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

1. Development of Industrial Clusters: East Asia Experience and New Development Strategy for Africa Keijiro Otsuka November 29, 2006 FASID: Foundation for Advanced Studies on International Development

2. 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 AfricaDate: 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.

3. Type 1 - Cluster that is characterized by the dominance of SMEs. Type 2 Pyramid Type - Pyramidal type in which there are one assembler, many sub-contractors, and so many sub-sub-contractors (e.g., Toyota). What is Industrial Cluster? Definition Geographical concentration of enterprises producing similar and closely related products in a small area (e.g., assemblers and part-suppliers). We focus on the first type, because it is common in developing countries.

4. Why is the Industrial Cluster so 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.

5. Advantages of Industrial Clusters [Agglomeration Economies, A Dominant View] Alfred Marshall - Clustering is the key to successful industrial development because of • Information spillovers (typically imitation) • Specialization and division of labor among enterprises (low transaction costs due to proximity of transacting partners) • 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.

6. Advantages of Industrial Clusters Paul Krugman’s Theory of “Cluster” Scale economies at the planet level High transport cost between areas - Reduction in transport cost due to clustering leads to geographical concentration of industries Sonobe-Otsuka Theory of Cluster Scale economies at the cluster level not at the planet level Emphasis on reducing transaction costs, not transport costs Emphasis on innovation possibilities in clusters

7. Endogenous Process of Industrial Development List of Case Studies in Asia Surprisingly great similarity is observed in the process of industrial development among different industries in different countries Most Important Finding

8. Endogenous Process of Industrial Development Stages of Industrial Development 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 Model 7) Quality competition

9. Endogenous Process of Industrial Development

10. Why Multi-faceted Innovations? First of all, the quality of products must be improved by employing engineers, designers, and skilled workers. 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. 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. 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.

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

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

13. Table 3. Characteristics of Enterprise Founders: the Case of Electric Appliance in Wenzhou Increasing importance of traders

14. Table 4. Basic Production Statistics: the Case of Electric Appliance in Wenzhou Decreasing entry and surprisingly high growth of enterprises

15. Table 5. Proportion of Engineers, the Number of Subcontractors, and Marketing Channels: the Case of Electric Appliance in Wenzhou Increasing importance of multifaceted innovations

16. Agglomeration Economies Reconsidered Information spillovers Specialization and division of labor Development of skilled labor markets Transactions between manufacturers and wholesalers/retailers are also important Accumulation of various human resources such as engineers, merchants, parts-suppliers, that leads to Industrial Cluster Develops Market and Enlarges Innovation Possibilities Enlarges Opportunities for Innovation A New Combination =

17. Case Studies in Sub-Saharan Africa

18. Footwear Industry in EthiopiaA 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

23. Table 6. Average Size of Sample Enterprises in 2004

24. 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.

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

26. 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.

27. Justifications for Policies to Promote Industrial Clusters New Development Strategy Cluster promotes enterprise-enterprise and enterprise-merchant transactions by reducing transaction costs. (Transaction costs = cheating, stealing, lying, shirking, etc) Cluster stimulates multifaceted-innovations by attracting a variety of useful human resources. Cluster, however, discourages investment in innovation to the extent that benefits from innovation are reduced by imitation.

28. New Development Strategy • Initiate new industry (like planting seeds): SOEs? FDIs? Model plants? • Support for cluster formation (like growing plants): Construction of market-places and industrial zones • Support for innovation (like producing high-quality tree products): Appropriate training programs, once cluster is formed.