformational lead- edge.25&26&27 Moreover, the amount of time spent ership vision for changing current situations, learning is positively related with the amount whereas, distrust will impair the effectiveness of of knowledge gained, shared, and implemented. transformational leaders leadership.14 Thus, trans- Therefore, transformational leaders reshape, and formational leaders can manifest themselves as in some cases, manipulate corporate culture to change agents who manipulate corporate culture facilitate knowledge management practices within with the aim of improving knowledge manage- departmental and business units of companies. ment and financial performance. Executives today realize that knowledge is Transformational leaders can facilitate collab- the one of most strategic factors for financial oration by developing relationships in companies. performance.28&29 For example, knowledge is These leaders can contribute to the cultural aspect shared and synthesized with an aim to providing of trust, through considering both employee’s indi- higher quality services. This can improve finan- vidual interests and company’s essential needs.15&16 cial performance in various metrics such as the customer focus, the quality of services, and the Also, transformational leaders identify individual organizational revenue. Shared knowledge can needs of their employees and develop a learning also contribute to the development of a learning culture by intellectually stimulating them to organization in which people continuously grow generate new knowledge and share it with others. and develop. It enables companies to actively Transformational leaders, therefore, manipulate a respond to environmental changes through company’s culture to conform to the needs and developing interactions and awareness from the expectations of strategic goals and objectives. external environment, which can in turn improve financial performance. Executives have found that corporate culture impacts knowledge management.17&18&19&20&21 Ergo, corporate culture indirectly improves financial performance through disseminating Particularly, the three cultural aspects of collab- oration, trust and learning play a critical role europeanfinancialreview.com 77

Leadership Financial success can focal point so that academic scholar- (Unpublished doctoral dissertation). University of be achieved by the ship can meet the needs of managerial Minnesota, USA. implementation of implications at the higher echelons of 11. Vera, D., & Crossan, M. (2004). Strategic leadership and knowledge management organizations worldwide. organizational learning. Academy of Management Review, and facilitated by a 29(2), 222–240. transformational leader Mostafa Sayyadi, CAHRI, 12. Dix C.R. (2013). Leadership and learning: the impact acting as a change agent. AFAIM, CPMgr, works with of transformational leadership on learning culture within senior business leaders to global ministry non-profits (Unpublished doctoral disserta- and managing organizational knowl- effectively develop innova- tion). Indiana Wesleyan University, USA. edge that can play a crucial role in tion in companies, and helps 13. Lee, H., & Choi B. (2003). Knowledge management enhancing various metrics such as the companies – from start-ups to the enablers, processes, and organizational performance: an quality of services and the organiza- Fortune 100 – succeed by improving the integrative view and empirical examination. Journal of tional revenue. Therefore, executives effectiveness of their leaders. He is a busi- Management Information Systems, 20(1), 179-228. act in a supportive role as transforma- ness book author and a long-time 14. Lines, R., Selart, M., Espedal, B., & Johansen, S.T. (2005). tional leaders but academicians point contributor to HR.com and Consulting The production of trust during organizational change. Journal out that if transformational leaders Magazine and his work has been featured of Change Management, 5(2), 221–245. do not adequately support knowledge in these top-flight business publications. 15. Podsakoff, P.M., Mackenzie, S.B., Moorman, R.H., & dissemination and creation through Fetter, R. (1990). Transformational leader behaviors and various mechanisms such as corpo- References their effects on followers’ trust in leader, satisfaction, rate culture, knowledge management 1. Bowditch, J.L., & Buono, A.F. (2000). A primer on and organizational citizenship behaviors. Leadership cannot be successful. organizational behavior, New York: John Wiley & Sons. Quarterly. 1(2), 107-142. 2. Tafvelin, S. (2013). The transformational leadership 16. Klinsontom, S. (2005). The influence of leadership In Conclusion process, Retrieved from http://umu.diva -portal.org/ styles on organizational commitment and employees Executives can now see how culture smash/get/diva2:640843/FULLTEXT01.pdf. performance (Unpublished doctoral dissertation). Nova and structure constitute the foun- 3. Jarvenpaa, S.L., & Staples, D.S. (2000). The use of Southeastern University, USA. dation of a supportive workplace collaborative electronic media for information sharing: An 17. Ruggles, R. (1998). The state of the notion: Knowledge to share and synthesize organiza- exploratory study of determinants. Strategic Information management in practice. California Management Review, tional knowledge and subsequently Systems, 9(2), 129-154. 40(3), 80–89. improve financial performance. In 4. Damanpour, F. (1991). Organizational innovation: A 18. O'Dell, C., & Grayson C.J. (1999). Knowledge transfer: fact, financial success can be achieved meta-analysis of effects of determinants and moderators. Discover your value proposition. Strategy & Leadership, by the implementation of knowledge Academy of Management Journal, 34(3), 555–590. 27(2), 10-15. management and facilitated by a trans- 5. Woodman, R.W., Sawyer, J.E., & Griffin, R.W. (1993). 19. Gold, A.H., Malhotra, A., & Segars, A.H. (2001). formational leader acting as a change Toward a theory of organizational creativity. Academy of Knowledge management: An organizational capabilities agent. 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