Report and Joint Policy Recommendations
on Strengthening Economic Cooperation
among China, Japan and Korea in 2002
Joint Research by the
Development Research Center of the State Council of China
National Institute of Research Advancement of Japan
Korea Institute for International Economic Policy
I. Joint Research Situation of the Three Institutes
In accordance with the common understanding reached during the Manila Summit by the leaders from China, Japan and Korea in November 1999, the joint research on "Strengthening Economic Cooperation among China, Japan and Korea" was officially launched by the representative institutes from the three countries, namely the Development Research Center of the State Council of China (DRC), the National Institute of Research Advancement of Japan (NIRA) and the Korea Institute for International Economic Policy (KIEP) in November 2000.
The first two-year project jointly carried out by the three research institutes was on the promotion of trade and investment among the three countries. In 2001, the emphasis was on trade facilitation. Based on the same questionnaires for the respective enterprises engaging in bilateral trade and the in-depth discussions at the international symposiums and workshops, we jointly drafted the "Report and Policy Recommendations on Strengthening Economic Cooperation among China, Japan and Korea." At the Brunei meeting in November 2001, Chinese Premier Zhu Rongji, Japanese Prime Minister Junichiro Koizumi and Korean President Kim Dae-jung confirmed the report and joint policy recommendations delivered by the research institutes from the three countries and agreed to establish a system of annual meetings attended by the economic ministers of the three countries. We are glad to see that the mechanism of economic and trade ministerial meetings by China, Japan and Korea has been officially launched and the first meeting was held in Brunei in September 2002. This important progress will no doubt have a positive impact on economic and trade cooperation among the three countries, regional cooperation and multilateral cooperation.
The joint research in 2002 focuses on "Facilitating Investment among China, Japan and Korea." Against the background of economic globalization and regional economic integration, cross-border investment plays an ever-increasing role in such aspects as enhancing the economic ties and promoting the economic development and structural readjustment of the three countries. According to the questionnaires jointly designed by the research institutes, NIRA mainly surveyed Japanese enterprises with investment activities in China and Korea and DRC concentrated on the Japanese and Korean-funded enterprises in China, while KIEP focused on Japanese enterprises investing in Korea and Korean enterprises investing in China. The survey aims at evaluating the current situation of mutual investment of the three countries, identifying the obstacles affecting their investments, not only in the host countries but also at home, and seeking ways to reduce or eliminate those investment barriers.
Due to the ever-closer relations between trade and investment, the three sides analyzed comprehensively, on the basis of the joint research in 2001, the relations of trade and investment among the three countries, which is also a summary of the first two-year joint research project for the first stage by the research institutes of the three countries.
In the "Joint Policy Recommendations" of 2001, the research institutes of the three countries proposed to establish an extensive official, business and academic dialogue mechanism regarding trade and other economic issues. In order to help establish such a mechanism, the entrepreneurs and officials from the three countries were invited for the first time to attend the international symposium on "Strengthening Economic Cooperation among China, Japan and Korea" held in Beijing in September 2002.
This report aims at proposing specific policy recommendations to the leaders of the three countries on trade and investment facilitation among them and providing advice on starting the joint research for the second stage by the three representative institutes. The report and joint policy recommendations based on their joint research will be delivered to the leaders of the three countries during the annual ASEAN + China, Japan and Korea meetings.
II. Abstract of Joint Research
(I) Global Trends and Intra-regional Trends in FDI between China, Japan and Korea
Global FDI grew rapidly in the 1980s and 1990s, with its growth rate much higher than that of other economic aggregates like GDP and trade. From 1990 to 2000, global FDI inflows increased six fold, while trade volume went up only by 85%. However, following a visible decrease in its rate of growth in 2000, the trends in global FDI reversed in 2001. Most recently, UNCTAD reported that global FDI inflows dropped by more than 50% in 2001 compared with that of the previous year, and was expected to decline further in 2002 because of a fizzling M&As market.
FDI is an important impetus promoting regional economic integration, but the mutual investment in Northeast Asia is obviously less than sufficient.
First, the share of China, Japan and Korea in global FDI flows has become very small. The three countries' share of global FDI inflows amounted to 15.4% in 1994, but shrank to 4.7% in 2000, while their share of global FDI outflows declined from 20.4% in 1990 to 3.4% in 2000.(Note:1) The low level of these FDI shares becomes more evident when we remind ourselves that in the same year their shares in the world's total GDP and trade are 19.8% and 11.8%, respectively. For the sake of comparison, the proportions of FDI outflows and inflows of the EU to those of the world were 67.2% and 48.6% respectively in 2000, while those of the US were 12.1% and 22.1%.
Second, compared with the EU and NAFTA, the level of intra-regional FDI flows in Northeast Asia is quite low. For the past ten years, the share of intra-regional FDI between China, Japan and Korea varied substantially. It increased rapidly in the first half of the 1990s, peaking in 1995 before diminishing in the second half of the 1990s. It rose from 2.3% in 1990 to 9.8% in 1995, before declining to 6.1% in 2000. The proportion of intra-regional FDI in the EU was 52% in terms of outflows and 40% in terms of inflows in 1998. Though there aren't any directly comparable statistics of NAFTA, the following facts can, to some degree, reflect its situation of intra-regional FDI: as of the end of 2000, the direct investment from the US to Canada accounts for 64% of Canada's total FDI inflows, and Canada's direct investment in the US accounts for 75% of Canada's total FDI outflows; from 1994 to 2001, 72% of Mexico's total FDI inflows are from the US and Canada. What is noteworthy is that the share of intra-regional FDI in Northeast Asia is obviously quite low even if compared with its share of intra-regional trade, which is 19.8% in 2000 (Figure 1).
Figure 1: Proportion of Regional Trade and Investment in Northeast Asia
According to an analysis based on FDI statistics, the reason for the low level of intra-regional FDI in Northeast Asia seems to be the inactiveness of Japan's direct investment in China. At present, China has become one of the most important destinations for Korea's FDI, while Japan's direct investment in China only accounts for a small percentage in Japan's total FDI outflows. The main reasons are as follows: firstly, Japan's foreign investment mainly focuses on the developed countries in Europe and America. Secondly, the growth of Japan's FDI outflows in recent years has been mainly motivated by M&As, while Japan's investments in China are still mostly greenfield investments. Thirdly, some of the FDI from Japan to China might be undertaken via Hong Kong; seeking partners in Hong Kong may be a way to share investment risks.
In addition, since Chinese and Korean enterprises still do not enjoy ownership-specific advantages against their Japanese counterparts, there has been little direct investment from China and Korea to Japan. This constitutes another reason for the low level of intra-regional FDI flows in Northeast Asia.
However, there are signs that the share of intra-regional FDI between China, Japan and Korea is likely to rise again. Firstly, both Japan and Korea's investment in China increased rapidly in 2001. This might be a recovery growth after the Asia financial crisis on one hand, or related with China's successful entry to the World Trade Organization in 2001 on the other hand, for the promises made by the Chinese government have enhanced the confidence of investors. Secondly, the rapid growth of global FDI in the latter part of the 1990s has mostly been motivated by the upsurge of M&As, and with the shrinkage of M&As in developed countries, the share of intra-regional FDI in Northeast Asia is likely to rise correspondingly, for the regional investments in Northeast Asia are mainly greenfield investments.
(II) Analysis on Obstacles Existing in the Mutual Investment among China, Japan and Korea on the Basis of the Survey Results from Enterprise Questionnaires
A questionnaire survey was conducted in China, Japan and Korea by the research team of the three representative institutes.
1. Investments from Japan and Korea to China
The joint research team presented seventeen determinants of FDI attraction in the questionnaire. The results of the survey, conducted respectively by the three research institutes, all show that (see Table 1) both Japanese and Korean enterprises are attracted by the same leading factor, namely the potential market size (with average value all above 4.) (Note:2) In addition, the survey results confirmed a slight difference in investment motivations for Japanese and Korean enterprises investing in China. Korean investments and production in China aim largely at enjoying China's low production costs and labor force abundance, while Japanese enterprises mainly focus on preferential policies for foreign investments, labor force abundance and administration efficiency. And at the same time both Japanese and Korean enterprises admitted that China's economic stability is an important attractive determinant.
2) General Assessment of Investment Environment
The survey results confirm that the investment environment in China has largely improved, especially in such aspects as infrastructure, labor force quality, laws and regulations, policy transparency, restrictions on market entry and general attitude towards FDI. The survey shows the aspects with the least improvement include production cost, investors' rights including IPR, additional charges over taxation and regulations on withdrawing capital. It implies that Japanese and Korean investors have a great interest in their low production cost in China and worry about possible increases to some extent.
3) Barriers in Host Country: China
In the questionnaires sent to both Japanese and Korean enterprises in China, the three-country joint research team listed 31 factors affecting investment environment, in which six are related to market conditions, five to institbutional factors, ten to policy factors, seven to preferential FDI policies and three to social and cultural factors. Enterprises were requested to choose the most important factors impeding their investment and operation in China (see Table 2).
Although Japanese firms evaluate that China's investment environment has greatly improved, there are still problems considered to be obstacles to further investment including "production cost," "protection of investors' rights and intellectual property rights," "tax preferential policies," "a sound system of laws and regulations," and "transparency of government policy." Aside from the production costs, the aspects raised by many Japanese firms are mainly related to government policy. Japanese firms are most annoyed by the ambiguity of government policy and law, enforcement of tax policies, and insufficient protection of intellectual property rights.
The Korean firms share similar views with their Japanese counterparts. They, however, place more emphasis on barriers such as laws and regulations, inspection and approval procedures, extra charges over taxation, and tax preferential policies.
4) Obstacles from Home Country
As home countries, both Japan and Korea have internal factors affecting their enterprises' final decisions on making investments into China.
First, social pressures. Japanese and Korean enterprises encounter various social pressures when conducting overseas investment, mainly from local governments and business circles in their own countries with major concerns about losses of government tax revenues. Besides, DRC's survey shows that one-third of Japanese companies believe that such issues as the industrial hollowing-out effect and employment are the major concerns of business circles and trade unions from home countries. The survey conducted by KIEP also confirms that Korean enterprises encounter pressures from local government.
Second, institutional factors. According to the survey results of the three institutes, both Japanese and Korean FIEs think that the inspection and approval system in their home countries need to be simplified and improved. In addition, more Japanese companies hold that restrictions in Japan on overseas investment and technology exports have basically not been changed, and more Korean invested companies believe that Korea's financial environment for investing abroad needs to be further improved.
2. Investment from Japan to Korea
For Japanese companies investing in Korea, the most attractive factors are market potential and human capital abundance, followed by infrastructure, economic stability and transparency of government policies.
2) Barriers in Host Country
In general, the investment environment in Korea has improved greatly in terms of market conditions, institutional factors, and restrictions over market entry and trade access as well as general attitude toward FDI. There are still, however, some impediments to foreign invested enterprises in Korea.
According to the survey conducted in Korea, Japanese investors in Korea designate the following as the top five impediments to FDI among the total 31 factors: extra-charges over taxation, tax preferential policies, policy on local employment, production cost as well as laws and regulations.
According to survey results from the Japanese research team, Japanese firms think that the largest obstacle in Korea's investment environment is the high production costs. The structural reforms after the financial crisis may have improved the productivities in labor, which in turn led to the increase in the real wages. It implies that for Japanese investors, the comparatively lower level of labor cost in Korea is still one of the determinant factors of their investment in Korea.
3. Attitude on Economic Cooperation in Northeast Asia
Regarding economic cooperation in Northeast Asia, more than 95% of Japanese and Korean companies surveyed believe economic cooperation will facilitate intra-regional investment and comply with the global trend of regional integration. But some enterprises (less than twenty percent of total firms surveyed) think that at the same time, Northeast Asian countries should also pay attention to their own economic development, for it is quite difficult for the three countries to reach an agreement on regional economic cooperation.
4. Proposals from Enterprises to the Three Governments
At the end of the questionnaires, we asked FIEs for suggestions on policy measures that the three governments should take in order to promote intra-regional investment between China, Japan and Korea. Japanese and Korean enterprises share almost the same views on recommended policy measures (see Table 3), only differing in the order of preference. Most enterprises pin high hopes for economic cooperation among China, Japan and Korea, recommending that joint research be conducted on the long-term objectives of the three countries' economic cooperation and the possibility of establishing an FTA or EPA so as to promote the development of economic cooperation among the three countries into a substantial stage. And, as the second preference, the three countries should establish a dialogue mechanism between governments and enterprises so as to get opinions directly from enterprises on investment facilitation and promotion policies. At the same time, more Japanese firms think it is necessary to jointly establish an investment information platform that can be easily accessed by the enterprises so as to introduce the three countries' industrial situations, investment-related information as well as policies, laws and regulations. More Korean enterprises attach great importance to coordinating policies and resolving conflicts through consultation on investment facilitation and promotion under the framework of annual meetings between the economic ministers of the three countries.
(III) Trade and Investment Relations among China, Japan and Korea
The Joint Research Report in 2001 indicates that the similarity of bilateral trade structures among China, Japan and Korea or the expansion of intra-industrial trade is closely related with investments. In the research on the intra-regional investment among the three countries this year, we are trying to further analyze the relations between trade and investment.
1. Investments among the Three Countries Promote Intra-regional Trade
While there are theoretical reasons to suggest both substitution and complementary effects, empirical work in this area almost invariably shows a net complementary relationship between trade and investment. In other words, the FDI from Japan and Korea tend to promote the exports and overall trade of the two countries; and since the proportion of FIEs in China's foreign trade has exceeded 50%, they become the major driving force to import and export growth.
The stimulation effect of investment on trade has direct relations with the motivations of the investors. The results of the enterprise survey carried out by the research institutes of the three countries indicate that FIEs pursue both market size and efficiency in their production in the host country, implying that the FIEs sell mainly to local consumers and at the same time sell their products back to home countries or export to a third country. Large conglomerates have a much higher local sales share while small and medium-sized enterprises are more likely to export their products.
2. Similarities in Trade Structure Originate from Intra-industrial Trade and Intra-firm Trade
The bilateral trade among China, Japan and Korea is still based on complementarities, and that is especially obvious between China and Japan. In the trade of some industrial sectors, the phenomenon of exporting to each other becomes more and more distinctive. It is closely related with the industrial distribution of FDI and the sale and procurement patterns of FIEs.
Japanese and Korean investments in China concentrate on the manufacturing industry with the electronics and communication equipment industry being the most concentrated sectors of Japanese and Korean funded enterprises. Japan's investments in Korea are mainly in such sectors as electronics, electrical equipment and chemical products. The procurement of both Japanese and Korean funded enterprises highly relies on imports, and comparatively speaking, Japanese firms are more dependent on the local market in procurement than the Korean ones. FIEs depend more on imports from their home countries than other import sources. The local sales rates of Japanese funded enterprises in China and Korea both exceed 50%, and the export tendency is much higher in Korean enterprises than in Japanese ones. Markets in home countries are the most important export markets of Japanese funded enterprises, while compared with their Japanese counterparts, Korean enterprises rely more on markets in third countries such as the US, Japan and the EU.
Survey results show that the intra-industrial trade among China, Japan and Korea consists to a large degree of intra-firm procurement and sales. It means that Japanese and Korean FIEs conduct trade with their parent companies or other affiliates. It is very common in Japanese enterprises investing in China and Korea as well as in Korean enterprises investing in China.
3. Influence of FDI on Trade Direction and Trade Balance
The steel, chemical, machinery and electronic industries in Japan and Korea enjoy prominent competitive advantages. This applies not only to those whose products are sold directly to the EU and US, but also the major suppliers of capitals goods and intermediate goods for the export processing industry in Northeast Asia. Through FDI, Japan and the NIEs carried out industrial transfers, thus changing the origin of the products without altering the role of Japan and Korea as the suppliers. On the contrary, FDI promotes exports in Japan and Korea.
Japan has always maintained a trade surplus with Korea; Korea also enjoys a trade surplus with China, and China has begun to gain a trade surplus with Japan in recent years, all of which is closely related with the imports and exports of FIEs. Japanese enterprises investing in Korea not only import a lot from Japan, but also export part of their products to China. The procurements of Japanese and Korean enterprises in China also promote the exports of Japan and Korea to China. Yet the target markets of exports of Japanese and Korean enterprises differ: Japanese enterprises sell more of their products back to the home country, while the major export markets of Korean enterprises are the US, Japan and the EU. As a result, part of Japan's trade surplus with Korea changes into Korea's trade surplus with China, and part of Korea's trade surplus with China turns into China's trade surplus with the US, EU and Japan. And China's export growth to Japan mainly originates from the rapid growth of exports of FIEs, including the exports of Japanese and Korean enterprises to Japan.
4. Future Prospects on Trade and Investment among China, Japan and Korea
Facing the challenges of economic globalization and regionalism, it is necessary for China, Japan and Korea to expand intra-regional trade and investment so as to promote regional economic integration in Northeast Asia.
The positive interaction of trade and investment among China, Japan and Korea will not only bring direct benefits to enterprises but also help to transfer technologies and managerial expertise. And, the resulting market competition is conducive to the upgrading of economic structures of the three countries and the improvement of efficiency that in turn ensures economic development and growth. From a short-term perspective, trade and investment among China, Japan and Korea has recovered to the same level as before the Asia financial crisis. After China's WTO accession, the huge potential market is turning into a real one, which further enhances confidence in the trade and investment of enterprises from the three countries. From a long-term point of view, the development of trade and investment among the three countries will not only help to consolidate and strengthen the position of Northeast Asia as the center of the global manufacturing industry but also gradually improve the trade balance situation among the three countries along with the expansion of the regional market. Furthermore, employment opportunities are likely to increase, therefore forming a win-win-win strategy for economic integration in Northeast Asia.
The flow of commodities and essential factors of production among the three countries calls for a sound market environment. Scale of demand and ability of supply are indeed important, but there are still barriers to trade and investment due to the lack of institutional cooperation among the three countries. Survey results on FIEs show that, though the three countries have made great achievements in promoting the process of trade liberalization, problems still exist in such aspects as improving the system of laws, rules and regulations, the transparency of government policies, the protection of investors' rights and intellectual property rights and the reduction of high costs caused by structural impediments. Therefore, it is necessary for China, Japan and Korea to strengthen the dialogue and consultations among governments and gradually advance institutional cooperation by starting from trade and investment facilitation. It is also of great significance to promoting domestic structural reforms in the three countries and boosting the region's international negotiating power.
III. Joint Policy Recommendations
1. Policy Measures Directly Related to Trade and Investment Facilitation
Jointly Establish an Information Exchange Platform and Network for Trade and Investment
In order to increase the policy transparency of the three countries and provide enterprises (small- and medium-sized enterprises in particular) with more sufficient information service, the three countries should, by making full use of the current windows and channels, jointly establish an information exchange platform and network for trade and investment so as to publish laws, regulations and policies related to trade, investment and other economic cooperative matters of the three countries.
Further Improve the Investment Environment
Efforts made by the three countries in improving investment environment have been affirmed by the business community, but host countries should further simplify their inspection and approval procedures on foreign direct investment, give practical protection of the intellectual property rights of investors, improve the mechanism for handling complaints lodged by investors, and avert the increase of production and labor costs caused by structural impediments by accelerating structural reforms to create a sound and predictable investment environment for enterprises.
Strengthen Follow-up Mechanism for Policy Implementation
In order to ensure the implementation of the consensus or agreements reached during meetings attended by state leaders and relevant ministers of the three countries, the respective government ministries (or agencies) in charge of relevant policy issues should strengthen their follow-up efforts and facilitate the implementation of agreements. Each country will appoint relevant ministries (or agencies), so that channels of communications can be established.
2. Policy Recommendations with More Profound and Long-term Significance
Comment on the Progress of Economic Cooperation among the Three Countries
In order to ensure the sound development of economic cooperation among the three countries and enhance the confidence in the business community, it is recommended that the leaders comment on the progress of trade, investment and other economic cooperation matters of the three countries during their annual summit. In view of the fact that after the Asian financial crisis, trade and investment among the three countries underwent a recovery growth and the beneficial interaction of trade and investment generated a win-win effect on the economic growth and structural reform of the three countries, it is hoped that the state leaders can give a positive appraisal so as to create a sound atmosphere for further economic cooperation among the three countries.
Launch Joint Research on "Economic Effects of a Possible Free Trade Area among China, Japan and Korea"
After finishing the first stage of research on trade and investment, the three representative research institutes have jointly suggested the launch of a new research phase, with the topic of "Long-term Economic Vision and Medium-term Directions to Strengthen Economic Cooperation among China, Japan and Korea." It includes the institutional arrangements of economic cooperation and other issues of common interest such as environment, energy and information technology, etc. The joint research on the new phase will be carried out step by step, beginning with the "Economic Effects of a Possible Free Trade Area among China, Japan and Korea" as the research topic in 2003, which is also confirmed by most investors, during a survey on enterprises by the research institutes of the three countries, to be the most important measure to be taken by the three countries in order to promote economic cooperation.
Table 1: Comparison of survey results conducted by three countries' research teams on investment motivation (average value)
DRC's survey KIEP's survey Japanese
FIEs in China
1. Potential Market Scale 4.12 4.00 4.33 2. Sound Infrastructure 3.85 3.75 3.84 3. Labor Force Abundance 4.03 3.87 4.23 4. Low Wages 3.14 3.57 4.23 5. High Quality Labor Resources 3.80 3.57 3.60 6. Cheap Land Price and Rent 3.86 3.67 4.04 7. Mineral Resources 1.90 1.77 2.41 8. Following Enterprises in Upper or Lower Reaches 2.38 2.17 3.34 9. Supporting Ability of Local Enterprises 2.70 2.97 3.19 10. Scale Accumulated in China by Enterprises from
3.17 2.63 3.00 11. Geographical Proximity 2.97 2.80 3.69 12. Easy to Accept Language and Culture 2.77 2.88 3.10 13. Economic Stability 4.22 3.97 3.71 14. Tax Preferential Policies Attracting Investment 4.18 4.02 3.79 15. Policy Transparency 4.03 3.91 3.74 16. Government Work Efficiency and Fairness 4.14 3.99 3.74 17. Evasion of Trade Barriers 2.84 2.81 3.64
Note: Average value is calculated in a five-scale framework where 5 stands for "highly important," 4 for "important," 2 for "not so important," and 1 for "unimportant."
Table 2: Different opinions on barriers from host country for Japanese and Korea FIEs in China
DRC's survey NIRA's survey KIEP's survey Japanese FIEs in China Korean FIEs in China Japanese FIEs in China Korean FIEs in China 1 Production cost Production cost Business credit A sound system of laws and regulations 2 Quality and efficiency of the labor force Various charges apart from taxations A sound system of laws and regulations Various charges apart from taxations 3 Tax preferential policies Infrastructure conditions Transparency of government policies Inspection and approval procedures 4 Transparency of government policies Tax preferential policies Protection of investorfs rights and intellectual property rights Quality and efficiency of the labor force 5 A sound system of laws and regulations Quality and efficiency of the labor force Production cost Tax preferential policies 6 Various charges apart from taxations Transparency of government policies Various charges apart from taxations Production cost 7 Efficiency of administration Central and local taxation system Tax preferential policies Transparency of government policies
Table 3: Policy Measures Suggested By Enterprises to the Three Governments
DRC's Survey NIRA's Survey KIEP's Survey Japanese FIEs in China Korean FIEs in China Japanese FIEs in China Japanese FIEs in Korea Japanese FIEs in Korea Korean FIEs in China 1. Coordinating policies and resolving conflicts through consultation on investment facilitation and promotion under the framework of annual economic minister meeting between the three countries 64.3 66.4 28.9 32.5 54.5 64.0 2. Jointly establishing an investment information platform easy to be browsed by enterprises so as to introduce the three countries' industrial situations, investment-related information as well as policies, laws and regulations 57.3 60.5 40.5 40.3 60.0 51.0 3. Establishing a dialogue mechanism between governments and enterprises so as to get opinions directly from enterprises on investment facilitation and promotion policies 71.3 71.4 30.6 28.6 65.5 63.5 4. Exchanging views on cooperative fields of common concern such as environment, energy and telecommunication by using the official, industrial and educational seminars 22.7 26.9 27.5 28.6 32.7 31.0 5. Conducting joint research on the long-term objectives of three countries' economic cooperation and the possibility of establishing an FTA or EPA so as to promote the economic cooperation relations among the three countries to a substantial stage 74.3 64.7 46.7 58.4 67.3 73.5
Note: 1) Figures are percentage 2) Figures do not add up to 100 because of plural answer
1. If take Hong Kong into consideration, the proportions of FDI inflows and outflows of Northeast Asia to those of the world should increase to 10% and 9% respectively. Since Hong Kong mainly plays a role as a capital transfer station, however, it is inappropriate to view it as an important investment source or destination. 2. It means important when the average value is higher than 3, not important when lower than 3.
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