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Development of Industrial Clusters: East Development of Industrial Clusters: East Asia Experience and New Development Asia Experience and New Development

Strategy for AfricaStrategy for Africa

Keijiro OtsukaKeijiro OtsukaNovember 29, 2006November 29, 2006

FASID: Foundation for Advanced Studies FASID: Foundation for Advanced Studies on International Developmenton International Development

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The Labor Markets Team in the Social Protection Network in conjunction with PREM and DEC

Development of Industrial Clusters:East Asian Experience and New Development Strategy for Africa

Date: Wednesday, November 29, Time: 2:30 - 3:30 pm, Room: MC3-570

Summary: Despite its utmost importance, the issue of industrial development has been largely neglected in the literature on development economics for the last few decades. Thus, we have conducted comparative case studies of the garment and motorcycle industries between China and Japan and the machinery and printed circuit board industries between China and Taiwan. We have found striking similarities in the pattern of industrial development across the eight cases. According to our observations, industrialization is initiated either by merchants or engineers, depending on the complexity of the production technology, which is followed by the quantity expansion phase characterized by the imitated production of low-quality products. Declining profits due to the increased supply of such products induces educated managers to carry out multifaceted innovations, while taking advantage of the increased availability of diverse human resources in the cluster. Such arguments are formalized as "an East Asian Model of Cluster-Based Industrial Development." We have also proposed a new strategy for industrial development in developing countries with a view to assisting, in particular, the development of the existing industrial clusters in Sub-Saharan Africa, where we have completed several case studies.

The presentation draws from Prof. Otsuka's recently published book and ongoing research (attached).

About the Presenter:  Professor Otsuka is a faculty at The Foundation for Advanced Studies on International Development (FASID), set up in March 1990 and based in Tokyo. FASID's primary functions are to conduct education and training of a new generation of Japanese development professionals and research on international development. Prof. Otsuka is also a visiting professor of the National Graduate Institute for Policy Studies (GRIPS) and the Program Director of the joint FASID-GRIPS Graduate Program. He was a visiting Research Fellow at the International Food Policy Research Institute (IFPRI, Washington, DC, 1993-98), and is board chair for IFPRI at the upcoming CGIAR Annual meeting to be held in Washington on Dec. 5-7, 2006. Keiji has a Ph.D. from the University of Chicago, and has been very active in research. His research interests are wide and covers industrial development, land tenure, rural labor market, the Green Revolution, etc. He has published extensively in scientific journals, articles and books.

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What is Industrial Cluster?What is Industrial Cluster?

DefinitionDefinition

Geographical concentration of enterprises producing similar and closely related products in a small area (e.g., assemblers and part-suppliers).

Type 1Type 1 - Cluster that is characterized by the dominance of SMEs.

Type 2Type 2

- Pyramidal type in which there are one assembler, many sub-contractors, and so many sub-sub-contractors (e.g., Toyota).

Pyramid Type

We focus on the first type, because it is common in developing countries.

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Why is the Industrial Cluster so Why is the Industrial Cluster so Important?Important?

Many successful industrial development is cluster-based, not only historically but also at present throughout the world

(e.g., Silicon Valley, Bangalore, Dhaka, Northern Italy, whole region of Taiwan, Wenzhou and many other regions in China, …..).

A small number of strong industrial clusters tend to dominate in the globalizing world, where country borders lose significance.

There is increasingly “broad” recognition that clusters have certain advantages over non-clusters.

There is also increasing recognition that development of SME-led labor-intensive industrialization is indispensable to reduce widespread poverty.

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Advantages of Industrial Clusters Advantages of Industrial Clusters [Agglomeration Economies, A Dominant View][Agglomeration Economies, A Dominant View]

Alfred MarshallAlfred Marshall

- Clustering is the key to successful industrial development because ofa) Information spillovers

(typically imitation)

b) Specialization and division of labor among enterprises (low transaction costs due to proximity of transacting partners)

c) Development of skilled labor markets (usually through poaching)

- If an enterprise is located outside the cluster, it will find it difficult to learn from other enterprises, to sell/buy parts and recruit workers with desired skills.

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Advantages of Industrial Clusters Advantages of Industrial Clusters

Paul Krugman’s Theory of “Cluster”Paul Krugman’s Theory of “Cluster”

a) Scale economies at the planet levelb) High transport cost between areas

- Reduction in transport cost due to clustering leads to geographical concentration of industries

Sonobe-Otsuka Theory of ClusterSonobe-Otsuka Theory of Cluster

a) Scale economies at the cluster level not at the planet level

b) Emphasis on reducing transaction costs, not transport costs

c) Emphasis on innovation possibilities in clusters

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Endogenous Process of Industrial DevelopmentEndogenous Process of Industrial Development

List of Case Studies in AsiaList of Case Studies in Asia

Garment Japan, China, Vietnam, Bangladesh

Motorcycle Japan, China

Machinery Taiwan (Machine tool), Taiwan (Printed-circuit board), China (Printed-circuit board), China (Electric appliances)

Surprisingly great similarity is observed in the process of industrial development among different industries in different countries

Most Important FindingMost Important Finding

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Endogenous Process of Industrial DevelopmentEndogenous Process of Industrial Development

Stages of Industrial DevelopmentStages of Industrial Development

Stage Typical Process of Development

Initiate

QuantityExpansion

Quality Improvement

1) Pioneer imitate foreign technology

2) Pioneer’s success in business

3) Emergence of followers (imitation of pioneer)

4) Expansion of production quantity

5) Decline in profit

6) Innovation

7) Quality competition

Model

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Endogenous Process of Industrial DevelopmentEndogenous Process of Industrial Development

Stage Prior experience

Education

Innovation & imitation

Institutions & locations

Initiation

TradersEngineers

Low Imitate foreign technology

Suburbs and villagesUrban

Quantity Expan sion

Spin-offs

Entrants with various backgrounds

Mixed

Imitate imitationStagnant productivityProfitability

Market transactionDivision of laborFormation of industrial cluster

Quality Improve

ment

Second generation of foundersNewcomers with new ideas

Very

high

Multi-faceted innovationsExitEmergence of large enterprisesProductivity

Reputation & brand namesDirect salesSub-contracts or vertical Integration

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Why Multi-faceted Innovations?Why Multi-faceted Innovations?

a) First of all, the quality of products must be improved by employing engineers, designers, and skilled workers.

b) Since consumers do not immediately perceive the quality improvement, innovative enterprises must convey the quality information by establishing brand names, opening own retail stores, and so on.

c) Since improved products are differentiated products, innovative enterprises need special parts, which embody new ideas. To protect new ideas, they must develop trust and establish long-term sub-contracts with parts-suppliers.

d) Innovative enterprises should embark on exports, absorb non-innovative enterprises, and seek scale economies.Such multi-faceted innovations can be carried out only by educated entrepreneurs.

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Table 1. Initiators, Imitators, and Innovators Table 1. Initiators, Imitators, and Innovators [[the Machine Tool (MT) Industry in Taichung, Taiwan]the Machine Tool (MT) Industry in Taichung, Taiwan]

InitiatorsEarly

ImitatorsInnovators

New Imitators

# sample enterprises 7 24 2 10

Year of establishment 1957 1979 1980 1994

Years before MT production 12.6 0.7 0 0

Prior job of founders (%)

Machine tool enterprises 0 59 100 90

Other machinery enterprises

88 13 0 10

Schooling of founders (%)

Primary 71 13 0 0

Secondary 0 12 0 0

High/vocational 29 54 0 60

University/graduate school 0 21 100 40

# parts-suppliers/enterprise 19.0 29.6 40.5 38.7

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Table 2. Quantity Expansion to Quality ImprovementTable 2. Quantity Expansion to Quality Improvement[[the Case of the Garment Industry in Jili, Chinathe Case of the Garment Industry in Jili, China]]

1990 1995 1999

# sample enterprises 27 66 98

Average enterprise size

Real value added 114 203 224

# workers 8.7 11.1 16.7

Marketing channels

% local market/traders 73.7 51.6 39.2

% outside traders 26.3 48.4 60.8

Price: local market 12.3 18.5 13.0

value added/piece 3.3 5.0 2.2

Price: outside traders 15.8 19.9 18.8

value added/piece 5.0 5.1 3.9

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Table 3. Characteristics of Enterprise Table 3. Characteristics of Enterprise Founders: the Case of Electric Appliance in Founders: the Case of Electric Appliance in

Wenzhou Wenzhou

Before 1980

1981-85 1986-90 1991-95 1995-2000

No. of enterprises 4 32 30 36 10

Years of schooling 8.0 9.8 10.0 10.5 10.9

Occupation (%)

Farmers 50 12.5 6.7 2.8 0

Factory workers 0 25 16.7 16.7 10

Salesmen or traders

25 25 43.3 63.9 50

Engineers 0 3.1 13.3 5.6 0

Managers 0 9.4 10 5.6 10

Others 25 25 10 5.6 30

Increasing importance of traders

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Table 4. Basic Production Statistics: the Case Table 4. Basic Production Statistics: the Case of Electric Appliance in Wenzhou of Electric Appliance in Wenzhou

1990 1995 2000

Number of enterprises 66 102 112

Number of independent enterprises 66 96 73

Sales revenue 320.4 964.1 9525.7

Value added 123.7 375.8 3671.4

Number of employees 46.7 104.1 338.3

Capital stock 372.0 983.9 7922.1

Decreasing entry and surprisingly high growth of enterprises

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Table 5. Proportion of Engineers, the Number of Table 5. Proportion of Engineers, the Number of

Subcontractors, and Marketing Channels: Subcontractors, and Marketing Channels: the Case of the Case of Electric Appliance in WenzhouElectric Appliance in Wenzhou

1990 1995 2000

Proportion of workers that are engineers (%)

1.5 2.7 4.2

Number of parts supplying subcontractors

0 2.8 34.8

Composition of marketing channels (%)

Local wholesale market 23.5 20.4 3.6

Wenzhou traders 26.5 23.8 5.7

Sales agencies 22.0 30.7 50.6

Own retail outlets 9.5 12.6 27.1

Other channels 18.5 12.5 13.0

Increasing importance of multifaceted innovations

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Agglomeration Economies ReconsideredAgglomeration Economies Reconsidered

1. Information spillovers2. Specialization and division of labor3. Development of skilled labor markets4. Transactions between manufacturers and

wholesalers/retailers are also important5. Accumulation of various human resources such as

engineers, merchants, parts-suppliers, that leads to

Industrial Cluster Develops Marketand Enlarges Innovation Possibilities

Enlarges Opportunities for Innovation

A NewCombination==

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Case Studies in Sub-Saharan Africa

Industry Town/City Country # enterprises

Garment 3 marketplaces

In Nairobi

Kenya 1,000

Footwear Addis Ababa Ethiopia 1,000

Vehicle repair & metalwork

Kumasi Ghana 10,000

Kariobangi in

Nairobi

Kenya 100

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Footwear Industry in EthiopiaFootwear Industry in EthiopiaA Brief HistoryA Brief History

Started in the 1930s by Armenians Producers proliferated through spin-offs of spin-offs Clustered in Addis Ababa More than 1,000 shoe enterprises now Vast majority are informal China shock in 2000, 2001, 2002 Largely recovered from the shock and thrives Exporting to Italy and UK as well as African markets Large private shoemakers have emerged

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Table 6. Average Size of Sample Enterprises in Table 6. Average Size of Sample Enterprises in 20042004

Years of operation by current owner

2-4 5-9 10+ All

Owners without parents in the shoe business

No. observations 43 23 6 72

Men’s shoe price (USD) 6.1 6.9 8.0 6.5

Value added (000USD) 7.1 9.6 17.0 8.7

Owners with parents in the shoe business

No. observations 4 9 5 18

Men’s shoe price (USD) 6.7 9.3 12.5 9.6

Value added (000USD) 5.9 84.8 107.7 73.6

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There are micro, small, medium, and large enterprises. All started from micro sizes.

Massive new entry even in the worst period.– Easy entry and easy exit: small initial investment

and almost no sunk costs.– Management of tiny workshops is much easier.

Enterprise size tends to increase with the years of operation.

Second-generation enterprises are much larger. Our analysis clearly indicates that high education

is the main source of their advantages.

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Table 7. Owners’ Education and Number Table 7. Owners’ Education and Number of Business Trips Abroadof Business Trips Abroad

Years of operation by current owner

2-4 5-9 10+ All

Owners without parents in the shoe business

Years of schooling 8.2 8.7 10.7 8.5

Entered university % 2 0 0 1

No. of trips abroad 0 0.05 0.20 0.03

Owners with parents in the shoe business

Years of schooling 11.7 11.9 11.7 11.8

Entered university % 25 44 60 44

No. of trips abroad 0 1.9 9.4 3.6

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Intense competition with a swarm of new entrants have driven established enterprises into the production of higher quality shoes.

Among the established enterprises, more innovative are highly educated entrepreneurs.

They introduced new ideas and practices in products, production processes, marketing, procurement, etc.

These new ideas and practices are adopted from abroad, especially Italy.

Some of them have found their way into European markets.

The industry is entering the quality improvement phase.

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Justifications for Policies Justifications for Policies to Promote Industrial Clustersto Promote Industrial Clusters

a) Cluster promotes enterprise-enterprise and enterprise-merchant transactions by reducing transaction costs. (Transaction costs = cheating, stealing, lying, shirking, etc)

b) Cluster stimulates multifaceted-innovations by attracting a variety of useful human resources.

c) Cluster, however, discourages investment in innovation to the extent that benefits from innovation are reduced by imitation.

New Development StrategyNew Development Strategy

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New Development StrategyNew Development Strategy

1. Initiate new industry (like planting seeds): SOEs? FDIs? Model plants?

2. Support for cluster formation (like growing plants): Construction of market-places and industrial zones

3. Support for innovation (like producing high-quality tree products): Appropriate training programs, once cluster is formed.