Technological Capabilities and Export Success in Asia (Routledge Studies in the Growth Economies of Asia)

Technological Capabilities and ExportSuccess in Asia

In this volume, a team of international contributors argue that a policy of cheap labour combined with currency devaluation is no longer sufficient for export success. They demonstrate through a series of case studies of firms in the textile, garment and electronic industries of five Asian economies—Korea, Taiwan Province of China, Thailand, Indonesia and Viet Namthat learning and capability formation are critical to sustain competitiveness. The main findings of these case studies include: • Learning and internalization of knowledge are crucial to acquiring the technological know-how to break into export markets and then maintain market share. • Continuous innovation in product design, production processes, management routines, marketing and the organization of production are the basis for competitiveness in all industries and in all countries. • Growing international competition and rising labour costs have reduced the time that new entrants into a market have for enjoying wage and cost advantages. • There are no fixed formulas or sequences in marketing and technology development for firms to become successful exporters of manufactured goods. • Domestic demand is of increasing importance in the region in terms of providing opportunities for dynamic growth in the market for manufactured goods. Dieter Ernst is currently a Professor of International Management at the Copenhagen Business School. Tom Ganiatsos is currently Senior Officer with the Independent World Commission on the Oceans. Lynn Mytelka is currently Director of the Division on Investment, Technology and Enterprise Development at the United Nations Conference on Trade and Development (UNCTAD) in Geneva.

ROUTLEDGE STUDIES IN THE GROWTH ECONOMIESOF ASIA 1 THE CHANGING CAPITAL MARKETS OF EAST ASIA Edited by Ky Cao 2 FINANCIAL REFORM IN CHINA Edited by On Kit Tam 3 WOMEN AND INDUSTRIALIZATION IN ASIA Edited by Susan Horton 4 JAPAN’S TRADE POLICY Action or Reaction? Yumiko Mikanagi 5 THE JAPANESE ELECTION SYSTEM Three Analytical Perspectives Junichiro Wada 6 THE ECONOMICS OF THE LATECOMERS Catching-Up, Technology Transfer and Institutions in Germany, Japan and South Korea Jang-Sup Shin 7 INDUSTRIALIZATION IN MALAYSIA Import Substitution and Infant Industry Performance Rokiah Alavi 8 ECONOMIC DEVELOPMENT IN TWENTIETH-CENTURY EAST ASIA The International Context Edited by Aiko Ikeo 9 THE POLITICS OF ECONOMIC DEVELOPMENT IN INDONESIA Contending Perspectives Edited by Ian Chalmers and Vedi Hadiz 10 STUDIES IN THE ECONOMIC HISTORY OF THE PACIFIC RIM Edited by Sally M.Miller, A.J.H.Latham and Dennis O.Flynn 11 WORKERS AND THE STATE IN NEW ORDER INDONESIA Vedi R.Hadiz 12 THE JAPANESE FOREIGN EXCHANGE MARKET Beate Reszat

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13 EXCHANGE RATE POLICIES IN EMERGING ASIAN COUNTRIES Edited by Stefan Collignon, Jean Pisani-Ferry and Yung Chul Park 14 CHINESE FIRMS AND TECHNOLOGY IN THE REFORM ERA Yizheng Shi 15 JAPANESE VIEWS ON ECONOMIC DEVELOPMENT Diverse paths to the market Kenichi Ohno and Izumi Ohno 16 THE THAI ECONOMY Uneven Development and Internationalization Chris Dixon 17 TECHNOLOGICAL CAPABILITIES AND EXPORT SUCCESS IN ASIA Edited by Dieter Ernst, Tom Ganiatsos and Lynn Mytelka 18 TRADE AND INVESTMENT IN CHINA The European Experience Edited by Roger Strange, Jim Slater and Limin Wang 19 TECHNOLOGY AND INNOVATION IN JAPAN Policy and Management for the 21st Century Edited by Martin Hemmert and Christian Oberländer 20 TRADE POLICY ISSUES IN ASIAN DEVELOPMENT Prema-chandra Athukorala 21 ECONOMIC INTEGRATION IN THE ASIA PACIFIC REGION Ippei Yamazawa

Technological Capabilities and Export Success in Asia Edited by Dieter Ernst, Tom Ganiatsos and Lynn Mytelka Published for and on behalf of the United Nations (UNCTAD)

London and New York

First published 1998 by Routledge 11 New Fetter Lane, London EC4P 4EE This edition published in the Taylor & Francis e-Library, 2005. “To purchase your own copy of this or any of Taylor & Francis or Routledge’s collection of thousands of eBooks please go to www.eBookstore.tandf.co.uk.” © 1998The United Nations All rights reserved. No part of this book may be reprinted or reproduced or utilized in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. British Library Cataloguing in Publication Data A catalogue record of this book is available from the British Library Library of Congress Cataloging in Publication Data Technological capabilities and export success in Asia/edited by Dieter Ernst, Tom Ganiatsos, and Lynn Mytelka. p. cm.—(Routledge series in the growth economies of Asia) Includes bibliographical references and index. 1. Exports—Asia. 2. Technological innovations—Economic aspects—Asia. I. Ernst, Dieter, 1942–. II. Ganiatsos, Tom (Thomas George), 1936–. III. Mytelka, Lynn Krieger. IV. Series. HF3752. T43 1998 97–35428 382′.6′095–dc21 CIP ISBN 0-203-18422-X Master e-book ISBN

ISBN 0-203-26537-8 (Adobe eReader Format) ISBN 0-415-15854-0 (Print Edition)

Contents

Tables and figures

ix

Contributors

xi

Preface

xii

Acknowledgements

xv

Introduction

1

1

Technological capabilities in the context of export-led growth: aconceptual framework Dieter ErnstLynn Mytelka and Tom Ganiatsos

4

I

Technology and economic development: a review of earlierdebates

4

II

Key aspects of the innovation process: a focus on learning andknowledge accumulation

11

III

Defining technological capabilities

16

IV

Factors shaping a firm’s capacity to develop and upgrade itstechnological capabilities

23

The dynamics of technological capability formation

29

Alternative approaches to technological capability formation

34

2

Export success and technological capability: textiles andelectronics in Taiwan Province of China San Gee and Wen-jeng Kuo

46

I

Introduction

46

V VI

II

The incentive system and the development of the Taiwanesetextile and 47 electronics industries

III

Factors which contribute to export performance andtechnological capability

64

IV

New challenges and responses in the 1990s

78

Conclusions

83

V

vii

3

Catching up, keeping up and getting ahead: the Korean modelunder pressure Lynn Mytelka and Dieter Ernst

88

I

Introduction

88

The Korean textile and apparel industry

95

II III

The Korean electronics industry

112

IV

Conclusions

139

4

Technological capability building and the sustainability of exportsuccess in Thailand’s textile and electronics industries Nipon Poapongsakorn and Pawadee Tonguthai

158

I

Introduction

158

Overview of the Thai economy

160

III

Effects of the incentive system on industrial structure andexport performance

163

IV

Building technological capabilities

178

New challenges to sustained export success

193

Conclusions

201

5

Technological capabilities and Indonesia’s manufactured exports Thee Kian Wie and Mari Pangestu

211

I

Introduction

211

The impact of the incentive system on the textile, garment andelectronics industries

215

II

V VI

II III

Technological capability formation and its relationship toexports over 227 time

IV

New competitive challenges and strategic options

254

V

Conclusions

260

6

Technological dynamism and R&D in the export of manufacturesfrom Viet Nam Tran Ngoc Ca and Le Dieu Anh

266

I

An overview of Viet Nam’s development: stages ofindustrialization

266

Impact of the incentive system on the development and exportperformance of two selected industries

271

II

viii

III

Patterns of building technological capabilities in the textileand garment and the electronics industries

286

IV

New challenges to sustained export performance

312

7

Learning, technological capability building and sustainable exportgrowth Lynn MytelkaDieter Ernst and Tom Ganiatsos

322

I

Reconceptualizing the technology capability building process

323

The importance of foreign direct investment in technologycapability building

324

III

Policy dynamics and the promotion of exports

326

IV

The role of technological capabilities in sustaining exportsuccess

328

V

Technology capability building as a non-linear, interactiveprocess

330

Domestic markets as a stimulus to technological change

332

Index

334

II

VI

Tables and figures

TABLES 1.1 Exports of selected goods (based on Standard International Trade 6 Classification, Revision 2: US$ millions) 1.2 Changing commodity exports from Asian NIEs, 1965–1994 (% of total 9 non-oil exports) 2.1 Textile exports (value and share in total exports: US$ millions) 53 2.2 Value of textile exports by product (US$ millions) 55 2.3 Installation of water-jet looms (WJL) and air-jet looms (AJL) in major 55 countries (thousands of sets) 2.4 Major textile export markets (US$ millions) 56 2.5 Man-made fibre capacity in 1989 and 1991 (tons per day) 57 2.6 Information industry in perspective (US$ millions) 62 2.7 Ten leading information products in 1991 and their share in the world 63 market 2.8 Exports of computer hardware by type of production arrangement, 1987– 63 1991 (%) 2.9 Background information on electronics firms interviewed 65 2.10 Background information on textile firms interviewed 66 3.1 Basic data on the interviewed textile and garment companies 99 3.2 Modernization in the spinning and weaving industries in Korea, Taiwan 103 Province of China and Hong Kong, 1974–1984 (cumulative shipments) 3.3 Foreign direct investment by Korean textile and clothing firms 109 3.4 Policies to promote the Korean electronics industry 119 3.5 Inter-firm technology networks, 1982–1992 133 4.1 GDP manufacturing value added and exports (current prices: baht 159 millions, %) 4.2 Trends of textile and clothing exports, 1980–1993 (baht millions) 164 4.3 Structure of the Thai textile and clothing industries, 1993 165 4.4 Distribution of electronics firms by subsector and start-up year 170 4.5 Export value of electronics (baht millions) 171 4.6 Basic data on textile and clothing firms surveyed 179 4.7 Selected data on sample electronics firms 180 5.1 Changes in policy direction and external conditions 212 5.2 Manufactured exports by resource intensity (US$ thousands) 214

x

5.3 Ownership pattern in Indonesia’s textile and garment industries, 1975– 216 1985 (% of value added generated by major ownership group) 5.4 Textile production, 1970–1991 (thousand tons) 217 5.5 Relative shares of major export markets for Indonesia’s textile 220 industry,1989–1991 5.6 Electronics output and export, 1985–1992 (US$ millions) 225 5.7 Exports of main electronics goods (major destinations) 228 5.8 Basic data on firms interviewed 230 6.1 Main industrial output (VND billions; fixed price, 1989) 269 270 6.2 Foreign direct investment in Viet Nam, 1988–1993 (30 June 1993) (US$ billions) 6.3 Foreign direct investment by sector 270 6.4 Number of enterprises in the textile and garment sector 274 6.5 Employment in the textile and clothing industries (thousands of persons) 275 6.6 Textile and garment production in Viet Nam 276 6.7 Export of textiles and clothing in millions of roubles and US$ (1991 277 and 1992, US$ only) 6.8 Export structure of textile and garment industry, 1991–1992 (%) 277 6.9 Destination of garment exports, 1986–1990 and 1991–1992 (%) 278 6.10 Number of enterprises (for both electronics and electrical industries) 286 6.11 Employment in electronics and electrical industries (thousands of 286 persons) 6.12 Exports of electronics industry (US$) 287 6.13 Main characteristics of companies in the sample case studies 288 6.14 Technological capabilities in the surveyed companies 289 FIGURES 3.1 Growth rates of productivity in Korean spinning and weaving 5.1 Exports of semiconductor devices and ICs

109 224

Contributors

Le Dieu Ann, Economist, Consulting Section, Development and Management, Research Department, Institute for Economic Research, Hochiminh City, Viet Nam. Tran Ngoc Ca, Deputy Director, Technology Studies Division, Institute of Science Management, Ministry of Science, Technology and Environment, Hanoi, Viet Nam. Dieter Ernst, Professor of International Management, Copenhagen Business School and Senior Fellow, the Berkeley Roundtable on the International Economy (BRIE), University of California, Berkeley. Tom Ganiatsos, Former Chief of Policy Research, Division for Science and Technology, UNCTAD, Geneva, Switzerland. Currently Senior Officer, Independent World Commission on the Oceans. San Gee, Professor, Department of Economics and Graduate Institute of Industrial Economics, National Central University, Chung-Li, Taiwan Province of China. Wen-jeng Kuo, Research Fellow, Chung-Hua Institution for Economic Research, Taipei, Taiwan Province of China. Lynn Mytelka, Professor, Institute for Political Economy, Carleton University, Ottawa, Canada. Currently Director, Division on Investment, Technology and Enterprise Development (DITE) of the United Nations Conference on Trade and Development (UNCTAD). Mari Pangestu, Head of the Economics Department, Centre for Strategic and International Studies (CSIS), Jakarta, Indonesia. Nipon Poapongsakorn, Vice President, Thailand Development Research Institute Foundation (TDRI), Bangkok, Thailand. Pawadee Tonguthai, Professor, Faculty of Economics, Thammasat University, Bangkok, Thailand. Thee Kian Wie, Senior Research Associate, Centre for Economic and Development Studies (PEP/LIPI), Jakarta, Indonesia.

Preface

Many have written about East Asia’s economic performance. Some have used the word ‘miracle’ to characterize the breathtaking pace with which countries in the region have until recently been modernizing their economies, expanding their productive capacity and introducing their manufactured wares in western markets. The interest in them is chiefly driven by a desire to understand the complex of historical, economic and institutional factors that explain their industrial competitiveness and at the same time gain some insight into the more general question of what other late-industrializing countries need to do in order to lift themselves onto a path of self-sustained economic and social development. Two competing ideologies for industrial development have emerged—both of which take as given the compelling need to respond to the globalizing tendencies of rapid technological change and growing competition. The one which holds sway in western thinking is the neo-liberal model, preaching maximum reliance on market forces in determining the allocation of resources between different sectors and the speed of integration into the global economy; the other is the Japanese model in which the state exercises a role in selectively targeting individual sectors and industries for promotion and in regulating the pace of their international economic integration. This book makes a valuable contribution to this ongoing debate by reminding us that it is at the level of the firm that we must focus if we are to make sound judgements about how trade and industrial policy affects productive decisions. It is at this level that the culture of modern capitalism finds its ultimate expression, in the drive to produce, to invest, to expand into new markets, to meet and take on competition from other enterprises, to adjust to sharp changes in market conditions and to the challenges and opportunities of globalization. The book is essentially about catching up, keeping up and getting ahead, and the firms under consideration are at three different stylized phases of this process. Korean and Taiwanese firms are followers that have begun to innovate; Thai firms have made important inroads into industrial country markets but have not yet learned to innovate; and Indonesian and Vietnamese firms are highly dependent on external sources of technology for breaking into low-wage exports. A distinguishing feature of all the essays is a common framework for interpreting how firms in these two industries have succeeded in mastering the

xiii

complex of human skills needed in order to export in today’s global economy, particularly the strategic ones associated with organization, marketing, linkage with suppliers and customers and design capabilities. They show it to be a continuous process involving incremental acquisition of knowledge based on a conscious process of learning. It is a process that is driven by competitive forces mediated by a complex interaction between government policies pointedly aimed at promoting business interests and autonomously changing market conditions. This view of things contrasts with the classical emphasis on factor proportions and static comparative advantage in which the state has only a minimalist role of providing an enabling environment for profit-seeking firms. A number of findings relevant to other developing countries in the current climate of globalization emerge from this collection of studies: First, despite cost advantages, firms did not rest on their laurels. Whether in highly industrialized Korea or industrially emergent Indonesia, they were constantly under pressure to invest in knowledge acquisition and in upgrading their technological capabilities. Some of that pressure came from government policy. Second, no straightforward sequence of capability acquisition can be claimed. Some electronics manufacturers in Viet Nam, for example, managed to move directly into exports without prior acquisition of production capabilities but with an acute sense of product design, well developed linkage capabilities and knowledge of markets. Third, the government policy framework that was so favourable to the export success of textile and electronics firms is best characterized as outwardly oriented rather than open. All countries provided varying degrees of protection to domestic textile and electronics manufacturing while simultaneously promoting exports. Fourth, in electronics and to a lesser extent in textiles and garments, foreign investment has had a stronger role to play in Indonesia and Thailand than it has had, even from the beginning, in Korea and Taiwan Province of China. Fifth, the ideal conditions for breaking into OECD textile and electronics markets that were enjoyed by East Asian firms in the 1970s no longer prevail for new entrants today, both because of the far greater number of potential participants and the less hospitable climate for developing country exports today. On the other hand, the rise of a relatively affluent middle class in much of Asia and parts of Latin America suggests promising opportunities for intra-regional investment and trade expansion, as the experience among ASEAN and MERCOSUR countries already indicates. Yet as this book goes to press, three out of the five countries studied here have been undergoing an economic crisis that is leading a number of observers to speak of the ‘end of the miracle’ and to ask whether the apparent lessons learned from the Asian experience may not have been discredited by the current disorder. I believe that a closer look at the facts shows something different. While there are some cases of excess capacity and a need for fine-tuning of

xiv

policies directed at the industrial sector, the crisis is essentially financial, originating in the banking, finance and real estate sectors. Until very recently the basic fundamentals of all of these economies was sound, with very high savings and investment rates and, compared with Latin American countries in the 1980s, low fiscal and trade deficits. Contrary to the view that has emerged from some quarters, the collapse of the financial sector was not a manifestation of excessive economic regulation and controls but of something else—lack of prudent regulation, of oversight and transparency in the financial sector coupled with the pegging of currencies to the dollar. If there is any ideology that has been discredited by the present chaos in East Asia it is that reflected in the neo-liberal model of blanket deregulation and virtual disenfranchisement of the state in economic matters. It is to be hoped that the present situation of falling exchange rates and a credit squeeze in the affected Asian countries will not lead manufacturing exporters, such as the textile/garment and electronics firms studied in this book, to shorten their time horizons in favour of quick returns based on transitory cost advantages and foreign exchange differentials rather than their strategic reliance on investment in constant technological upgrading and in the formation of the complex innovative skills that are needed for building the kind of durable competitiveness needed for export success in a globalizing world. Rubens Ricupero Secretary-General of the United Nations Conference on Trade and Development

Acknowledgements

This book was prepared under the auspices of the Technology Programme of the United Nations Conference on Trade and Development (UNCTAD) in which two of the editors—Tom Ganiatsos and Lynn K.Mytelka—have successively served as staff members. The editors gratefully acknowledge the generous financial assistance received by the UNCTAD secretariat from the Swedish Agency for Research Cooperation (SAREC), without which the kind of multi-country field research leading to this book would not have been possible. We very much appreciate the enthusiasm for the project—from its very inception—shown by Dr M.A.Bhagavan of SAREC and his moral support and understanding through all phases of the exercise. Thanks also go to Helen Argalias of the UNCTAD Secretariat for her assistance, with help from Ana Paola Teixera during her tenure at UNCTAD, in easing the task of project administration, in providing comments, and suggestions on methodology and on the draft chapters. In addition, Professor Dieter Ernst gratefully acknowledges the support of the Council for Global Partnership (CGP) and the Alfred P.Sloan Foundation for his research on international production networks and local capabilities, as well as the intellectual support received from colleagues at the Berkeley Roundtable on the International Economy (BRIE), University of California at Berkeley. Professor Lynn K.Mytelka expresses her gratitude to the Social Science Research Council of Canada which made possible complementary research on the textile and clothing and the telecommunications industries in Korea.

Introduction

This book examines the sources of export success in six East Asian developing countries and the sustainability of this success in the context of current changes in the competitive environment. For comparative purposes, we have chosen to concentrate on three groups of countries: two leading newly industrialized economies (NIEs), the Republic of Korea and Taiwan Province of China, two second-tier newly industrializing economies, Thailand and Indonesia, whose manufactured exports have been growing rapidly over the past decade; and one country that is only now emerging as a new location for industrial exports, Viet Nam. Traditional manufactured exports from developing countries today face new constraints in the international economy—particularly as regards markets and technology. As a result, they are under increasing pressure to continuously upgrade the sources of their competitiveness. The main objective of this book is to analyse the role which firm strategies and government policies can play in the transition from traditional forms of competitiveness, based on cheap labour, natural resource endowments and currency devaluation, to more sustainable forms through a wide diffusion of technological capabilities and organizational competence. We are thus addressing an important issue that is central to the current debate between accumulation theorists, such as Young (1993), Kim and Lau (1994) and Krugman (1994) and growth theorists writing in the Schumpeterian tradition who argue that development in essence requires learning and innovation (Freeman: 1987, Nelson and Pack: 1995). For the accumulation theorists, growth in Asian NIEs is largely a result of ‘rapid movement along prevailing production functions’ (Krugman: 1994). Much of their growth is said to be due primarily to quantitative factors, i.e., the growth of the labour force and capital, rather than gains in efficiency. It is claimed that productivity growth in these countries has been very slow and that, as a result, Asia’s NIEs are trapped with obsolete ‘Soviet-style’ economic structures. The conclusion drawn is that technological bottlenecks will make current growth rates unsustainable. Our research does not support this argument. Instead, and in keeping with innovation theorists, we proceed from the assumption that sustainable development involves capital accumulation, i.e., investment,

2 INTRODUCTION

complemented by a variety of technological capabilities. That economic growth requires innovation is as true for OECD countries as it is for NIEs. Recent econometric analysis, for example, shows that ‘the main factors influencing differences in international competitiveness and growth across countries are technological competitiveness and the ability to compete on delivery… Costcompetitiveness does also affect competitiveness and growth to some extent, but less so than many seem to believe’ (Fagerberg: 1990, pp. 370–371). Technological capabilities thus increasingly influence export performance in developing countries. Yet, abstract theoretical reasoning and quantitative analyses such as those undertaken by Krugman and other accumulation theorists are unable to uncover the many incremental changes associated with the development of technological capabilities and to identify the factors that facilitate this process. This critique also applies to much of the ‘new’ neoclassical growth theory. Paul Romer’s concept of ‘idea gaps’ (1992), for example, is reminiscent of the old notion of ‘technology transfer’ in leaving the impression that learning to do what others do is easy. While such theoretical work is important, it needs to be complemented by empirical case studies that address three sets of questions: (1) How do indigenous firms develop technological capabilities? (2) What policies affect their decisions concerning the development of such capabilities? (3) How do firm strategies and government policies interact in the building of technological capabilities? The focus in this book is therefore primarily on successful indigenous exporting firms in East Asia: how they have approached the development of their technological capabilities and organizational competence, how they have succeeded in overcoming what have often been quite substantial barriers and the important role that governments have played in this context, particularly by creating an environment that stimulates such firms to invest in and upgrade their technological capabilities and to improve the effectiveness of their innovation management strategies. It deals far less directly with the habits and practices of foreign subsidiaries or the foreign investment process more generally, although both are considered in terms of their contribution to the building of technological capabilities within the domestic system of innovation and production. BIBLIOGRAPHY Fagerberg, P. (1990) ‘International competitiveness’, The Economic Journal,Vol. 98, pp. 370–371. Freeman, C. (1987) Technology and Economic Performance: Lessons from Japan,Pinter, London. Kim, J.I. and Lau, L.J. (1994) ‘The sources of economic growth in the East Asian newly industrialized countries’, Journal of Japanese and International Economics. Krugman, P. (1994) The myth of Asia’s miracle’, Foreign Affairs,December. Nelson, R. and Pack, H. (1995) ‘The Asian growth miracle and modem growth theory’, School of International and Public Affairs,Columbia University, December.

INTRODUCTION 3

Young, Alwyn (1993) ‘The tyranny of numbers: confronting the statistical realities of the East Asian growth enterprise’, Quarterly Journal of Economics,Vol. 110, No. 3, pp. 641–680.

1 Technological capabilities in the context of export-led growth A conceptual framework

Dieter Ernst, Lynn Mytelka and Tom Ganiatsos

This chapter introduces the conceptual framework used in the five country case studies. It begins with a brief review of earlier debates on the role of technology in economic development (section I), followed by an examination of two key aspects of the innovation process—learning and knowledge accumulation, which emphasizes the importance of continuous interaction among a variety of economic actors (section II). The third section introduces our own concept of technological capabilities and the indicators that are used in our case studies of successful East Asian exporting companies. It broadens traditional approaches to include ‘strategic marketing’ and ‘linkage’ capabilities consonant with the learning and innovation approach adopted here and stresses the importance of a conscious effort to accumulate increasingly sophisticated ‘minor change’ capabilities for export success. Section IV discusses how firms are building their technological capabilities and what shapes their capacity to adapt to the changing requirements of competition. This section introduces an innovative approach to the analysis of technological capability formation by focusing on the habits and practices of actors, market forces and policy dynamics that constitute an economy’s incentive system. Section V then uses this approach to examine the dynamics of technological capability formation, i.e., the factors responsible for changes in the required capabilities and for different sequencing patterns. Finally, section VI distinguishes between two alternative approaches to technological capability formation and looks at how they differ in terms of their impacts. I TECHNOLOGY AND ECONOMIC DEVELOPMENT: A REVIEWOF EARLIER DEBATES In the post-World War II period much of the debate on how to overcome poverty and low productivity in developing countries centred on the need to transfer technology. A brief review of the basic assumptions in this literature will enable us to better distinguish this approach and its descendants from one based on learning and innovation.

TECHNOLOGICAL CAPABILITIES AND EXPORT GROWTH 5

During the 1950s and 1960s, it was assumed that technology transfer was a byproduct of investment and that simply encouraging foreign firms to locate in a country or region would bring in the needed technology, which was largely defined in terms of machinery and equipment. The initial focus in the literature was thus on promoting ‘technology transfer’, and then on the problems of gaining ‘access to technology’ at affordable prices given the extent of patents, licensing fees and restrictive clauses that such licences often contained.1 By the 1970s, the assumption that production automatically implied technology mastery through a kind of ‘learning by doing’ model was being questioned. Case studies in developing countries revealed that ‘learning by doing’ was not an automatic process.2 While some researchers continued their search for the various factors which in different temporal and spatial contexts led to declining productivity over time, others turned to uncovering examples of firms that had mastered imported technology and to specifying the conditions under which this took place.3 But attention was rarely paid in this literature to the development of technologies locally—whether indigenous technologies or of the imitative kind developed through reverse engineering—although most studies of Japan showed this to be important.4 The literature also contained a static bias, with little emphasis, for example, on the fact that since competitive conditions were always evolving, so, too must the technology and the most efficient production systems. This led a number of researchers to introduce the notion of technology capability building.5 Since this was most often interpreted narrowly as education, training and R&D, the literature was heavily ‘supply oriented’ and marked by a linear conception of technological capability formation according to which the process would proceed sequentially from the acquisition of foreign technology to its adoption, assimilation, absorption and diffusion—and from there to new product and process development. This linear concept is still quite influential and assumes that progress can be measured in terms of a number of stages. It is particularly evident, despite disclaimers, in work on the stages in ‘technology mastery’ (Hobday: 1995) or ‘stages of growth in a dynamic environment’ (Heeks and SlamenMcCann: 1996) within the electronics industry. It is somewhat less so in the development of industrial lifecycle frameworks applied to the textile and clothing industry (Singleton: 1997). It soon became clear, however, that not all companies nor countries were following this path. Through comparisons with Latin America and Asia, analysts of the ‘East Asian Miracle’ sought to explain when this virtuous path was followed and what factors caused some firms and countries to deviate from it. One explanation, promoted especially by the World Bank, focused on the difference between import substitution and export orientation. Exportoriented manufacturing, this view argued, was the most rapid path to growth. Import substitution, in contrast, led to inefficient firms incapable of competing at home or abroad. For others, the critical contribution which exporting made to development was its role in technology capability building, not in the automatic

6 D.ERNST, L.MYTELKA AND T.GANIATSOS

sense that the East Asian miracle seemed to imply, but rather because of the resulting interaction with more sophisticated foreign clients which drew forth innovative behaviour. Westphal (1990) was among the first to identify this in his work on Korea. Lall (1990) has advanced similar arguments. In the East Asian case, export growth in manufactured goods took off in the late 1960s and early 1970s and remained robust in Korea and Taiwan Province of China until 1995 (Table 1.1). Starting more slowly, Thailand and more recently Indonesia have developed their exports in textiles and clothing and in electronics (Table 1.2). Viet Nam is only now emerging as an exporter in the textile and clothing industry (Table 1.1). A second explanation focused on the role of the state. According to those who subscribed to the ‘East Asian miracle’ approach, the state played only a marginal role beyond creating the macroeconomic environment (exchange rates, inflation rates) that encouraged such exports and building the requisite infrastructure (externalities)—education, communications, transportation. The critics, however, took a very different view. Robert Wade (1990), for example, argued that in countries like Japan and in Taiwan Province of China, the market was neither free nor was state intervention merely designed to provide the kinds of incentives6 which would have occurred naturally in a free trade environment. Instead, the market was ‘governed’ in such a way that rapid growth took place because (1) a high level of productive investment made for the fast transfer of newer technology into production; (2) more investment in certain key industries was undertaken than would have occurred in the absence of government intervention, a point later supported by econometric analysis (Rodrik: 1994); and (3) the impact of foreign competition was moderated at home but there was some exposure of industries to international competition in foreign markets. These causes were in turn the result of a set of government policies to spread risks and allocate resources differently than in a free or a ‘simulated’ free market, policies that were made possible by special organizational arrangements between the state and the private sector. Peter Evans (1995) opened the ‘black box of the state’ still further by looking at the internal organization of the developmental state and relating its underlying structural basis to four archetypical roles that it has played in industrial transformation. In developmental states such as Korea, Brazil and India, outcomes in the informatics sector, he argues, depend upon how these four roles are combined. India and Brazil, for example, tended to combine the roles of ‘custodian’ and ‘demiurge’. In the former, the state regulates the market, generally privileging the policing function over promotional policies. In the latter, it plays an entrepreneurial role, not just in providing public goods but out of a presumption that private capital is not adequate to cover the whole gamut of production. Both countries made much less use of ‘midwifery’, where the state tries to shape the private sector out of a belief that its capacities are malleable, rather than substituting for it. The costs they incurred in playing custodian and

Table 1.1 Exports of selected goods (based on Standard International Trade Classification, Revision 2: US$ millions)

TECHNOLOGICAL CAPABILITIES AND EXPORT GROWTH 7

Source: UNSO Trade Data Bank, COMTRADE Database Note: Statistical yearbook, Hanoi: 1992

8 D.ERNST, L.MYTELKA AND T.GANIATSOS

Table 1.2 Changing commodity exports from Asian NIEs, 1965–1994 (% of total non-oil exports)

a

Source: UNCTAD: 1996, p. 119

TECHNOLOGICAL CAPABILITIES AND EXPORT GROWTH 9

10 D.ERNST, L.MYTELKA AND T.GANIATSOS

demiurge, however, left them in a poor position to engage in ‘husbandry’ since the latter requires the state to take a long-term view recognizing that even if it successfully induces private groups to tackle promising sectors in its role as midwife, as global changes challenge these firms, the state must continue to cajole and assist private groups to meet these challenges by, for example, signalling opportunities, reducing risks and engaging in R&D. In contrast, Korea built up firms through midwifery and then helped them through husbandry to meet competitive challenges in information technology. The real question is the extent to which states will be able to play such roles in the future. Today, competition cuts across national and sectoral boundaries—hence the term ‘global competition’. Firms are now forced to compete simultaneously in all major growth markets. This has led to a rapid expansion of international production, with new production sites being added at a breath-taking speed outside the industrial heartlands of Europe, North America and Japan. Since the mid-1980s, international production has grown considerably faster than international trade. By the 1990s, sales of the foreign affiliates of TNCs far outpaced exports as the principal vehicle to deliver goods and services to foreign markets. Thus a growing number of national economies have become mutually interconnected through crossborder flows of goods, services and factors of production. Pressure to liberalize markets has accelerated the pace of globalization. Yet relatively little of the literature dealing with the role of the state in late industrialization has addressed this important issue.7 Instead, the dominant view is that globalization will act as a powerful equalizer and that, over time, it will lead to a greater uniformity of development potential.8 This dominant view also holds that globalization will accelerate the decline of the nation state as the relevant unit of policymaking and that anything that smacks of industrial policy is unlikely to improve local competitiveness. Governments, according to this view, should concentrate on the pervasive deregulation and liberalization of national economies. The more willing a government is to embrace sweeping liberalization, the more it can use international trade and investment as engines of growth. We do not agree with this neo-liberal concept of globalization.9 Nothing is predetermined about the impact of globalization. It can certainly increase geographical inequality, if left to the invisible hand of the market and to the quite visible hand of transnational corporations. The main reason for this is that TNCs have become much more selective and demanding in their choice of locations. Low labour costs are taken for granted, and alternative locations are judged by the quality of certain specialized capabilities that the TNC needs in order to complement its own core competencies (Ernst: 1994b, 1996, 1997a). Those regions that cannot provide such capabilities are left out of the circuit of international production and vast areas of the international economy that house a

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majority of the world’s population have thus experienced a dramatic decline in their development potential (UNCTAD: 1997). Alternatively, regions that can provide such capabilities and, as a result, can attract higher value added investments, have clearly benefited. Successful late industrialization in Korea and Taiwan are cases in point. Markets are notoriously weak in generating these capabilities, which are subject to externalities. Investments in such capabilities are typically characterized by a gap between private and social rates of return (Arrow: 1962), which means that national policy interventions are required to compensate for these market failures. In addition to the subsidies and tax incentives, suggested by Arrow, this also implies a variety of organizational and institutional innovations in the implementation of government policies. There is now thus a much greater need for national and regional policies to develop local capabilities that can attract high value added investments. But there is also now more space for national policy and politics to vary and to make a difference. A growing body of research on economic policy-making in advanced industrial countries has demonstrated that choice is possible, in terms of institutions and policy instruments, and that this applies to macroeconomic policy-making as well as to industrial and technology policies.10 This book shows that the same is true for East Asia. The real question then is no longer whether national policies can make a difference, but rather: What kind of policies and institutions are most conducive for improving local competitiveness? Understanding the process of learning and knowledge accumulation at the level of the firm is a critical first step in designing such policies and developing such institutions. II KEY ASPECTS OF THE INNOVATION PROCESS: A FOCUS ONLEARNING AND KNOWLEDGE ACCUMULATION Technology cannot be reduced to machines. It has to do with certain kinds of knowledge which allow the adaptation of means to ends. Part of this knowledge is embodied in machines, but most of it is not. It lies elsewhere–in the skills of people, in behavioural patterns and in organizational structures and procedures. These are in turn conditioned by the strategies of different social actors (in particular governments, firms and organized labour) and the patterns of conflict and cooperation between them. Our main concern is with the factors influencing the innovative behaviour of firms in late-industrializing nations. Much of the literature associates innovation with the kind of activity undertaken by firms at the technological frontier. We prefer a more mundane definition that reflects more adequately the requirements of late industrialization.11 ‘Innovation’ is thus defined as the processes by which firms master and implement the design and production of goods and services that

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are new to them, irrespective of whether or not they are new to their competitors —domestic or foreign. Most of the time, and in most industries, innovation is based on the continuous and incremental upgrading of existing technologies or on a new combination of them. Radical innovations, which involve a substantial departure from existing knowledge and may also require fundamental changes in existing organizational and behavioural patterns, are less common. Such radical innovations have a huge productivity-enhancing potential and can drastically change the existing distribution of competitive advantages. They are however much more difficult to implement and thus their diffusion normally occurs in a highly unequal manner. Innovation does not take place in a vacuum. To a very large degree, it is driven by the requirements of competition. Earlier, linear models of innovation were unable to capture the complexities involved. This applies as much to the ‘science push’ approach as to the ‘demand pull’ theories.12 According to the former, innovation can be reduced to a well-defined time sequence that originates in research activities, followed by a phase of product development, before production and the eventual marketing of the new product. The ‘demand pull’ theory, in contrast, highlights the importance of demand factors which affect the allocation of R&D efforts through their influence on the size of the market for particular new products. Although both approaches address important aspects of the innovation process, they fail to identify probably its most important feature: the continuous and numerous interactions among the great variety of economic actors and the feedbacks across all stages of the production chain.13 Successful innovation today depends on the close interaction between producers and users of a particular technology, hence the importance of iterative ‘trial and error’ and cumulative learning by doing, by using and by interacting.14 What really matters is a firm’s capacity to organize innovation as an interactive learning process. Within a firm, such interaction exists, for instance,15 between: • Marketing and production (feedback from consumer complaints and suggestions leading to product improvement). • Production and design (continuous interactions between production engineers and designers leading to a bottom-up approach to design where the focus is on manufacturability). • R&D, marketing and production (joint product development teams, consisting of R&D, marketing and production people who are responsible for the product throughout all stages of its development cycle, up to the final manufacturing, which has led to a substantial acceleration of ‘speed to market’). However, the various interactions that constitute the process of innovation extend well beyond the boundaries of the firm. Given the increasing importance of materials technology and core components for the cost, performance and quality

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of final products, strong and continuous interactions between materials producers, component suppliers and final assemblers, have substantially increased in importance.16 This has given rise to the rapid expansion of international production networks: firms break down the value chain into discrete functions and locate them wherever they can be carried out most effectively and where they are needed to facilitate the penetration of important growth markets.17 At the same time, this has increased the importance of local capabilities. The competitive strength of a nation’s firms crucially depends on the existence of a well-developed domestic supply base.18 An integrated domestic supply base constitutes an important externality for firms attempting to participate in global competition. Not only does it improve their access to technology and learning possibilities, but it is a necessary prerequisite for increasing the flexibility of the production system and accelerating their ‘speed to market’. Relations to customers have also gained enormously in importance. In many industries, a shift has occurred from sellers’ to buyers’ markets. As a result, identifying customer requirements (i.e. system design requirements) has become a key instrument of competitive strategies. Knowledge about customer requirements strengthens the interactions between R&D, production and marketing. Bringing the customer into the company as a participant in the development and adaptation of goods and services reduces the gap between market requirements and a firm’s innovation priorities. At the same time, close interaction with customers contributes to a further reduction of product development and product lifecycles. In short, innovation management today not only cuts across all stages of production, but increasingly extends beyond the boundaries of the firm. The organization of innovation as a social learning process requires the management of complex interactions with suppliers and users, and with the domestic science and technology infrastructure. Our definition of technological capabilities thus centres on the concept of technological learning. Following a research tradition established by Nelson and Winter (1982), Chesnais (1988), Nelson (1990b) and Cantwell (1993), we distinguish two components of technological knowledge which a firm needs to acquire and absorb. The first component is what Cantwell (1993, p. 4) calls the ‘public knowledge element of technology’, which covers all codifiable items such as engineering blueprints and designs and the underlying generic scientific knowledge plus management manuals and handbooks describing system features, performance requirements, materials specifications and quality assurance criteria and the organizational methods and routines which are used to implement them. As Nelson (1990a) has shown, the public element of technology also includes individual practitioners’ knowledge of the way such scientific, engineering and organizational principles are applied or knowledge about how things work in practice.

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The second element of technology is tacit and is specific to particular firms. It is embodied in the organizational routines and collective expertise or skills of specific production, procurement, R&D and marketing teams. This is the part of technology which differentiates firms and which cannot be exchanged among them, as it is derived from and tied to the localized and collective learning experience of a given company through its own development of technological capabilities. We will define in a moment the nature of these technological capabilities. Suffice it to say here that ‘[w]hile the first element of technology may be traded between firms, the second element is the essence of firm-specific competitive advantage, which is non-tradeable and relies instead on…learning processes’19 which are accumulated either within a firm or within a variety of inter-firm networks.20 The two components of technology are strictly complementary: ‘even though public knowledge can be exchanged, to make it operational it is necessary to develop some supporting expertise of a tacit kind’. In short, technological learning has to cope with two challenges: the acquisition of the public knowledge element of technology and the development of the tacit, firm-specific knowledge which we will call technological capabilities. On the one hand, access to the public knowledge component of technology may at times be constrained by patenting, aggressive Intellectual Property Rights (IPR) strategies and the proliferation of ‘high-tech neomercantilism’.21 This first challenge results from some basic failures of international technology markets. While even the tightest technology appropriability regime is unable to prevent technology leakages, such restrictions can delay the actual entry of such knowledge into the public domain. The public element of technology is thus only potentially public and remains subject to the constraints of entry deterrence strategies pursued by both firms and governments.22 This first challenge could be of particular relevance for countries such as Korea and Taiwan Province of China which are today confronted with the ‘successful catching up trap’ (Ernst and O’Connor: 1989). As these countries move closer to the technological frontier, they face potential constraints with regard to access to the public knowledge component of technology, especially in the case of new product designs and core components. While such ‘access to technology’ constraints are not to be minimized, it would be misleading to focus undue attention on them. We propose that the first-tier East Asian NIEs will always be able, one way or another, to circumvent such ‘access to technology’ constraints—provided they keep upgrading their own domestic technological capabilities. This brings us to the second challenge which for most developing countries is of much greater importance than the first. In addition, it applies to all kinds of developing countries. Even if all firms can gain access to a common pool of generic knowledge, the public component of technology, they must undertake a costly and invariably time-consuming learning process in which they develop the tacit capabilities required to use, adapt and further develop the generic knowledge which has been associated with the imported technology. We argue

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that such learning processes, or, in our terminology, the formation of domestic technological capabilities, are the decisive prerequisite for successful technology absorption and diffusion. Weak domestic technological capabilities, we believe, constitute the major barrier that delays or in some cases even obstructs international technology diffusion, especially to developing countries. Collective learning processes are therefore at the centre of successful technological capability formation. In this study, we distinguish between three types of technological learning:23 • Formal learning, defined as a planned and evaluated sequential programme leading to a certificate, degree or diploma. • Non-formal learning, defined as organized learning that is usually ungraded, non-sequential and/or part-time, such as on-the-job training and professional development. Non-formal learning can result from direct training within a TNC’s local affiliate or at its headquarters. It can also result from the transfer of technological knowledge, operational and managerial practices through collaborative arrangements between foreign TNCs and local firms, in which case we will use the term learning externalities. In many cases, non-formal learning, either through in-house training or through learning externalities, has been of substantially greater importance than formal learning. We will thus place more emphasis on non-formal learning than is the case in much of the earlier literature on technology transfer, which is often biased towards formal learning. • A third type of learning may also be of increasing importance for international technology diffusion, but has so far received only limited attention in the technology transfer literature. This is informal training, which is defined as a lifelong process by which persons who work in foreign affiliates or in domestic companies which closely interact with foreign TNCs may acquire values, attitudes and beliefs embedded in the organizational culture of TNCs through daily experience, observation and exposure to indoctrination. Given our focus on learning rather than on the straightforward exchange of embodied technology, we consider the term transfer of technology to be somewhat misleading and prefer instead to talk about the absorption and diffusion of technology. While absorption takes place at the level of the firm and contributes to the formation of its technological capabilities, diffusion refers to broader impacts for the economy. Leading-edge foreign technologies will first be absorbed only by a few major domestic companies. In the medium term what really matters, however, is the pace with which the technology becomes widely diffused among most firms operating in the same or related industries in the host country and how this interacts with the formation of domestic technology networks.

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Technology absorption refers to active efforts of the domestic firm which enable it to acquire, utilize and improve upon foreign technology.24Technology diffusion on the other hand is a much broader concept and stresses the forces which induce a firm to apply, adapt and further develop a particular technological and organizational innovation and the conditions under which technological learning processes can be extended beyond the boundaries of the firm which originally acquired the technology. Thus, technology diffusion is to a large extent concerned with the generation of technological externalities which could help to improve the productivity and the competitiveness of a nation’s production and innovation systems.25 III DEFINING TECHNOLOGICAL CAPABILITIES We have already seen that successful innovation today depends on the close interaction between producers and users of a particular technology—hence the importance of iterative ‘trial and error’ and cumulative learning by doing, by using and by interacting and the firm’s capacity to organize innovation as an interactive process. The concept of ‘technological capabilities’ can help us to understand better some of the issues involved.26 The term refers to the great variety of knowledge and skills which firms need so that they can acquire, assimilate, use, adapt, change and create technology. We have chosen a fairly broad definition which goes beyond engineering and technical know-how and includes organizational know-how as well as knowledge of behavioural patterns, for instance of workers, suppliers and customers. In order to create, mobilize and improve their technological capabilities, firms need continuous and reliable access to certain complementary assets, which include: finance, human resources, materials, intermediate inputs and support services. However, in order not to overload our definition, a distinction is made between ‘complementary assets’ and the actual technological capabilities themselves. The following classification of technological capabilities is therefore used: 1 production; 2 investment; 3 minor change; 4 strategic marketing; 5 linkage; 6 major change. This classification suggests a sequential ordering of priorities for late industrialization strategies based on imported technology. For instance, a country at an early stage of industrialization may spend much of its original efforts on the development of some basic pre-investment, production and minor change

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capabilities. At the other extreme, firms in successful industrial latecomer societies like Korea, Singapore and Taiwan Province of China may have to focus much more on the development of marketing, linkage and major change capabilities in order to remain competitive. To a large extent, the technological capabilities that a firm needs to master thus appear to depend on the stage of development reached by its own economy. But, as we shall see in section IV and in the case studies that follow, they also depend upon the type of innovation strategy the firm has chosen. Linkage capabilities, moreover, appear critical from the very beginning for firms which consciously set out to master technology and to export. Production ‘Production capabilities’ relate to the knowledge and skills used in plant operation, where shopfloor experience and ‘learning by doing’ continue to play an important role, despite the growing scientific intensity of industrial manufacturing. Three broad types of activities are included within this category: production management; production engineering; and repair and maintenance of physical capital. The first involves the organization and control of the production process, as well as its interactions with upstream, downstream, and ancillary activities. Production engineering includes raw material control, production schedthrough their impact on the ‘down time’ and ‘mean time between failure’ of production equipment, can have an important influence on the productivity of the production process. Another very important activity which lies on the border between production capability and minor change capability is adaptive engineering. This involves minor adjustments and incremental improvements in the production process. There are many possible reasons uling, quality control and trouble-shooting. Repair and maintenance, for such adjustments, including the need to adapt the process better to local environmental conditions, for example, to accommodate a locally available raw material. Two firms employing the same production technique to produce the same product may have very different productivities. This may reflect differences in their capacities to master the same technology. There may be a number of reasons for such differential performance, some internal to the firm and others deriving from the environment.27 One important internal constraint may be a lack of industrial engineering know-how. External constraints could include discrimination against SMEs in terms of access to certain technical resources or complementary assets such as finance. For example, if capital markets are imperfect, some firms may have more difficulties than others in raising their working capital requirements, which in turn will affect the efficiency with which they can utilize their existing productive capacities.

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Investment ‘Investment capabilities’ refer to the knowledge and skills used in the identification, preparation, design, setting up and commissioning of a new industrial project or the expansion and/or modernization of existing ones. This broad group includes capabilities needed before the investment is undertaken (the so-called ‘pre-investment’ capabilities) and those needed for carrying out the investment itself (‘project execution’). Pre-investment capabilities are of particular importance for developing countries which are at an early stage of their industrial development. They cover a variety of activities, ranging from pre-feasibility and feasibility studies, site selection and the scheduling of investment, to the search for sources of technology, negotiation of contracts and bargaining for suitable transfer conditions. Project execution in turn involves several subsidiary activities, including civil engineering and associated services, the selection and procurement of equipment, detailed engineering, training and recruitment of the workforce, and start-up operations. Many of these investment functions are normally not carried out by the manufacturer himself, but acquired from external, mostly foreign sources. Selective sourcing for external capabilities has played an important role in the generation of investment capabilities. Thus the local firm does not need to carry out the full range of investment activities enumerated above, some of which can always be acquired from foreigners. Other capabilities relate to the sourcing of technology and the evaluation of what specialized engineering consultants recommend; an assessment of which of the technologies available is most appropriate to the firm’s needs; the negotiation of the terms of purchase, decision on the method of procurement (for example, whether as a turnkey plant or in unbundled components); and the determination of the mode of transfer of the technology (for example, training of the firm’s personnel prior to installation, the use of foreign experts, etc.). Many have argued that even if the firm relies on foreign experts for installation and start up, it should become an active participant in this activity if it is to absorb the principles of the technology, i.e. the technological know-why. As the experience of Korean petrochemical companies shows,28 it is possible to reap substantial learning benefits from the sourcing of foreign investment functions, if only the local firm knows what it wants and has ‘learned to learn’.29 At the other extreme lies the experience of many African countries, where weak local investment capabilities led to a situation where, despite heavy reliance on foreign contractors, projects are often delayed and much more costly than elsewhere.30 As the local firm subsequently diversifies into new product areas, there may be some ‘learning spill-over’ from earlier investment activities if the new project requirements are not radically different. This certainly applies to generic capabilities required to organize pre-investment and project execution activities or to the selective sourcing of investment functions. There are, however, definite

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limits to building upon prior investment experience. This is true in particular for product-specific investment capabilities such as basic process design, equipment design and system integration. Minor change Minor change capability is a firm’s ability to improve and adapt continuously its products and processes. It refers to the vast area of adaptive engineering and organizational adjustments involved in the incremental upgrading of product design and performance features and of process technology. Minor change capability is probably one of the most important elements in successful technological catching up strategies.31 Without strong minor change capabilities, a firm is ill-equipped to reap the dynamic benefits of technology diffusion. ‘Firms must accumulate the deeper forms of knowledge, skill and experience required to generate continuing paths of incremental change, which both improve on the original performance standards of the technology in use, and modify its inputs, outputs and processes in response to changing input and product markets’ (Bell and Pavitt: 1993, p. 162). In addition to sophisticated ‘reverse engineering’ techniques, firms rely on ‘analytical design’ and at least some ‘system engineering’ capabilities, in order to analyse the ‘various arrangements of existing components or of modifications of designs already within the state-of-the-art to accomplish new tasks or to accomplish old tasks more effectively at a lower cost’ (Kline and Rosenberg: 1986, p. 292). Our case studies show that one of the greatest strengths of successful exporting firms has been their conscious effort to accumulate such increasingly sophisticated minor change capabilities. Strategic marketing In a growing number of industries, competitive success today requires strong product differentiation capabilities whose development depends on whether producers can build up close links with customers and identify in time their needs and changing demands.32 Thus marketing must be part of a firm’s technological capabilities. Our definition is a broad one and includes the knowledge and skills required for collecting market intelligence, the development of new markets, the establishment of distribution channels and the provision of customer services. In order to be able to translate its knowledge about customer requirements into successful products and services, a company needs strong product design and system engineering capabilities. Companies have therefore transformed their concept of marketing into a strategic management function. Rather than exploiting given markets, strategic marketing aims primarily at the development of new markets and the continuous improvement of the firm’s competitive advantages. Its main purpose is to bridge the gap between market demands and the firm’s innovation priorities and to reduce the time and cost

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requirements of product development. Defined in this sense, marketing has become a crucial component of a firm’s technological capabilities. Linkage ‘Linkage capabilities’ relate to the knowledge, skills and organizational competence associated with the transfer of technology at three different levels: within a firm, from one enterprise to another, and between the firm and the domestic science and technology infrastructure. Within a firm, linkage capabilities refer to the capacity to manage interactions and information-sharing among different divisions and business functions, such as R&D, design, engineering, procurement, production, marketing, sales and customer service. It has been claimed, for instance, that one of the strong points in the organization of innovation within Japanese firms has been their heavy reliance on horizontal communications across divisions or departments and the frequent rotation of personnel between different departments (Mowery and Rosenberg: 1989, Chapter 8). Japanese firms have been quite successful in spreading feedback loops across nearly all stages of the production chain. As noted earlier, such linkages exist between: marketing and production; production and design;33 and R&D, marketing and production. Empirical research in OECD countries has shown that there are substantial possibilities for improving the effectiveness of firm-level innovation strategies and that strong intra-firm linkages can play an important role in this context. Inter-firm linkages can relate to either domestic or foreign companies. They encompass such diverse activities as the procurement of materials, parts and components and services and the related exchange of information with suppliers, the sharing of marketing and distribution activities and the sharing and joint development of product design and production technology and of related scientific knowledge.34 Subcontracting relationships, for example, have been the source of three important forms of technology diffusion which are indirect in the sense that they are not the result of a conscious effort to transfer specific product, process or organizational technologies (Wong Poh Kam: 1991, p. 15): • Learning facilitation which results from the exposure of the local subcontractor to the foreign buyer’s qualification process and which includes: testing and diagnostic feedback on quality and other aspects of the performance of the supplier’s products; the sourcing of technical experts to solve specific technical problems encountered by the supplier; and advanced indications on future quality/performance/feature requirements and targets. • Knowledge spillover effects which include: product design specification and performance requirements; early supplier involvement in prototype development; access to technical and marketing information on competitors’ products; informal sharing of technical information and ideas among the

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technical staff of both companies; and exposure to the foreign company’s system of managing production and R&D. • Investment inducement, which relates to investments in the formation of technological capabilities which the local supplier can only undertake because the subcontracting relationship reduces the perceived risk of such investments through a procurement commitment by the foreign company, because it offers a stable source of income to finance the investment, and because it offers access to superior market information that may reduce the risks involved in the investment decision. Finally, linkages with the country’s science and technology infrastructure relate to a firm’s capacity to attract, absorb and upgrade the available pool of human resources, to screen and scan new technology developments, and to establish close interactions with applied and basic science. While a strong domestic S&T infrastructure is an important advantage, such linkages are increasingly extending across national frontiers as R&D becomes internationalized.35 Major change This last category encompasses the most demanding and sophisticated set of technological activities. ‘Major change’ capability is defined as the knowledge and skills required for the creation of new technology, i.e. major changes in the design and core features of products and production processes. This includes in particular new product ideas, applied and some basic scientific knowledge, and the ability to develop patentable ideas. Major change capabilities are derived from many sources, including inhouse R&D, although this is certainly not the only one. Empirical research has shown that a majority of advances in technology result from activities which are not covered by the conventional definitions of R&D, such as those used in the OECD Frascati Manual or by the United States National Science Foundation. Nelson (1990a), for instance, has emphasized the role of design and production engineering for product and process innovation. In a number of industries neither is counted as R&D36 and von Hippel (1988) has painstakingly documented that in a wide range of industries most innovations are developed by users and later adopted by manufacturers. In other words, ‘organized free-standing R&D is an important part of the investment and organization involved in advancing technology in many industries. However, it seldom accounts for all of that effort, and in a number of industries it accounts for only a relatively small share’ (Nelson: 1990a, p. 40). In most firms R&D has a much broader purpose than just to develop new products and processes. Probably of greatest importance is its contribution to the development of successful technology-scanning capabilities. ‘Modern industrial R&D laboratories are as much “intelligence” facilities that enable a company to stay up with the evolving state-of-the-art as they are sources of major invention’

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(Nelson: 1990a, p. 41). R&D is also widely used ‘to gain a head-start on a significantly better product…which is time-consuming and costly for a competitor to overcome, to tailor their products for particular consumers’, and as a catalyst for a continuous upgrading of the whole ensemble of a firm’s technological capabilities. For the purposes of this study, therefore, the concept of major change capabilities extends beyond those activities which a firm explicitly declares as R&D. Many companies that carry out no explicit R&D nonetheless do a great deal of creative work. Moreover, companies which perform R&D often do so outside of R&D departments. Our research thus takes explicit account of the role of a number of activities related to both production and marketing, such as design, production engineering and feedback information, in particular from lead users as defined by von Hippel.37 In addition, part of the knowledge that underlies major change capability can in principle be externally sourced from universities and from public or private R&D laboratories. The relevance of basic and applied science for production and process innovation has increased considerably. According to a widely quoted study, computer science and materials science head the list, followed by metallurgy and chemistry (Levin et al.: 1987). In addition, major breakthroughs in biochemistry have transformed the possibilities for initiating major changes in a number of industries ranging from mining and agriculture, to the food industry, pharmaceuticals and the chemical industry (OECD: 1989). It is in biotechnology that developing countries have been most immediately affected by the growing science-intensity of industrial production.38 There is an increasingly intense interaction between scientific research and the technology strategies of private companies. In OECD countries, academic research has provided many of the original ‘inventions’ or pilot versions of designs that industry subsequently develops and commercializes. The main contribution of academic research, however, relates to the production of ‘generic knowledge’, defined as ‘a body of understanding of how things work, key variables affecting performance, the nature of various opportunities and currently binding constraints and promising approaches to pushing these back’ (Nelson: 1990b, p. 195). In all major OECD countries, this has led to an increasingly close interaction between private companies and university or public research laboratories (Mytelka: 1991a). Such problem-solving capabilities can also be found in the universities and research institutes of developing countries. The key question, however, is the extent to which university research and public research laboratories have been playing such a role in the development of major change capabilities in the companies under study here. While major change capabilities are of limited relevance during the technological catching-up phase, they become a central concern once the limits of catching up have been reached. The experience of a number of leading Korean exporters of electronics products illustrates some of the issues discussed above.39

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IV FACTORS SHAPING A FIRM’S CAPACITY TO DEVELOP AND UPGRADE ITS TECHNOLOGICAL CAPABILITIES Technological capabilities do not fall like manna from heaven. Their development requires conscious and sustained efforts by both firms and governments. In this section, we look at the way in which policy dynamics, market forces, and the historical practices of firms interact to stimulate or discourage efforts to build technological capabilities. First, we consider the prerequisites of building up technology capability awareness and macroeconomic stability. Second, we look at the ‘incentive system’, the combination of policy dynamics, market forces, and the historical practices of key actors within the national economy. Third, we sketch out several broad strategies that firms have followed in developing their technological capabilities and the various channels they have used to acquire technology. Awareness and macroeconomic stability Building technological capabilities at the firm level first requires an awareness by management of the need to develop such capabilities and a willingness to try to do so. As part of their growth strategies, many firms in the industrialized countries have an explicit commitment to building up of their technological capacities, whereas in most firms in developing countries, such an explicit innovation strategy rarely exists. Some well-intentioned statements concerning the need to build technological capabilities may occasionally be made, but they are not effectively integrated into day-to-day management procedures or long-term planning. In such firms, technological capabilities often emerge in an ad hoc fashion, in reaction to particular bottlenecks or as a result of certain features of industrial organization or the structure of the industry. This was the case in Argentina in the late 1960s and early 1970s, for instance, where sub-optimal size and an excessive degree of vertical integration led many local industrial firms ‘to establish in-house engineering departments whose basic mission was that of adapting foreign product designs and production processes to the local working and regulatory environment’ (Katz and Bercovich: 1993, p. 6). Learning more about how the firms have responded to such bottlenecks or other stimuli is an important part of our research task in this study. In some instances, a firm’s management itself may not recognize the extent to which technological capabilities are being built in the course of solving such problems. For an economy to invest in its industry, there must also be macroeconomic stability. Financial and exchange rate stability are probably the most important prerequisites for high rates of savings and investment. In most Latin American countries, a disastrous decline in economic growth and the spiralling inflation

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resulting from the debt crisis of the 1980s have been amongst the main causes of the slow-down of investment in R&D and technological capability formation.40 The same is true for the financial crisis that has swept through Asia since June 1997: asset prices are collapsing, financial and corporate insolvency are spreading, and economic growth has been drastically reduced. There is a strong likelihood of a chain reaction effect of mass bankruptcies of major banks and firms; stagnation is likely to last for a couple of years with potentially devastating effects on investment, employment and social consensus. Whenever there is low or negative growth or high inflation, investment of any kind becomes unlikely. Thus macroeconomic stability is a basic prerequisite for the successful development of technological capabilities and it is affected in a major way by government policies. But it would be misleading to claim that macroeconomic stability is a sufficient condition for such developments to take place. In order to build up and strengthen its technological capacity, a firm must have access to financial resources and be willing and capable of investing in productivity-enhancing efforts of various kinds, whether internally or through its linkages to other firms or universities and research institutions in its environment. Richard Nelson (1990b, p. 46) confesses that ‘the conditions under which those needed investments…are made, and the conditions under which they are not, remain…the great mystery for development theory’. In what follows we consider a set of factors which, in our view, may have a strong bearing on such decisions. We call this set of factors the “incentive system” (IS) in order to stress the interactive nature of its various elements.41 For the purpose of this study, we define the ‘incentive system’ broadly to include the following three basic elements: 1 policy dynamics; 2 market forces; 3 historical practices. In essence, the incentive system shapes the extent to which firms are willing and able to invest in the acquisition and diffusion of productivity-enhancing technological and organizational innovations. An incentive system is conducive to technological capability formation if: • by constraining rent-seeking strategies of the economic actors it raises the economy’s investible surplus; • it ensures that a high proportion of these resources is invested in productive capacity and the formation of technological capabilities within the national territory; • it guides investment into industries and towards the building of technological capabilities that are important for the economy’s ability to sustain higher wages in the future; and

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• it gradually proceeds to expose these investments to international competitive pressure. Policy dynamics From the above it is evident that we do not subscribe to the view that a nation’s incentive system is, or indeed should be, determined solely by the unconstrained operation of market forces. Market forces are themselves shaped by government policies and the organization and strategies of economic agents, in particular, private firms. Historical analysis, moreover, shows that governments and enterprises interact in shaping a nation’s incentive system.42 Governments, for example, have developed an impressive array of policy instruments which affect firm-level innovation strategies, either directly through tax credits or subsidies for the purchase of equipment or R&D or indirectly through their impact on the macroeconomic environment, factor markets, demand structure, patterns of competition, labour and other practices. Some of these aspects will be examined below. What needs to be emphasized at this point is that our interest is not in the policies themselves but rather in the policy dynamics which result from the impact of specific policies on particular types of economic actors. Different actors, in contexts shaped by different incentive systems, will react differently to policies which for all intents and purposes appear identical. Moreover, policies which at one point in time might stimulate innovative behaviour may at a later date, given changes in other policies or in market dynamics, discourage innovation. A few examples will clarify this perspective. Small industrialists who are riskadverse may not be as responsive to a credit-based stimulus for investment in new machinery and equipment as they would to a risk-spreading inducement to innovate. It was precisely this kind of reasoning that lay behind the Japanese government’s decision to create the Japan Robot Leasing Corporation as a means of more rapidly diffusing robot technology to small and medium-sized enterprises. To take another example, a small firm whose management has traditionally used retained earnings to finance its investments might be reluctant to incur debts in order to innovate. In France, where this was typical of small tradition-bound textile manufacturers in the early 1970s, tax credits intended to stimulate innovation were used instead to reduce a firm’s debt burden. By adopting a short-term perspective on the need for change, firms failed to adjust in an incremental fashion as competitive pressures increased and, in the end, many of them went into receivership. Similar stories can be told about the variable impact trade policies have on the behaviour of a given country’s economic actors in the same industry over time. The changes in impact, in this instance, were not due to differences in the nature of the economic actor or its historical patterns of innovation or competition, but resulted from modifications in market forces which interacted negatively with an unchanged tariff policy to create a negative incentive for innovation. The

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evolution of the Indian textile industry during the 1970s and into the 1980s is a case in point. To preserve the village-based and employment-generating handloom sector, limits on imports of modern mechanical and later automated looms were imposed. Because the diffusion of newer more efficient looms was relatively slow during much of the 1970s, Indian firms remained competitive and retained their place in world textile exports. Moreover, as the larger textile firms sought to expand production but could not do so through imports of new machinery, they developed the in-house capacity to produce mechanical looms and later exported some of these to their joint ventures in Africa. But as other developing countries became more efficient and the use of shuttleless looms became more widespread, the Indian textile industry rapidly lost ground to Korea and other countries which had abandoned such trade policies earlier on. While the latter example illustrates that liberalization is unavoidable in small economies, a considerable body of research now shows that it is selective liberalization that has proven to be a key element in successful latecomer industrialization in, for example, Japan, South Korea and Taiwan Province of China.43 This applies as much to the reduction of import restrictions as to the liberalization of financial markets, as will be seen below. With regard to trade liberalization, all three countries combined liberal trade policies for some industries with import substitution policies for others, thus creating different incentives for different industries. In these countries, moreover, import liberalization proved to be particularly important when it affected the cost of inputs used in the manufacture of exports. Their experience also shows that there are ways and means for a developing country to ‘soften pressures from its trading partners to open its markets or face retaliation, by a judicious combination of camouflage, statements of intent, and real liberalization’ (Wade: 1990, pp. 360– 361). The argument that ‘there is no alternative’ to complete liberalization thus tends to foreclose debate on the availability of other options. In analyzing the changing policy context in the five countries in our study, we have made an effort to be sensitive to these dynamics in interpreting the behaviour of firms and the nature of the policies developed to influence that behaviour. Market forces Market forces that affect the behaviour of firms come from many different sources, including factor markets, particularly labour and capital markets, the size and structure of demand; and industry structure, including patterns of competition. Factor markets The functioning of factor markets, in particular for capital and labour, can play an important role in determining the extent of a firm’s investible resources and in

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shaping its decision as to whether or not to invest in the development of technological capabilities. In many developing countries, organized capital markets, including the banking system, have not traditionally played a supportive role in providing resources for investment. In part, this is due to a chronic scarcity of capital which leads to high real rates of interest and in part to the lack of adequate institutions for financing investment, including investment in learning and innovation. The scarcity of capital has led many governments to engage in the rationing of bank credit, with subsidized interest rates and ready availability of financing for some sectors and disproportionately high interest rates and little access to organized sources of financing for others. Typically, the enterprises that have benefited have been state-owned and large private firms able to provide the collateral demanded by banks. This generally takes place in a setting where the supply of credit to the poorly-developed enterprise sector is a risky proposition. The cost and availability of long-term capital is highly relevant to this research because it influences the ability of firms to invest in productive assets, particularly in R&D and knowledge accumulation. The supply of short-term credit for working capital is also significant because of its role in financing exports. Since productive investment of all kinds, including in technology, has a high import content in developing countries, it is not only the supply of credit itself that may be critical but also that part of it which is in foreign exchange. Although, in principle, export-oriented enterprises should not be constrained by inadequate access to foreign exchange, in practice the operation of foreign exchange controls in some developing countries has put their firms at a disadvantage compared with competitors in other countries. Institutions in both developed and developing countries are notoriously inadequate for dealing with the relatively large sums of investment that may be required for R&D. Investment in the development of new or improved products and processes is costly, long to mature, uncertain in its outcome. Ordinary commercial bank lending institutions are not able to put up the kind of ‘venture capital’ required for investment in technology. Specialized venture-capital firms, which have sprung up in a number of developed countries to fulfil these needs, are absent in developing countries. Moreover, developing countries typically lack organized security markets to which firms can turn for financing of part of technological investment. Recognizing that the social rate of return on investment in knowledge creation is higher than the return to private investors, governments have intervened in a number of ways to fill the gap, notably by providing grants and financial support for such investment. The cost and availability of skilled labour also has important implications for the choice of products, technologies and production processes. If labour is cheap, but relatively unskilled, such choices may be limited to low-end market segments and low levels of factory automation which, in turn, reduce the sophistication of the technological capabilities that will initially be required. Moving into higher levels of factory automation under these conditions

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may, as in the case of the textile industry in Africa, lead to considerable inefficiencies in production (Mytelka: 1985). If, on the other hand, labour is skilled and thus can command a higher price, the firm has a strong incentive to upgrade its products as well as its production technologies. In this case, although the requirements for technological capability formation are bound to be much more demanding, the availability of a skilled workforce raises a firm’s chances of success in upgrading its technological capabilities. Size and structure of product markets Empirical studies have shown that both the volume and the structure of demand have played an important role in explaining growth in a country’s industrial output.44 Since many industrial technologies are characterized by increasing returns to scale, only a significantly large demand volume will allow for efficient growth. Demand can originate from either domestic or export markets. If international trade were free and costless, the size of the domestic market would not constrain investments in technological capabilities. In reality, however, international trade is neither free nor costless: trade barriers are ubiquitous and the establishment of overseas distribution outlets is expensive. Thus, local firms normally need a sufficiently large domestic market in order to reap learning economies and to build up production experience and technological capabilities. In addition, the rate of investment in an industry is also a function of how fast demand is growing, whether in the domestic economy or abroad. Rapid demand growth is of particular importance during periods of rapid technological change, when investment requirements for the development of technological capabilities are particularly high. In an industry confronted with demand stagnation and surplus capacity, firms are unlikely to invest in technological capability formation. In developing countries which rely heavily on exports, the main role of the domestic market is a qualitative one. A sufficiently large and sophisticated domestic market may be conducive to cooperation between producers and users in improving products and processes and in other types of technical cooperation which innovation theory suggests are an important vehicle for strengthening a society’s technological and organizational capabilities.45 The interesting empirical question is whether a sophisticated domestic market is indispensable for such interactions to arise or whether they can also occur in international markets. Industry structure and patterns of competition Developing countries have vastly different industrial structures, average firm sizes and size distributions of firms. In so far as these differences affect internal financial resources available for investment, they may have implications for investment in technology. Large, diversified firms are better equipped to finance

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the major investment outlays required to develop sophisticated technological capabilities. At the same time, a highly concentrated industrial structure may preempt many opportunities for learning and technology diffusion, which could occur if technological capabilities were more evenly distributed among a larger number of firms. In many developing countries, the lure of a comfortable oligopolistic home market has hardly motivated large companies to engage in long-term technologyrelated investments.46 Historical practices Over the course of their existence and in given social and cultural contexts, firms develop ways of thinking about and dealing with the challenges of change and competition. When such practices are generalized across many firms, and when they achieve some measure of longevity, these historical practices become important elements in the incentive system that shapes a firm’s subsequent decisions with regard to technology capability formation. Practices which constrain or improve a firm’s ability to build up technological capability can reside within industry structure, management, or even broader cultural patterns. In some cases, historical practices will reinforce the positive inducements for innovation resulting from the interplay of market forces and policy dynamics at a particular point in time. But it is also possible that some historical practices will act as disincentives for technology capability formation. This does not mean that such practices must, or indeed will be eliminated, for in some instances the very effort to deal with such negative historical practices will itself be a creative force for innovation. An example should clarify what we mean by historical practices and the role they play in the incentive system. We refer once again to the case of the small textile manufacturers in France which, because of their traditional reluctance to borrow, failed to invest in new machinery and equipment which were needed to remain competitive. Moreover, traditional management practices impeded a reorganization of the work process which, by raising productivity, might have compensated for the absence of investment in newer, more efficient machinery. Thus, historical practices with respect to both investment and the organization of work acted as disincentives to innovation in this case. V THE DYNAMICS OF TECHNOLOGICAL CAPABILITY FORMATION Changing technological capability requirements We refer to the dynamics of technological capability formation in order to underscore the fact that at different moments in the process of

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industrial development, different patterns of interaction (and trade-offs) will prevail among the different types of technological capabilities. By industrialization, we mean the simultaneous occurrence of high growth of industrial output—with the industrial sector accounting for a progressively larger share of GNP, mostly at the expense of agriculture—and a transformation of the structure of industrial production itself. Industrial transformation, in our view, can be captured at three levels of analysis. A first level relates to shifts in the composition of industrial output between consumer, intermediate and, in particular, capital goods. A higher percentage of capital and durable consumer goods in industrial output indicates a higher level of industrialization. Second, industrial transformation is reflected in shifts in the intensity of critical factors of production (i.e. labour, capital, skills and technology). Earlier debates centring around Destanne de Bernis’s (1966) concept of ‘industries industrialisantes’ had assumed that a shift from ‘light’ to ‘heavy’ industries could be taken as an indicator of industrial progress, as it presumably would require greater technological capability and more sophisticated skills on the part of management and labour. Today, however, we know that industrial transformation cannot be reduced to such mechanistic and one-dimensional concepts. It is true that a shift from labour-intensive to capital- and knowledgeintensive forms of production indicates important transformations in industrial manufacturing. Yet, such shifts can occur as much in supposedly ‘light’ industries like consumer electronics, personal computers, garments and software production as in the classical ‘heavy’ industries like steel, chemicals and shipbuilding. Third, for any given industry, the technology requirements of a particular production process evolve over time. Abernathy and Utterback (1975) have broken down the evolution of an industry into what they call a ‘process life cycle’, which typically begins with a ‘fluid’ production process—one that is highly flexible but not very cost-efficient, which then proceeds towards increasing standardization, mechanization and automation until it eventually becomes ‘systemic’—very efficient, but much more capital-intensive, inter-related and hence less flexible than the original ‘fluid’ process. This typology can be extended to accommodate changes resulting from the spread of computer-based factory automation. Thus, today, there is a shift from what was generally a highly capital-intensive mode of production towards ‘plant down-sizing’ (e.g. in steel), the use of smaller machine tools in the capital goods industry and fewer looms with higher productivity in textiles. In all these cases, capital/output ratios have significantly declined.47 Yet, in absolute terms, fixed capital cost burdens still remain a major concern. While the new flexible manufacturing technologies have diminished the importance of economies of scale at the plant level, scale economies have increased at firm level as a result, in particular, of the rising indirect costs for R&D and marketing.48 In other words, despite some important changes brought about in the economics of industrial production due to the spread of computer-based factory

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automation, the overall argument continues to hold: technological capability requirements keep changing over time. Sectoral shifts by type of industry as much as industry lifecycles condition the nature and mix of the technological activities performed. Technological capability requirements may also differ for the same type of products, however, as illustrated by the case of plant operation capabilities. Firms may employ different production techniques to produce the same output, each of which demands different sorts of knowledge for effective use. For example, to produce a metre of cotton fabric, one firm may use a highly automated air-jet loom and another a traditional mechanical loom. Further, each type of machine functions best in a particular environment. For instance, the airjet loom requires different work scheduling, inventory, maintenance, climate control and other procedures from a mechanical loom. The type and quality of material inputs—for example, yarn properties—will also be different for the two types of machines. Thus, for any given product, more than one technique can generally be used in its production. Each of those techniques, however, requires a different type of know-how in order to be used efficiently. To some extent, the knowledge requirements may overlap, but they are not identical. Learning how to operate one technique efficiently does not necessarily enable a firm to operate another just as efficiently. Sequencing patterns49 The innovation strategies that firms adopt are closely related to choices they make with regard to their product mix and competitive strategies. These in turn have consequences for export performance. Three different approaches can be distinguished: 1 catching up; 2 keeping up; and 3 getting ahead. Catching up strategies We reject the position that ‘learners by definition do not innovate’ (Amsden: 1989, p. 323) and adopt the view that catching up is the period when the successful latecomer firm ‘learns to learn’, a skill which it can later apply to any product or process. Catch up strategies involve, for example, the building of problem-solving capabilities that enable the firm to improve its productivity, to imitate and to adapt product, process and organizational technologies already developed elsewhere. In newly industrializing economies, catching up critically depends upon deepening production capabilities thereby ensuring that the clones, copies or OEM goods are, at least, of similar quality and yet initially competitive because they are cheaper. By turning themselves into learning institutions, firms

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which ‘learn to learn’ during the catch up phase are in a position to sustain their competitiveness over the longer term, a point which emerges clearly in the case studies.50 Technological catching up strategies initially focus on the ability to operate production facilities according to competitive cost and quality standards. Production capabilities are used as the foundation for developing capabilities in adaptive engineering and in investment, while product and market development and process innovation are postponed to a later stage of development. Through the ‘creative imitation’ of foreign technology and by integrating themselves into the global supply networks of United States, Japanese and European companies, many firms in Asia and Latin America avoided the huge cost burdens and risks involved in R&D and in setting up international distribution and marketing networks. Such innovation strategies reflect a particular set of product strategies. During the catching up phase, firms typically pursue one of the two following product strategies. At the beginning, they tend to rely predominantly on imitation or ‘cloning’ strategies, using common and widely spread ‘me too’ technology and targeting the low value added market segments for massproduced standard products (‘commodities’). Once these firms have accumulated a certain amount of technological capabilities, particularly in production, investment and marketing, they typically try to shift their focus, at least in some carefully selected market segments, to ‘quick follower’ strategies, tracking the development of a new product or technology and attempting to adopt it as quickly as possible and at a lower cost. Firms in developing countries, including the more advanced countries, such as Korea and in Taiwan Province of China, continue to rely overwhelmingly on these two product strategies. This is a reflection of their still quite weak product design and market development capabilities. Catch up strategies are most likely to succeed when: (1) the target is clear—a product or process whose characteristics are widely known or obtainable through such means as reverse engineering and licensing; (2) the technological change is incremental, thereby permitting enough time to build technological capabilities by starting with an earlier generation; and (3) the components and skill inputs are easily identified and relatively freely available, through purchase, hire or local development. The classic post-war example of a successfully pursued catch up strategy was the Japanese VLSI project (Levy and Samuels: 1991; Fransman: 1990; Kodama: 1991). A similar strategy was pursued in the development of computer memories (DRAMs) and digital telecommunications switches in Korea.51 Keeping up: technology diversification strategies Keeping up is more difficult than catching up because the target is much closer, the technology still in flux and there is less time to put the package of

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components and skills together. It thus requires a more substantial science and technology infrastructure on which it can draw rapidly for new inputs, a strong production base to move down the cost curve quickly and the design and development capabilities to go beyond imitation to the introduction of variety. Moreover, as one OECD document pointed out innovative behaviour is not simply an attribute of individual firms but rather results to a large extent, from ‘national or local environments where organisational and institutional developments have produced conditions conducive to the growth of interactive mechanisms on which innovation and the diffusion of technology are based’ (OECD: 1992, p. 23). Nowhere is this more evident than in supporting quick follower strategies. Furthermore, since keeping up is a continuous process, it is predicated upon having sufficient financial resources to move products to the market early enough in the product cycle to capture market share and generate the revenue needed for investment in successive product generations. As firms approach the limits of technological catching up, they begin to search for new approaches to product development and innovation. Rather than jumping right into ‘technological leadership’ strategies, recent research has shown that industrial latecomers may have an intermediate option, i.e., technology diversification. Roughly defined as ‘the expansion of a company’s or a product’s technology base into a broader range of technological areas’ (Granstrand: 1992, p. 291), such strategies are an attempt to reap technology-related economies of scope. They differ quite substantially from so-called ‘high tech’ product innovation strategies with a focus on products with a high R&D content (i.e., high R&D intensity or high R&D value added) in that they focus on products which are ‘based on several…crucial technologies which do not have to be new to the world or difficult to acquire’ (Granstrand: 1992, p. 300). Japanese firms have played a pioneering role in the development of technology diversification strategies. The underlying rationale has been threefold: an attempt to compensate for the increasing constraints on their existing manufacturing exports; a deliberate strategy to develop generic technologies that could form the base for penetrating future growth markets; and finally, a reaction to the increasing technological complexity and rising R&D cost of new products (Odagiri and Goto: 1993). For firms in East Asian NIEs, technology diversification strategies could have a number of important advantages. As technology diversification normally goes hand in hand with extensive reliance on external technology sourcing, NIEs could make use of their accumulated capabilities in external technology sourcing, imitation and adaptive engineering. To the extent that their R&D investments are rapidly increasing, these companies will have to find ways to spread these costs, not only over many markets (countries and segments), but over many products. Furthermore, the spread of technological diversification strategies in OECD countries may help to increase technological plurality and thus open up new windows of opportunity for dedicated lateentry strategies. Limited empirical research on Japanese, United States and Swedish companies has shown that ‘technological co-existence is

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more predominant than technological substitution, as seen from the larger number of old technologies in a current product generation, compared to the number of obsolete technologies’ (Granstrand: 1992, p. 305). Getting ahead: technology leadership strategies If catching up and keeping up are difficult processes, they are still more predictable than getting ahead. Front runners, for example, have no firm targets to guide their choices. Unlike quick followers, they derive fewer learning benefits from the failures of their predecessors (Freeman: 1974, p. 176). Uncertainty affects decisions such as which combination of generic technologies might produce a product acceptable to consumers or which new frontiers will yield the greatest benefits. Whether hot pursuit, a rupture in the technological trajectory or a change in standards will deprive them of the rents that make such races rewarding cannot be predicted with much certainty. To hedge against the high costs, risks and uncertainties involved in competing at the frontier, wouldbe front runners have increasingly complemented in-house R&D with a wide array of R&D, production and marketing partnerships (Mytelka: 1991a). Technology leadership strategies have recently gained in importance among market leaders in OECD countries. This is due to the fact that attempts to expand a firm’s market share simply through product differentiation and heavy advertising are running into severe demand constraints. Attention has thus shifted to the establishment of a new market or to the redefinition of the rules of competition by means of introducing a new, supposedly superior, product. For NIEs, technology leadership strategies would involve head-on competition with established world market leaders. It is thus hardly surprising that only a few companies in the NIEs have tried to pursue such strategies—and mostly with very limited success. Our case studies show that, with rare exceptions, attempts to move up towards technology leadership strategies are still premature. VI ALTERNATIVE APPROACHES TO TECHNOLOGICAL CAPABILITY FORMATION Firms can build technological capabilities in a variety of ways. The most important distinction is whether they do so internally, based on their own R&D design and engineering activities, or whether they rely on external linkages. Such linkages may be with technology producers within the domestic economy, such as universities or public R&D laboratories, the R&D laboratories of other private firms, or with specialized engineering companies, design houses, or software firms. However, they may also be with foreign technology suppliers. In the case of most developing countries, the acquisition of foreign technologies has, in fact, been an important instrument for building up firm-level technological capabilities.52

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External technology sourcing External technology sourcing obviously involves the trade-off of reduced management control. This is why one would expect firms, in principle, to prefer the internal generation of technological capabilities to any dependence on outside sources, all costs being equal. In reality, however, no firm, not even a dominant market leader, is able to rely exclusively on internal technology generation. Empirical research has shown that firms, in a number of industries, increasingly rely on external technology sourcing. This is due basically to the following three developments.53 Firms nearly everywhere are under increasing pressure to diversify their product portfolios and technology base into a broader range of technology areas. As a result, each firm requires a much larger set of different technological capabilities, which even a dominant market leader like IBM is finding increasingly difficult to provide through internal technology development. Second, even if a firm could mobilize the large resources required for internal technology development, the long lead times involved and the resultant heavy fixed capital cost burden would place the firm at a severe disadvantage compared to competitors who, relying on external technology sourcing, could commercialize new products much faster and thus retain a much greater flexibility with regard to changes in demand patterns. External technology sourcing, by reducing the capital and time requirements of innovation, enables firms to cope with the much shorter product lifecycles typical of today’s global competition. Third, in a growing number of industries, the focus of technology development is shifting from the level of the final product to technologies related to materials and core components. As a result, suppliers of materials and components have both had to upgrade substantially their technological capabilities in order to act as external technology sources for the final assemblers. This applies to both the computer industry and to the automotive industry.54 In short, external technology sourcing has historically played an important role in the formation of technological capabilities in industrial latecomer societies. Today, its importance is increasing even further and also affects dominant market leaders in major OECD countries. Globalization of competition has led to a proliferation of external technology sourcing. In order to improve its export performance, a firm now needs to be able to integrate external technology sourcing into its overall innovation strategy. The role of domestic technology networks To the extent that firms have to rely on external technology sourcing, it has sometimes been argued that they have a preference for domestic sources. This is because domestic linkages are ostensibly characterized by a higher degree of geographic and cultural proximity than international linkages, which improves a

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firm’s capacity to ‘internalise the relevant externalities that spill-over across industries and within industries from the R&D conducted by suppliers, customers and by competitors’ (Antonelli and Foray: 1991, p. 2). Integration into domestic technology networks thus enables a firm to reduce the transaction costs involved in external technology sourcing. In addition, firms tend to prefer domestic technology linkages, because they help to reduce ‘transition costs’ which are defined as ‘costs that organizations incur when they seek to undergo a drastic restructuring to meet new challenges and implement new strategies’ (Ciborra: 1991, p. 31). Faster decision-making and response time are probably the main reasons why firms prefer domestic forms of external technology sourcing. This brings us to an important difference between developing and developed countries. While the latter have been able to build up over many decades a sophisticated network of domestic technology linkages, this has not been the case in the majority of developing countries because most of these technologies are not available from other domestic sources. Thus external technology sourcing in developing countries has, first and foremost, related to the effective acquisition of foreign technologies. As a developing country progresses in its industrial transformation, the share of external technology sourcing within the domestic economy, however, may increase substantially. An important focus of our research has been the creation and spread of such domestic technology networks and their role in sustaining export success. Our country case studies thus inquire into the extent to which firms interact with the domestic science and technology infrastructure in their attempt to develop and upgrade their technological capabilities. In this connection particular attention is given to the contribution of the domestic educational system, university and public research institutes and the regulatory framework set for standards and intellectual property rights55 and to the role played by domestic supplier networks and related support industries, in particular for materials, core components, production equipment, software and support services. As the case studies demonstrate, over the 1980s and much of the 1990s, the Newly Industrialized Economies of Asia have enjoyed almost unrivalled economic growth—fuelled largely by the success of their export-oriented industrial strategies. These economies are now faced with new challenges: they will have to replace their traditional production advantage of cheap labour with more sustainable ones based on technological capabilities. How can the firms in these countries develop these capabilities, and how can their governments help? These are the questions that have shaped the conceptual framework presented here and guide the case studies that follow. NOTES 1 Grynspan (1982), Stewart (1979) and Vaitsos (1975).

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2 See, for instance, Bell, Scott Kemmis and Satyarakwit (1980), Mytelka (1979) and Ernst, D. (ed.) (1980). 3 Mytelka (1985), Katz (1984, 1987), Dahlman (1984) and Kaplinsky (1984). 4 Kemp (1983), Horie (1965), Ozawa (1980), Saito (1975) and UNCTAD (1978). 5 Bell (1984), Fransman (1986), Mytelka in UNCTAD (1990), Lall (1990) and Ernst (1991). 6 These would include changing relative prices of factors and products. 7 For a detailed analysis of the impact of globalization on late industrialization policies, see Ernst and O’Connor (1989), Ernst and O’Connor (1992) and Mytelka (ed.) (1997). 8 For a typical example of this neo-liberal globalization doctrine, see Ohmae (1991). 9 The following is based on Ernst (1996). 10 For macroeconomic policies, see Frieden (1991). For industrial and technology policies, see the contributions by Boyer, Wade and others in Berger and Dore (eds) (1996). 11 For a systematic definition of the requirements of late industrialization, see Ernst and O’Connor (1989). See also Amsden (1989). 12 For a review of the relevant literature, see Stoneman (1983). 13 For an inter-active model of the innovation process, see the important article by Kline and Rosenberg (1986). 14 For a now classical theoretical treatment, see Lundvall (1988). 15 Mowery and Rosenberg (1989, Chapter 8). 16 For evidence on the electronics industry, see Ernst and O’Connor (1992), in particular, Chapters 1 and 2; for textiles and clothing, see Mytelka (1991c). 17 For a detailed analysis of the spread of international production networks, see Ernst (1997b). 18 Ernst (1996). 19 This and the following quotation are taken from Cantwell (1993, pp. 4 and 5). 20 For a theoretical treatment of inter-firm networks and their impact on technology diffusion, see Ernst (1991; 1994b). 21 Today’s arsenal of policy instruments available to such ‘high-tech neomercantilism’ is impressive and includes subsidies for investment or research, restrictions on access to the domestic market by similar goods from foreign producers, restrictions on direct investment in the domestic market by foreign firms, or procurement policies that favour the domestic producer of a hightechnology good. For evidence, see Ernst and O’Connor (1989), pp. 26 passim; and Tyson (1992). 22 For a detailed theoretical treatment, see Ernst and O’Connor (1992, Chapters 1 and 2). 23 The following is based on ‘Transnational corporations, human resources development and growth’, Chapter 7 of the United Nations World Investment Report1992, UN, New York, 1992, pp. 172–183. 24 For a review of the considerable literature on technology absorption, see Bell and Pavitt (1993) and Enos (1989). 25 For a definition of a nation’s production and innovation systems, see Chesnais (1992), Lundvall (1992) and Nelson (1993). For the concept of ‘technological externalities’, see Guerrieri (1991).

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26 Important contributions to the definition of technological capabilities include Dahlman et al. (1987), Lall (1990), Bell and Pavitt (1993) and Mowery (1993). The following is based on Ernst (1991). 27 For a detailed discussion, based on the experience of the textiles industry, see Pack (1987) and Mytelka (1991b, 1991c). 28 Enos and Park (1987), Amsden (1991), Chesnais and Kim (1997). 29 Enos and Park (1987) and Amsden (1991). 30 Mytelka (1985, 1991b) and UNCTAD (1990). 31 Rosenberg (1972, 1976), Metcalf (1988), and Bell and Pavitt (1993). 32 Freeman (1982, pp. 124passim). See also von Hippel (1988), Lundvall (1988) and Perez (1990). 33 It has been shown for the electronics industry that Japanese electronics firms have a clear preference for ‘tried and tested’ technology rather than for ‘state-of-the-art’ or ‘breakthrough’ technology. Components are chosen whose design and process specifications guarantee high reliability and can thus be designed rapidly into the company’s main end-products, both in consumer and industrial electronics. See Ernst and O’Connor (1992, p. 36). 34 For a discussion of inter-firm linkages see Mytelka (1991a, Introduction and Chapter 1). A classification of such linkages can be found in Ernst (1994a). 35 For evidence, see Pearce (1990). 36 The most prominent example is the automotive industry. In the garment industry, fashion design and the make-up of samples, which are essential elements of product innovation, are also not treated as part of the R&D process (Mytelka, 1991c). 37 Von Hippel defines ‘lead users of a novel or enhanced product, process, or service’ as those that ‘face needs that will be general in a market place, but… [who] face them months or years before the bulk of that marketplace encounters them’ and who will ‘benefit significantly by obtaining a solution to those needs’ (von Hippel: 1988, p. 107). 38 See Sercovich and Leopold (1991) and Acharya (1997). 39 See the case study on Korea, Chapter 2. The point is also well illustrated by the experience of Indian pharmaceutical firms (Acharya: 1996). 40 Katz and Bercovich (1993), and Dahlman and Frischtak (1993). 41 The concepts ‘incentive system, policy dynamics’ and ‘historical practices’ are based on Mytelka (1996a). Related concepts can be found in Desi et al. (eds) (1988), parts II and IV and Lall (1997). 42 See, for example, Polanyi (1944), Landes (1969), Mowery and Rosenberg (1989) and Wade (1990). 43 For a review of this literature, see Bruton (1992). See also Mytelka (1996a). 44 Chenery and Syrquin (1975) and Chenery et al. (1986). 45 Freeman (1987, pp. 124 passim), Lundvall (1988) and Perez (1990). 46 The classic study remains Merhav (1969). For some recent case studies, see Mytelka (1991a and 1996b) and Ernst (1997b, c and 1998a, b). 47 For evidence, see Judet (1980) on steel, Broedner (1986) on machine tools and Mytelka (1987) on textiles. 48 For detailed evidence on the computer industry, see Ernst and O’Connor (1992, Chapters 1 and 2). 49 See Mytelka (1996) for an elaboration of these categories.

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50 On the Taiwanese machine tool industry, see Desai, Lautier and Charya (1996). On the Indian pharmaceutical industry, see Acharya (1996). 51 For DRAMs, see Chapter 3; for digital switches, see Mytelka (1996b). 52 For evidence, see Kim Linsu (1997) on Korea, San Gee (1990) on Taiwan Province of China, Dahlman and Frischtak (1993) on Brazil, Katz and Bercovich (1993) on Argentina. Early studies can be found in Mytelka (1978, 1979) on Colombia, Ecuador, Peru and Venezuela, and Ernst (ed.) (1980), which contains a number of case studies on African, Asian and Latin American developing countries. 53 For a general discussion, see Teece (1986), Mowery and Rosenberg (1989), Cantwell (1989) and Ernst (1990 and 1998c). 54 For the automotive industry, see Smitka (1991); for the computer industry, see Ernst and O’Connor (1992, Chapters 1 and 2). 55 The contribution of standards to technological capability formation is discussed in Farrell (1990).

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——(1994a) ‘Network transactions, market structure and technology diffusion— implications for South-South cooperation’, in Lynn Mytelka (ed.) SouthSouthCooperation in a Global Perspective,OECD Development Centre, Paris. (1994b) ‘The East Asian production networks of Japanese electronics firms—basic features and new challenges’, BRIE Working Papers, The Berkeley Roundtable on the International Economy, University of California at Berkeley. Ernst, D. (1998a), ‘Catching-up, crisis and industrial upgrading: Evolutionary aspects of technology management in Korea’s electronics industry’, to appear in Asia-Pacific Journal of Management. ——(1998b), ‘What permits David to defeat Goliath? Inter-organizational knowledge creation in the Taiwanese Computer Industry’, paper prepared for the Asia-Pacific Journal of Management Conference on Knowledge Creation Strategies inAsia,Ikujiro Nonaka (guest editor), Singapore, March 1998. (1997a), ‘Partners in the China Circle? The Asian production networks of Japanese electronics firms’, in: Barry Naughton (ed.), The China Circle, The Brookings Institution Press, Washington, D.C. (in press). ——(1997b), High-Tech Competition Puzzles. How Globalization Affects Firm Behaviour and Market Structure in the Electronics Industry, Danish Research Unit for Industrial Dynamics (DRUID) Working Paper no. 97–10, September. ——(1997c), Globalization and Local Capabilities: Does Knowledge Migrate withinInternational Production Networks?, Copenhagen Business School Press, Copenhagen Ernst, D. and P.Guerrieri (1998) ‘International production networks and changing trade patterns in East Asia: The case of the electronics industry,’Oxford Development Studies. Ernst, D. and D.O’Connor (1992) Competing in the Electronics Industry. The Experience of Newly Industrializing Economies,OECD Development Centre, Paris. ——(1989) Technology and Global Competition: The Challenge for Newly Industrializing Economies,OECD Development Centre, Paris. Evans, P. (1995) Embedded Autonomy. States and Industrial Transformation, Princeton University Press, Princeton, NJ. Fagerberg, J. (1990) ‘International competitiveness’, The Economic Journal,Vol. 98, pp. 370–371. Farrell, J. (1990) ‘The economics of standardization’, in H.Schumny (ed.) An Analysisof the Information Technology Standardization Process,Elsevier, Amsterdam. Farrell, J., S.Phillips and M.Chinn (1992) Financial and Currency Integration in theEuropean Monetary System: The Statistical Record,University of California, Center for German and European Studies, Working Paper No. 1.3, March. Fransman, M. (1990) The Market and Beyond: Cooperation and Competition inInformation Technology in the Japanese System, Cambridge University Press, Cambridge. ——(1986) Machines and Economic Development,Macmillan, London. Freeman, C. (1987) Technology and Economic Performance: Lessons from Japan,Pinter, London. ——(1982) Economics of Industrial Innovation,Frances Pinter, London. ——(1974) The Economics of Industrial Innovation,Penguin, Harmondsworth. Frieden, J.A. (1991) ‘Invested interests: the politics of national economic policies in a world of global finance’, International Organization,Vol. 45, No. 4.

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Granstrand, O. (ed.) (1992) Technology Management and International Business:Internationalization of R&D and Technology,Wiley, New York. Grynspan, D. (1982) ‘Technology transfer patterns and industrialisation in LDCs: a case study of licensing in Costa Rica’, International Organization,Vol. 136, No. 4, pp. 796–806. Guerrieri, P. (1991) ‘Technology and international trade performance of the most advanced countries’, BRIE Working Papers, The Berkeley Roundtable on the International Economy, University of California at Berkeley. Heeks, R. and Slamen-McCann, A. (1996) ‘Job and skill impacts of new technology in the East Asian electronics industry’, Institute for Development Policy andManagement,University of Manchester, Discussion Paper No. 44. Hobday, M. (1995) Innovation in East Asia: The Challenge to Japan,Edward Elgar, Aldershot. Horie, Y. (1965) ‘Modern entrepreneurship in Meiji Japan’, in W.Lockwood (ed.) The State and Economic Enterprise in Japan, Princeton University Press, Princeton, NJ, pp. 183–208. Judet, P. (1980) in D.Ernst (ed.) The New International Division of Labour, Technology and Under development,Campus, Frankfurt and New York. Kaplinsky, R. (1984) ‘Indigenous technical change: What we can learn from sugar processing’, World Development,Vol. 12, No. 4, pp. 419–432. Katz, J. (1987) Technology Generation in Latin American Manufacturing Industries,Macmillan, London. ——(1984) ‘Dynamic technological innovation and dynamic comparative advantage: further reflections on a comparative case study program’, Journal of Development Economics,Vol. 16, pp. 13–38. Katz, J. and N.Bercovich (1993) ‘National systems of innovation supporting technical change in industry: the case of Argentina’, in Nelson (ed.) (1993). Kemp, T. (1983) ‘Japan: a meteoric rise’, in T.Kemp, Industrialisation in the NonWestern World,Longman, London, pp. 18–43. Kim Linsu (1993) ‘Korea’s National System for Industrial Innovation’, in Nelson (ed.) (1993). Kim, J.I. and L.J.Lau (1994) ‘The sources of economic growth in the East Asian newly industrialized countries’, Journal of Japanese and International Economics. Kline, S.J. and N.Rosenberg (1986) ‘An overview of innovation’, in NationalAcademy of Engineering, The Positive Sum Strategy: Harnessing Technology forEconomic Growth, National Academy Press, Washington, DC. Kodama, F. (1991) Analyzing Japanese High Technologies: The TechnoparadigmShift,Pinter, London. Krugman, P. (1994) ‘The myth of Asia’s miracle’, Foreign Affairs,December. Lall, S. (1997) ‘Technological change and industrialization in the Asian NIEs: achievements and challenges’, paper presented at STEPi International Symposium on Innovation and Competitiveness in Newly Industrializing Economies, Seoul, Korea, May 26–27. Lall, S. (1995) ‘Industry strategy and policies on foreign direct investment in East Asia’, Transnational Corporations, UNCTAD, Vol. 4, No. 3, pp. 1–26. ——(1990) Building Industrial Competitiveness in Developing Countries,OECD Development Centre, Paris. Landes, S. (1969) The Unbound Prometheus, Cambridge University Press, Cambridge.

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Levin, R.C.et al. (1987) ‘Appropriating the returns from industrial research and development’, Brookings Papers on Economic Activity, No. 3. Levy, J. and D.Samuels (1991) ‘Institutions and innovation: research collaboration as technology strategy in Japan’, in L.Mytelka (ed.) Strategic Partnerships and theWorld Economy,Pinter, London. Lundvall, B.A. (1988) ‘Innovation as an Interactive Process: from UserProducerInteraction to the National System of Innovation’, in Dosiet al. (eds) (1988). Lundvall, B.A. (1992) (ed) National Systems of Innovation: Towards a Theory ofInnovation and Interactive Learning,Pinter, London. Merhav, M. (1969) Technological Dependence, Monopoly and Growth, Pergamon Press, Oxford. Metcalf, S. (1988) The Diffusion of Innovations: An Interpretative Survey, in G.Dosiet al (eds) (1988). Mowery, D. (1993) ‘Inward technology transfer and competitiveness: the role of national innovation systems’, paper presented at the UNU-INTECH Research Conference, Maastricht, The Netherlands. Mowery, D. and N.Rosenberg (1989) Technology and the Pursuit of EconomicGrowth, Cambridge University Press, Cambridge. Mytelka, L. (1996a) ‘Competition, innovation and competitiveness: a framework for analysis’, in L.Mytelka (ed.) Competition, Innovation and Competitiveness inDeveloping Countries,OECD, Paris (forthcoming). ——(1996b) ‘Telecommunications equipment manufacturing in Brazil and Korea’, in L.Mytelka (ed.) Competition, Innovation and Competitiveness in DevelopingCountries,OECD Development Centre, Paris (forthcoming). ——(1991a) ‘Crisis, technological change and the strategic alliance’, in L.Mytelka (ed.) Strategic Partnerships and the World Economy,Pinter, London. ——(1991b) ‘Ivorian industry at the crossroads’, in F.Stewart, S.Lall and S. Wangwe (eds) Alternative Development Strategies in Sub-Saharan Africa,Macmillan, London. Mytelka, L. (1991c) ‘New modes of competition in the textile and clothing industry: some consequences for Third World exporters’, in J. Niosi (ed.) Technologyand National Competitiveness,McGill-Queen’s University Press, Montreal, pp. 225–246. ——(ed.) (1991d) Strategic Partnerships and the World Economy,Pinter, London. ——‘Changements technologiques et nouvelles formes de la concurrence dans l’industrie textile et de l’habillement’, Economie Prospective Internationale, No. 31, troisiém trimestre, pp. 5–28. ——(1985) ‘Stimulating effective technology transfer: the case of textiles on Africa’, in N.Rosenberg and C.Frischtak (eds) International Technology Transfer,Praeger, New York. ——(1979) Regional Development in a Global Economy: The Multinational Corporation, Technology and Andean Integration, Yale University Press, New Haven. (1978) ‘Licensing and technological dependence in the Andean group’, WorldDevelopment, No. 6. Nelson, R. (ed.) (1993) National Innovation System,Oxford University Press, Oxford. ——(1990a) ‘Acquiring technological capabilities’, in H. Soesastro and M. Pangestu (eds) Technological Change in the Asia-Pacific Economy,Allen and Unwin, Sydney. (1990b) ‘Capitalism as an engine of progress’, Research Policy,Vol. 19, pp. 193–214. Nelson, R. and Sidney Winter (1982) An Evolutionary Theory of Economic Change, Belknap Press, Cambridge, MA.

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Nelson, R. and H.Pack (1995) ‘The Asian growth miracle and modern growth theory’, School of International and Public Affairs, Columbia University, December. Odagiri, H. and A.Goto (1993) ‘The Japanese System of Innovation: Past, Present and Future’, in Nelson (ed.) (1993). OECD (1992) Technology and the Economy: The Key Relationships,OECD, Paris. ——(1989), Biotechnologie: Effets economiques et autres repercussions,OECD, Paris. Ohmae, K. (1991) The Borderless World: Power and Strategy in the InterlinkedEconomy,New York: Harper. Ozawa, T. (1980) ‘Government control over technology acquisition and firms’ entry into new sectors’, Cambridge Journal of Economics, No. 4, pp. 133–146. Pack, H. (1987) Productivity, Technology and Industrial Development: A Case Studyin Textiles, Oxford University Press, Oxford. Pearce, R. (1990) The Internationalization of Research and Development by Multinational Enterprises,Macmillan, London. Perez, C. (1990) ‘Electronics and development in Venezuela: a user-oriented strategy and its policy implications’, Technical Paper No. 25, OECD Development Centre, Paris. Perrin, J. (1980) ‘Consulting engineering—a new form of technological dependence in developing countries’, in D.Ernst (ed.) The New International Division ofLabour, Technology and Under development,Campus, Frankfurt and New York. Polyani, K. (1944) The Great Transformation, Beacon Press, Boston. Porter, M. (1990) The Competitive Advantage of Nations,Macmillan, London. Rodrik, D. (1994) ‘King Kong Meets Godzilla: The World Bank and the East Asian Miracle’, CEPR Working Paper No. 944 , April. Romer, P. (1992) ‘Two strategies for economic development: using ideas and producing ideas’, Proceedings of the World Bank Annual Conference on DevelopmentEconomics. Rosenberg, N. (1976) Perspectives on Technology,Cambridge University Press, Cambridge. ——(1972) ‘Factors affecting the diffusion of technology’, Explorations in EconomicHistory,Fall. Saito, M. (1975) ‘Introduction of foreign technology in the industrialization process: Japanese experience since the Meiji restoration (1968)’, in The Developing Economies,Vol. 12, No. 2, pp. 168–186. San Gee (1990) The Status and an Evaluation of the Electronics Industry in Taiwan,Technical Paper No. 29, OECD Development Centre, Paris. Sercovich, F. and M.Leopold (1991) Developing Countries and the New Biotechnology.Market entry and industrial policy, UNIDO, Vienna. Singleton, J. (1997) The World Textile Industry,Routledge, London. Smith, B. and J.Jordan (1990) Transformation and technology transfer’, in H. Soesastro and M.Pangestu (eds) Technological Change in the Asia-PacificEconomy,Allen and Unwin, Sydney. Smitka, M.J. (1991) Competitive Ties. Subcontracting in the Japanese AutomotiveIndustry, Columbia University Press, New York. Stewart, F. (1979) ‘International Technology Transfer: Issues and Policy Options’, World Bank Staff Working Paper No. 344, July. Stiglitz, J.E. (1987) ‘Learning to learn, localized learning and technological progress’, in P.Dasgupta and P.Stoneman (eds) Economic Policy and TechnologicalPerformance, Cambridge University Press, Cambridge. Stoneman, P. (1983) The Economic Analysis of Technological Change.

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2 Export success and technological capability

Textiles and electronics in Taiwan Province of China San Gee and Wen-jeng Kuo

I INTRODUCTION Over the last decades, Taiwan Province of China successfully transformed itself from an agricultural-based economy into an industrial economy. The average annual growth rate of industrial production reached 11.7 per cent between 1951 and 1991, greatly helped by strong export performance. Due to the limited size of the domestic market and the lack of natural resources, the only way for Taiwanese industries to capture the benefits of economies of scale and to pay for needed material inputs and machinery was to link up with the international market, using its comparative advantage of a relatively rich and skilled labour force to engage in exporting processed manufactured goods. Trade policy reforms in the late 1950s and early 1960s, forcing Taiwan Province of China towards an export-oriented regime, proved to be critical for success. The average ratio of exports to GNP rose from 20.4 per cent between 1961 and 1970 to 46.4 per cent over the years 1971–1980, peaking at 53.5 per cent from 1981 to 1990 and declining to 46.1 per cent from 1991 to 1994 (UNCTAD: 1996, p. 110). Total trade value rose from $303 million in 1952 to over $139 billion in 1991, with an average annual growth rate of 17 per cent at current prices. Taiwan Province of China ranked fifteenth in the world for total trade value in 1990, and eleventh and sixteenth for exports and imports respectively. Furthermore, it has enjoyed continuous trade surpluses since 1976, which were well over $10 billion for seven consecutive years before coming down to $9.5 billion in 1992. Over the years 1975 to 1994, the structure of exports from Taiwan Province of China changed drastically. Textiles, clothing and footwear which accounted for 38.9 per cent of the total non-oil exports in 1975 fell to 19.4 per cent in 1994, while exports of electrical machinery rose from 5.1 per cent to 15.1 per cent and computer and office equipment from 1.6 per cent to 13.5 per cent over the same period (UNCTAD: 1996, 118). The successful Taiwanese experience with export promotion strategies has been well-documented. However, very few studies have addressed the relationship between the incentive system and the behaviour of firms in

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building up technological capabilities during the entire period. This study examines this issue for two major exporting industries—textiles and electronics. This chapter consists of three sections. Section I examines the macroenvironment as well as various important government incentive systems in Taiwan Province of China which are relevant to the development of its textile and electronics industries. Section II explores possible factors that are critical to successful export performance and the building of technological capability. Section III highlights the current challenges faced by the textile and electronics industries and possible responses in the coming years. II THE INCENTIVE SYSTEM AND THE DEVELOPMENT OF THETAIWANESE TEXTILE AND ELECTRONICS INDUSTRIES Historical background Taiwan Province of China was under Japanese colonial rule for 50 years from 1895 to 1945, when it was developed as a base for providing foodstuffs for Japan. Although politically repressive, the Japanese did lay the foundation for the island’s economic development. However, during World War II, much of the island’s infrastructure was seriously damaged by United States bombing before its return to China in 1945. In 1949, after the nationalist government led by the KMT was defeated by the communists and retreated from mainland China to Taiwan Province of China, the sudden influx of 1.6 million civilians and army personnel put a severe strain on resources and drove prices up. The chaotic economic situation and the military threat from the communists put the island in a very vulnerable position. However, the eruption of the Korean War brought United States aid that helped to stabilize Taiwan Province of China both politically and economically. United States aid played a major role in the 1950s in rebuilding infrastructure, containing the inflation caused by the shortage of foodstuffs, and providing needed foreign exchange for the importation of machinery and materials that were essential to the development of various industries. With the support and guidance provided by the United States government, the nationalist government undertook various major development programmes. The first to be implemented were the land reform programmes that included the reduction of farm rents in 1949, the leasing and selling of public farmland in 1951, and the land-to-thetiller programme in 1953 (Li: 1988, p. 61). Because the KMT had no ties with local landlords and was eager to redeem itself after the defeat in mainland China, caused partly by rebellious poor farmers, the government was determined to push ahead with land reform programmes, the results of which were relatively successful. In addition, the establishment of the Chinese-American Joint

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Commission on Rural Reconstruction (JCRR) in 1948 helped to channel significant United States aid and technology into the Taiwanese agricultural sector, where productivity grew rapidly and produced a surplus for the country’s economic development and industrialization (Lee: 1971). With regard to industrial development, the original objective was to recover the production capability of various industries taken over from the Japanese during the early reconstruction period. With United States aid, the government launched its first four-year economic development plan in 1953. The first three priority industries to be promoted under the plan were electric power generation, fertilizers and textiles to meet domestic demand (Du: 1970, p. 4). Most of the major industries such as chemicals, cement, fertilizers, petroleum refining, pulp and paper, and metallurgy were controlled by the government, and accounted for more than 50 per cent of total industrial production (Ranis: 1979, p. 212). The late 1950s and the early 1960s marked a significant shift in policy away from import substitution towards export promotion. The main driving force was the need to earn foreign exchange for the importation of capital equipment and materials. The Taiwanese realized that continuous import substitution was no longer sustainable and that ways would have to be found to earn foreign exchange. This resulted in a series of economic reforms to create an environment which would encourage the growth of investment and exports. The reform programmes included, most notably, the unification of the multiple exchange rates, devaluation of the NT dollar, tariff reductions on imported inputs, tariff rebates for capital goods and materials used in the production of exported products, liberalization of controls over foreign exchange and trade and encouragement of savings and investment. The government also established the Industrial Development and Investment Centre to facilitate and attract foreign direct investment. Although Taiwan Province of China was developing an export promotion strategy, it was by no means a free trade economy. Domestic industries were still heavily protected by high tariffs and various import control programmes. Import substitution was still emphasized in the electronics and machinery industries through local content requirements and various subsidy programmes (Du: 1970, p. 5). Over the years, the Taiwanese government did not adopt a hands-off approach in the industrialization process, but intervened quite frequently to guide and shape the development pattern. The pros and cons of various types of government intervention are controversial. For example, the heavily protective measures in the automobile industry proved to be disastrous, whereas successful interventions are to be found in the textile and electronics industries (Kuo: 1987). The essence of the Taiwanese development policies can best be described as a consistent and irrevocable movement towards greater market orientation, a trend which depoliticized the economic system and channelled creative energies into market-oriented activities. A freer market was slowly constructed through changes in policy focus. The move toward export promotion in the early 1960s and the initiation of a technology-oriented phase in the late 1970s and 1980s

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were both the result of pragmatic problem-solving policy moves that did not adhere entirely to either free market ideology or government interventionist beliefs. The macroeconomic environment and the incentive system In the area of macroeconomic management, the most important factors are prudent monetary policies and fiscal restraints. The judicious control of money supply growth and the maintenance of high deposit and lending market interest rates were instrumental in keeping prices stable and encouraging private savings. Similarly, the fiscal policy of maintaining a balanced budget throughout these years helped to prevent excessive demand in the economy and the bidding of resources away from the private sector. Unlike other developing countries, where rampant inflation and massive budget deficits destabilized their economies, the prudent Taiwanese monetary and fiscal policies created a stable environment for private economic activities. Second, the successful agricultural development programmes were also conducive to the island’s export drive and economic development. The highly productive agricultural sector not only provided abundant and cheap foodstuffs for the growing industrial sector in the cities, but agricultural surpluses were good sources of capital for the industrial sector. Third, labour laws and manpower programmes also made a significant contribution to the successful industrialization process. In the past, labour legislation prohibited union activities and strikes. Although critics resented the lack of labour rights, workers were obliged to work hard for more income rather than relying on collective bargaining. This might have helped to shape proper work ethics and enhanced greater labour productivity and efficiency. However, no restrictions were placed on labour mobility, and workers were free to search for better jobs and for better pay without being bound by contracts. This legal environment, together with a buoyant demand for workers, led to high labour turnover rates and meant that employers had to manage their enterprises efficiently and provide decent wages and benefits to retain their workers. This balance of power between entrepreneurs and workers helped maintain a harmonious working relationship on the island and built up confidence among investors. In addition, compulsory elementary education and the existence of many public and private vocational training schools also encouraged the development of labour skills and productivity, which in turn provided a further strong incentive to investors. Fourth, the government adopted aggressive programmes to encourage investment by domestic and foreign entrepreneurs. The Statute for Investment by Foreign Nationals was first promulgated on 14 July 1954 to attract foreign companies and was followed by the Statute for Investment by Overseas Chinese in November 1955 which was aimed at tapping the experiences of established overseas Chinese. Finally, the Statute for Encouragement of Investment was

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enacted in September 1960 to encourage investment and accelerate economic development. These statutes provided various kinds of generous tax benefits and laid down rules to facilitate the acquisition of land for industrial use by investors. Some important characteristics of these programmes are worth mentioning. First, no limits were set on the number of firms within each industry group, with the exception of a few mining and utility industries. Anyone could invest and enjoy the same tax and other privileges if they complied with the regulations. This open policy was conducive to the rapid growth of those industries that suited the comparative advantages of Taiwan Province of China. Second, there was no discrimination against smaller-sized firms and any firm, irrespective of size, could participate and was treated equally. This neutral policy was an important foundation for the development of small and medium-sized enterprises (SMEs). The successful development of SMEs contributed substantially to the country’s economic development and export expansion. Third, virtually equal treatment was granted to domestic and foreign investment, with the exception of some majority share-holding regulations applicable to foreign firms and strict foreign exchange control regulations governing domestic firms. This balanced policy attracted foreign investment without hindering domestic investment, and made it easier to generate horizontal and vertical linkage effects. Finally, a series of concerted trade promotion policies were instrumental in the island’s successful export drive. From 1958 to 1961, major policy reforms unified the multiple exchange rate system adopted during the import substitution phase of economic development and the overvalued NT dollar was sharply depreciated against the United States dollar. This was an important step towards making Taiwanese goods competitive on the world market. At the same time, the tight import controls were gradually relaxed to facilitate the importation of capital goods and materials. Various kinds of tax incentives were granted to exporters, including the rebate of customs duties, defence surtaxes, harbour duties and commodity taxes on imported materials, exemption from business and related stamp taxes, deduction of 2 per cent of total annual export earnings from taxable income and a 10 per cent tax reduction for manufacturing, mining or handicrafts businesses that exported more than 50 per cent of their output. Moreover, exports were greatly enhanced by the creation of tax- and duty-free export processing zones (EPZs) from 1966. The EPZs were set up to encourage investment in the processing and assembly of labour-intensive products such as textiles, garments, electrical and electronic products, etc. The Export Processing Zone Administration had the authority to represent all the relevant government agencies, which greatly simplified registration procedures, import and export licensing and foreign exchange transactions. Other innovations such as the constant revision of the tariff structure to make room for backward and forward linkages, and the setting up of the Export and Import Bank to provide long-term financing for investment were also helpful to Taiwanese export success. In recent years, however, there have been sharp changes in the policy environment and the incentive system. Following the steep appreciation of the

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NT dollar, severe labour shortages, rapidly rising wage rates, escalating land prices, and growing environmental protection and labour issues, Taiwan Province of China has lost its comparative advantage in labourintensive manufactured products. Severe competition from many other developing countries in Asia and Latin America, as well as the growing protectionist sentiment in the developed countries, have made the situation even worse. There have also been some major changes in the policy framework. Export promotion policies are no longer tolerated by Taiwan Province of China’s trading partners after the huge trade surpluses of the past ten years and the country is now moving toward a more liberalized trading economy, with many of its previous policies being suspended or revised. For example, the Statute of Encouragement of Investment was repealed in 1990 and replaced by the Statute of Industrial Upgrading, which takes a more neutral stand on resource allocation and removes many tax breaks. The export financing scheme was terminated in 1989 and privileges for exporters related to foreign exchange holdings have been discontinued since the liberalization of the foreign exchange market in 1987; the exchange rate of the NT dollar has been allowed to appreciate about 40 per cent in recent years, and labourers have been given the right to go on strike and awarded many new benefits since the promulgation of Labour Standards Law. All these changes indicate that firms must introduce severe structural changes and rely even more on improving their technologies through research and development efforts if they are to maintain their competitiveness in the international market. The development and status of the Taiwanese textile industry The development of the Taiwanese textile industry goes back more than forty years. Before the nationalist government moved from mainland China to Taiwan Province of China, there were only 14 textile mills with fewer than 1,000 weaving machines on the island. Total production capacity for grey cloth in the mid-1940s was as low as 2 million yards per year. To meet domestic demand, most of the clothes and textile-related products were imported from the coastal provinces of mainland China. After the mainland fell into the hands of the communists in 1949, domestic textile demand had to be met by imports from Japan which imposed a major financial burden on the fragile domestic economy. To conserve precious foreign exchange reserves and promote the development of the domestic textile industry, the government adopted import substitution policies by restricting the import of textile products and offering various types of assistance to encourage investment by local entrepreneurs. As a result, investments in the textile sector soared and, in 1954, local production capacity fully met domestic demand. Indeed, under the import substitution policies which offered guaranteed profit to investors, the major firms quickly turned from insufficient supply to oversupply. The factory utilization rates as reported by

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Liang and Liang (1981) for synthetic fabrics, woollen yarn and sewing machines were as low as 49.7 per cent, 52.6 per cent and 64.3 per cent, respectively. However, instead of relaxing the protective measures and removing various distorted incentives, the government in fact regulated and restricted investment in the textile industry from 1958 to 1959. Fortunately, it soon realized the inappropriateness of these policies and, following the adoption of a single exchange rate system, a new era of export promotion emerged which revitalized the development of the textile industry. Domestic economic conditions together with the international environment were all extremely favourable to the development of the textile industry in the 1960s and 1970s. This was largely because, at that time, the United States market was still wide open for foreign imports and provided excellent opportunities for Taiwanese textile firms. Domestically, the good quality and relatively low-cost labour force, along with the experienced textile entrepreneurs who had fled from mainland China in 1949, constituted a very strong base for Taiwanese industry. Thus, textiles became the island’s largest export item from the late 1960s. The textile industry has played a critical role in Taiwanese economic development. Table 2.1 shows the export value of textiles and textile products and their share in total export value, which increased from $20.7 million in 1960 to $1.6 billion in 1975, $6.3 billion in 1985 and $12 billion in 1991. The industry’s share in total exports increased from 12.7 per cent in 1960 to 29.3 per cent in 1975, and then decreased to 20.4 per cent in 1985 and 15.7 per cent in 1991. Until the early 1980s, textiles remained the island’s number one export item. Because of its rapid expansion, the textile industry also had the largest share of employment among all industries in the manufacturing sector. It not only helped resolve the rural unemployment problem in the 1950s, but brought in foreign exchange reserves which, in turn, facilitated industrialization. The development of the textile industry has not, however, been smooth and challenges have arisen at various stages. In the early 1960s, the main obstacle was the imposition of quantitative restrictions on textile exports by the United States in 1961. Furthermore, in 1965, United States aid to Taiwan Province of China was cut off, adversely affecting the dominant cotton spinning and weaving sector of the industry, which was still heavily dependent on low-cost capital from United States aid. To cope with this external shock, as Chen (1991) points out, two major adjustments were adopted in the 1960s: investment in the man-made fibre industry and the development of the apparel industry. The 1960s saw important structural changes in the world’s fibre industry, with many new technologies being developed to replace natural textile fibres with synthetic ones. This opened a new door for Taiwan Province of China. As many downstreamers began to invest in the production of man-made fibre in the late 1960s, an industrial backward linkage effect was created. At the same time, the industry pursued forward linkage strategies through the development of the apparel industry. Undoubtedly one way to circumvent the losses incurred by

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Table 2.1 Textile exports (value and share in total exports: US$ millions)

Source: The Trade of China (Taiwan District), Statistical Department, InspectorateGeneral of Customs, Ministry of Finance, ROC. Note: 1985–1988 textile statistics are based on the Standard International Trade Classification (SITC) while those of 1989–1991 are based on the Harmonized System (HS).

Taiwanese entrepreneurs following the imposition of the United States quota was to produce higher-priced products. The relative abundance of quality manpower made the development of the apparel industry an ideal selection and the apparel industry (together with fabrics) soon became one of the largest sectors of the textile industry.

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The 1970s continued to be a challenging decade. One of the direct effects of the first oil crisis in 1973 was to push up the import and production costs of chemical materials such as ethylene glycol, pure terephthalic acid, dimethyl terephthalate and acrylonitrile, etc., which were needed for the production of man-made fibres, thus considerably weakening the competitiveness of the country’s man-made fibre industry. The first oil shock in the early 1970s served as a caution to development strategies for man-made fibres. At that time, many key policy makers, concerned that Taiwan Province of China was primarily an oil-importing country, thought it inappropriate for too much emphasis to be placed on the development of the petroleum-based, man-made fibre industry. However, private entrepreneurs took a different view. They were much more optimistic about future prospects for man-made fibre and were determined to develop new and more energy efficient technologies to produce man-made fibre. Consequently, despite the adoption by the government of policies which would have restricted the expansion of the man-made fibre industry, many private companies continued their investment projects to enhance production and technological capability. This bold but determined decision by private entrepreneurs proved to be one of the most important factors in enhancing the industry’s leading global role. Other than the second oil shock of the early 1980s, the most challenging issues in the 1980s were twofold. First, rising labour costs due mainly to the shortage of skilled labour and the promulgation of the Labour Standards Law (LSL) in 1984 seriously weakened the Taiwanese apparel industry. Many garment and knitting firms either had to close their operations or move abroad. Continuous upgrading and the internationalization of operations seemed to be the main strategy option for the apparel industry. Second, the industry as a whole had to react promptly to the growing economic ties between mainland China and Taiwan Province of China when the latter began allowing citizens to visit relatives in 1987. Table 2.2 shows the export value of the industry’s major products and corresponding export share from 1986 to 1991. Apparel and textile accessories were the largest export items up to 1989, when they were overtaken by yarns and fabrics. In 1991, fabrics alone accounted for 44.09 per cent of total textile exports, substantially more than that of the sum of apparel and accessories. There are two major reasons for the rapid growth of the Taiwanese fabrics industry. First, the major fabric mills introduced advanced machinery such as water-jet looms (WJL) and air-jet looms (AJL) and achieved economies of scale in production. Table 2.3 shows that in 1988, Taiwan Province of China ranked next to Japan and the United States in the installation of WJL and AJL equipment. Second, due to the lessening tension between Taiwan Province of China and mainland China, the indirect trade in fabrics has grown rapidly. According to a study by the Bank of Taiwan Province of China, roughly 60 to 70 per cent of the island’s blended cloth is exported to mainland China. Meanwhile, the export share of apparel production fell rapidly from 38.07 per cent in 1989 to 29.32 per cent in 1991, primarily due to rising labour costs.

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Table 2.2 Value of textile exports by product (US$ millions)

Source: Taiwan Textile Federation Table 2.3 Installation of water-jet looms (WJL) and air-jet looms (AJL) in major countries (thousands of sets)

Source: Handbook of Japanese Chemical Fiber 1989, Japanese Chemical Fiber Association

Most of the indirect trade between mainland China and Taiwan Province of China goes through Hong Kong. Table 2.4, which lists major Taiwanese textile export markets, shows that, after the government allowed businesses to engage in indirect trade with mainland China in 1987, textile exports to Hong Kong tripled. Hong Kong’s share in Taiwanese total exports also increased from 15.7 per cent in 1986 to 29.7 per cent in 1991, making it the largest export market. The United States market share diminished rapidly from 36.8 per cent in 1986 to 24.6 per cent in 1991, following the appreciation of the NT dollar and the rising tide of protectionism in the United States.

Source: Taiwan Textile Federation

Table 2.4 Major textile export markets (US$ millions)

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Source: Taiwan Man-Made Fibre Association

Table 2.5 Man-made fibre capacity in 1989 and 1991 (tons per day)

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The other important structural change in the textile industry is the growing role of man-made fibres. In 1989, Taiwan Province of China became the world’s second-largest man-made fibre producer after the United States (see Table 2.5). Of the major man-made fibres, polyester is undoubtedly the most important. In 1991, daily polyester production capacity reached 2,386 tons for polyester filament and 2,214 tons for polyester staple, ranking number one and number two, respectively, in the world. One of the key factors in the rapid development of the Taiwanese man-made fibre industry was the strong derived demand by downstream textile mills. Many of the major man-made fibre manufacturers have attracted investments from downstream sources, indicating a clear backward linkage development trend from downstream to midstream. The major driving force for such a backward linkage effect was the strong competitiveness of the downstream industry in the 1960s and 1970s which enabled enterprises to generate enough capital to support a more technology- and capital-intensive backward linkage. Two additional factors were also critical to the development of the manmade fibre industry. First, as noted above, was the major production technology breakthrough for polyester from the mid-1960s to the 1970s, with the production of polyester through PTA (pure terephthalic acid), which is much cheaper than dimethyl terephthalate (DMT) production. In 1976, Japan’s annual polyester production capacity (through DMT) had already reached 500,000 tons, whereas Taiwanese annual production capacity (through DMT) was only about 50,000 tons. Japanese polyester manufacturers were reluctant to adopt new technology and still sceptical about the quality of polyester made through the low-cost PTA method. This provided an excellent opportunity for Taiwanese polyester manufacturers, who soon replaced DMT-type production processes with the latest PTA technology, enabling Taiwan Province of China to replace Japan as the major polyester supplier in the South-East Asian market. Second, as polyester production burgeoned in the late 1970s, Taiwan Province of China began to establish upstream PTA and ethylene glycol (EG) production plants, thus completing the entire backward linkage mechanism from downstream (apparel and accessories) to midstream (man-made fibre) and upstream (PTA, EG). Today, domestic upstream suppliers are able to supply more than 50 per cent of the required PTA and EG to midstream polyester manufacturers (the remainder is imported from abroad with tariff rates as low as 3 per cent). This not only provides a strong base for the development of the industry but enhances its overall competitiveness in the international market. In short, three stages can be discerned in the development of the textile industry: • Stage 1 (from the early 1960s to the mid-1970s): The flourishing of downstream industry. During this stage, garment and accessory firms fully capitalized on the island’s labour advantage as well as the openness of the

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United States market. This led to the establishment of a strong export-oriented industry which provided critical international experience and a strong financial capability for further development. • Stage 2 (from the early 1970s to the present): The creation of mid-stream industry. Technological change played a critical role in providing Taiwan Province of China with the opportunity to become a major global polyester producer. Strong downstream demand provided enough of a market for the midstreamers to reach a very large scale of production which, in turn, consolidated Taiwanese competitiveness in the man-made fibre market. • Stage 3 (from the late 1970s to the present): The production of upstream PTA. In the light of the growing demand for PTA, as Taiwan Province of China rapidly became the world’s major polyester producer, the first upstream PTA production plant was established in 1979, with a total annual production capability of 750,000 tons. Other major investment plans for PTA production are underway which will make the island the world’s largest PTA producer. The Taiwanese textile industry’s development experience has clearly shown that it fully capitalized on domestic factor endowments and coped well with both the international environment and technological changes. Although the textile industry played a very important role in the industrial development of Taiwan Province of China, the ratio of the industry’s exports to total exports did, however, gradually fall from 36.5 per cent in 1971 to 15.2 per cent in 1991. In contrast, the electronics industry’s export share rose from a small 6.2 per cent in 1967 to 20.6 per cent in 1986 to 26.6 per cent in 1991. In 1986 the electronics industry export share exceeded that of the textile industry and became the island’s largest exporting industry. The development and status of the Taiwanese electronics industry In the early 1950s, the emphasis placed on the electric power industry led to the emergence of some electrical machinery producers in related fields. For example, Pacific Electric Wire and Cable Co., Tatung, and Teco introduced Japanese technologies to produce wire and cables, motors, transformers, power switches, etc. for domestic consumption. Shortly after, several electrical household appliances such as electric fans, refrigerators, washing machines, and air-conditioners were also introduced successively under the import-substitution scheme. Tatung was again one of the major producers. The foundation of the electronics industry was thus established during this learning process. In the early 1960s, several electronics products such as transistor radios, black and white televisions and cassette recorders began to be manufactured in Taiwan Province of China, but only on a limited scale for domestic consumption. It was only with the arrival of several foreign multinational electronics firms in the late 1960s that the electronics industry began to expand at full speed. Of these

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companies, General Instrument, RCA, Admiral, and Zenith from the United States and Philips from the Netherlands were instrumental during the early 1970s in opening up opportunities for the electronics industry. General Instrument was the first to invest in Taiwan Province of China in 1964 and brought in many kinds of electronic components for domestic use and export. In 1974, RCA was the top Taiwanese exporter, with exports valued at US$100 million, followed by Admiral (US$69.9 million), and Zenith ranked fourth with US$41.7 million. Philips also contributed significantly, with exports of US$32.5 million in 1973, in addition to a large quantity of picture tubes and many kinds of electronics parts and components supplied to other electronics firms for indirect export. Attracted by the successful experience of these multinationals, many other foreign firms came to produce various kinds of new products. For example, electronic calculators were introduced in 1972 and electronic digital watches in 1975, as well as a wide range of electronics parts and components (Djang: 1977, pp. 69–73). There are several issues which deserve close attention in this connection. The first is that there is no clear-cut distinction in the electronics industry between an import substitution phase and an export promotion phase. Even though the export of electronics products speeded up in the early 1970s, the domestic market was still heavily protected through high import tariffs. Whether protection was necessary for the development of local electronics firms is controversial. However, the protection of consumer electronics did force Japanese firms into setting up joint ventures with local entrepreneurs and transferring technologies to local firms which helped expand their exporting capabilities. Tatung is an example of a company that benefited greatly from technology transfers by Toshiba whose goal was to capture the growing Taiwanese electronics market indirectly by providing key components to Tatung. In the mid-1970s, Toshiba helped Tatung to take OEM orders from Sears of the United States and Tatung finally became one of the largest television exporters in Taiwan Province of China. The second issue is the role of the local content requirement. In 1962, the local content requirement was put into effect for the production of various electronics products for domestic consumption in reaction to the low valueadded ratios for those products and the huge foreign exchange losses to the Japanese component suppliers. A minimum of 40 per cent local content was now required for products for domestic consumption, whereas products for export were exempted from this rule. Whether this regulation helped to strengthen the electronics components industry is again debatable since General Instrument, Philips, and hundreds of other foreign firms invested in various kinds of exportoriented electronics components without any links to import-substituting products. However, it may still be argued that the local content requirement, which basically affected Japanese firms, did help local firms such as Tatung, Teco, Taiwan National, and various other Japanese joint ventures to build up supplier networks, sometimes called centre-satellite networks, that strengthened

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the production capabilities of these companies, especially during the early development stage. The third issue is that the technologies acquired by Taiwanese electronics firms were at first focused largely on production technologies, and in particular on assembly technologies. Products were brought in by foreign multinationals or joint venture partners, with production processes and machinery being specified by foreign engineers (Keesing: 1983). There was almost no product design or process engineering during the early period. However, significant linkage effects were generated through the large number of new entrants spun off from the existing firms and which used the same assembly techniques to manufacture the same products. For example, eleven local companies were founded by former employees of General Instrument Corporation’s Taiwanese subsidiary which competed with the latter (Business Week: 3 March 1986, p. 62). The friendly investment environment provided by the non-discriminatory Investment Promotion Law also helped generate horizontal linkages. The rapidly growing number of new players in the market attracted many foreign buyers who were eager to source from cheaper places and were willing to help electronics firms meet their quality standards and specifications. Taiwanese electronics firms benefited greatly from these new opportunities and gradually learned to design different products for different customers. They also gained useful technical assistance from many machinery or materials suppliers. However, the growth path of the electronics industry was never a smooth one. Electronics firms have not only had to face constant challenges from numerous newcomers which often drove profit margins down, but they were confronted with formidable opponents from South Korea, led by Samsung and Lucky Goldstar. The giant Korean conglomerates constantly took markets away from Taiwanese firms with their capability of exploiting economies of scale and their access to low-cost financing. From transistor radios to black and white televisions, and from black and white televisions to colour televisions, Korean firms took over once the products reached maturity and became standardized. This repeated experience pushed domestic electronics firms into diversification and a constant search for new products in order to survive. To stay one step ahead of the Koreans has long been the conscious strategy of electronics firms in Taiwan Province of China. Serious efforts have also been made by Taiwanese firms to diversify market outlets and serve customers of different sizes within a short period of time.1 In the wake of stiff challenges from the Korean conglomerates, a series of massive structural changes were made in the Taiwanese electronics industry from the early 1980s. The share of household appliances and electronics products in the electronics industry total fell from 12.2 per cent in 1982 to 9.6 per cent in 1991. On the other hand, in the case of electronics parts and components, advanced integrated circuits and other computer-related parts replaced low valueadded semiconductors, with the share increasing from 29 per cent in 1982 to 30.1 per cent in 1991, making this the largest branch in the electrical industry. The

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Table 2.6 Information industry in perspective (US$ millions)

Source: Market Intelligence Centre (MIC) of the Institute for Information Industry (III) in Taiwan Province of China

most dynamic sector in the electronics industry over the past ten years has been that of computers, where the share rose from 2.7 per cent in 1982 to 23.9 per cent in 1991. Table 2.6 shows some achievements of the Taiwanese computer industry until 1991. Both the total production value and total export value grew more than 200 per cent over the past five years, while the GNP share of computer production increased from 2.7 per cent in 1986 to 3.9 per cent in 1991, with the export share of computer products rising from 5.2 per cent to 8.9 per cent during the same period. The share of computer products in the world market also increased rapidly from 1.5 per cent in 1986 to 3.1 per cent in 1991. Table 2.7 illustrates the ten major computer products in Taiwan Province of China and their world market shares in 1990. The mouse leads the way with a 72 per cent share, followed by PC system boards with 66 per cent. Colour monitors, keyboards and scanners have also captured significant shares in the world market. North America and Western Europe are the two major markets for Taiwan’s computer exports, consistently absorbing close to 80 per cent or more of production. Table 2.8 shows the market structure of computer exports. The share of brandname products increased from 20 per cent in 1987 to 35 per cent in 1991, when the share of OEM production also rose by 4 per cent. On the other hand, the share for foreign subsidiaries dropped sharply from 39 per cent in 1987 to only 20 per cent in 1991, indicating that the Taiwanese computer industry has gradually established its own design and marketing capabilities, although it is still heavily dependent on OEM production. However, the recent performance of microcomputers and monitors reveals that the share of brand-name exports of microcomputers and monitors declined significantly in 1992. On the other hand, OEM production once again became the most important market source for these two products. The chaotic restructuring of the computer market in the United States and the economic slowdown in Europe appear to be the main

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Table 2.7 Ten leading information products in 1991 and their share in the world market

Source: MIC/III Table 2.8 Exports of computer hardware by type of production arrangement, 1987–1991 (%)

Source: MIC/III

reasons behind this somewhat unsatisfactory performance. OEM seems a reasonable response to the price-cutting competitive strategy adopted by the leading PC manufacturers and the slowdown of the global economy to maintain a high capacity utilization rate and achieve economies of scale. In conclusion, the computer industry in Taiwan Province of China has grown exceedingly well over the past few years and has become the backbone of the electronics industry. This is due to the considerable efforts made by entrepreneurs in their losing battle in consumer electronics with the Korean conglomerates, accompanied by various government policies to promote the computer industry. However, growth relies heavily on the export market, and most of the momentum is generated by the hardware side. Although it will be very important for the island to maintain its export competitiveness for computer hardware products under the dramatically restructured market environment, it may also be increasingly necessary to put more emphasis on the future development of the computer software industry to support the long-term growth of the hardware sector.

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III FACTORS WHICH CONTRIBUTE TO EXPORT PERFORMANCE AND TECHNOLOGICAL CAPABILITY Based on firm interviews, the following section identifies critical factors for the successful export performance and improved technological capability in both industries. (For a description of the firms interviewed in this study, see Tables 2.9 and 2.10.) Factors which are common to both industries OEM production One of the most frequent common factors is the emphasis placed by firms on the importance of the original equipment manufacturing (OEM). More interestingly, the study also found that the importance of OEM is emphasized by both wellestablished large enterprises and newly established smaller firms. There are several important reasons for this. First, as pointed out by one leading personal computer manufacturing company (E.1), OEM is one of the most important mechanisms for maintaining a firm’s own production capability, without which firms fear that they might quickly lose their comparative advantage in production and have difficulty in producing competitive products under their own brand names. Second, another major electronics company (E.2) stressed that OEM can provide firms with a great deal of information and technical assistance from the order-placing company to ensure the product meets their quality standards.2 Consequently, the OEM practice itself can be an extremely fruitful learning process enabling the company to improve its own production engineering and to apply these production techniques to its own products. One of the garment companies interviewed (T.6), a major OEM raincoat supplier for a worldwide brand-name, said that OEM enables it to concentrate on production aspects rather than the rapid changes in fashion design—which is clearly a comparative advantage for the company. Personal connections Personal connections were found to be another important factor contributing to a firm’s export performance/technological capability. One interesting example concerned the founder of one of the major textile companies (T.3) who went abroad to study textile engineering in the 1950s. Several years later, he returned to start up his own knitting company. He met a classmate and learned that Japan had developed a new fibre which might be suitable for his product. He immediately contacted the Japanese manufacturer to obtain the material and put

Table 2.9 Background information on electronics firms interviewed

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Table 2.9 (Continued)

66 EXPORT SUCCESS: TAIWAN PROVINCE, CHINA

Table 2.10 Background information on textile firms interviewed

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68 EXPORT SUCCESS: TAIWAN PROVINCE, CHINA

all his efforts into developing the production process for this new fibre. This gave him a three-year lead in the market, long enough to build up a sound financial as well as technological base for further development. This case may be rather exceptional, but personal connections through classmates are no doubt a common and important channel of access to needed export opportunities as well as technologically relevant information. As pointed out by both an electronics firm (E.1) and a textile firm (T.1), a very fruitful information exchange network has been formed between former classmates in the United States on such matters as engineering, marketing and individual firm status, which is certainly very helpful for the management of firms. In the event of technical problems arising, firm E. 1 for instance prefers to contact former teachers or the classmates of staff rather than a commercial consultant or technology research institution. The same firm also pointed out that maintaining good relations with the company’s upstream key component suppliers is also critical to its export performance. This was particularly clear during the mid-1980s, when DRAMS were in short supply and when personal connections with major DRAM suppliers clearly made a difference in obtaining the needed memories. Overseas Chinese Another important factor in exports is building technological capabilities and facilitating overseas Chinese manpower. One example is that of an electronics company which specializes in microwave technology and produces satellite communication equipment (E.10), and which was established in 1983 by eight overseas Chinese engineers from the Silicon Valley in California. Using their experience in the United States, they started by designing and manufacturing a small line of microwave-integrated circuit products. Subsequently, the company went on to develop a whole line of high-quality thin-film microwave components, subsystems and systems. Two of the key factors in its success are the education and work experience in the United States of its founders. The company, now established in the Hsinchu Science Park not only promoted the development of the Taiwanese microwave technology industry and enabled the country to become one of the few in the world capable of manufacturing and exporting satelliterelated communication equipment, but has helped to train a large number of microwave engineers. The role of overseas Chinese in the enhancement of firms’ technological capabilities is not limited to ‘high-tech’ industries. Company T.6 in the textile industry hired pattern technicians from Hong Kong to improve the quality of its products. Overseas Chinese have also helped domestic firms set up marketing channels and networks abroad. One typical example is that of a Taiwanese textile company (T.3) which, together with an overseas Chinese partner in the United States, established a subsidiary company in the United States with a new Western-style brand name for its garment products. The United States subsidiary

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company places its OEM orders with its Taiwanese parent company for production, and the parent company delivers its products to the foreign subsidiary. All the marketing and promotion are handled by the foreign subsidiary under the Western brandname. In such cases, overseas Chinese clearly play a major role in promoting Taiwanese exports. Overseas Chinese also play an important role in supporting R&D activities in domestic firms. One electronics firm (E.2) said that it had established R&D centres in the United States and Japan. The main function of the United States centre was to undertake relevant research and technology scanning, while the centre in Japan concentrated on collecting information on component sourcing. In both cases, overseas Chinese have played a significant role. In Silicon Valley in California, overseas Chinese engineers are informally organized under the Jade-Mountain Scientific Technology Association (J-MSTA), the main functions of which are to: (1) give technical advice to Taiwanese firms; (2) provide overseas merger and acquisition information to Taiwanese firms; (3) exchange information and expertise in relevant fields for overseas Chinese engineers; and (4) offer job and investment opportunities for overseas Chinese engineers both in Taiwan Province of China and in the United States. Other examples can be found of self-organizing activities by overseas Chinese engineers who will undoubtedly continue to play an important role in promoting Taiwanese firms’ export performance and enhancing their technological capability. Foreign direct investments Foreign direct investment (FDI) (which includes investment of overseas Chinese) has also played an important role in fostering Taiwanese technological capability. Several electronics firms (E.1, E.6, E.7) emphasized that they have benefited considerably from FDI. In the 1960s and early 1970s, RCA, Philips and General Instrument brought in advanced managerial and production technology which was then extended to local enterprises through labour mobility. FDI has also helped train a large number of industrial engineers, who in turn have provided a sound base for the future development of industry. San Gee (1990) also reported that, on the basis of a large sample survey, 104 out of 318 electronics firms surveyed had high-level managers and engineers with work experience in foreign electronics firms. Of these, 42.6 per cent felt that their working experience with foreign firms was helpful for their management skills, 31.5 per cent said that it was useful for product design and development, and 29. 5 per cent that it enhanced their acquisition of market information. These results suggest that FDI can play a positive role in promoting domestic firms’ export performance and their technological capability.

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Family kinship Another important factor in the competitiveness of many Taiwanese firms is family kinship. Chairman of firm E.6 for example, was the eldest son in his family. After working for a travel agent as a tour guide for many years, he decided to change jobs. He registered for a government-sponsored computer training programme to learn more about programming and subsequently decided to invest in the computer-manufacturing business after his younger brother majored in computer science at university. His younger sister had taken a degree in business administration and he was thus able to combine his vast experience in tour-related sales and marketing with the technical expertise of his family members to set up a fully functioning computer-assembling company in 1983, which has now become one of the major PC exporters to, and investors in, the European market. Since most Taiwanese enterprises are SMEs, the power of family kinship is a common feature of both the electronics and textile industries. The above observation can also be made of some larger enterprises. For instance, large textile-related industrial groups such as T.4 and T.5, as well as large electronics companies such as E.2, are all characterized by strong family kinship ties. Liu and San (1988) have pointed out that many SMEs are family businesses, in the sense that firms established are not just owned by the establisher himself, but by the entire family. Family members all have a very high work incentive and the initial capital can be obtained from family savings at very low cost. Factors which are unique to the electronics industry Probably the most important success factor is an ability to upgrade and diversify the product-mix at short notice. Taiwan’s electronics industry has long been facing severe competition from large Korean conglomerates such as Samsung and Lucky Goldstar. Since Taiwanese wage levels used to be much higher than those in Korea, and because the SMEs could not usually achieve economies of scale or economies of scope, they were outcompeted by Korean firms once the products became standardized and mature. As a result, Taiwanese firms had to shift production constantly, first from transistor radios to black and white televisions, then to colour televisions, then to monochrome monitors and finally to colour monitors and personal computers. The experience gained in the process helped strengthen their capability to catch up with market trends and find market niches. For example, personal computer-makers have been quick to react to market trends and design-in new microprocessor generations. They were also quick to develop laptop and notebook computers and similar trends appeared in scanner production and export. Firms have moved quickly from desktop monochrome scanners to desktop colour scanners and handheld monochrome types, and began to produce handheld colour scanners in 1990. The development of fax machines from handset telephones also showed firms eager to explore new

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product areas. All our interviews confirmed that one important source of export competitiveness in the electronics industry is the ongoing ability of firms to improve product quality, find new market niches, and achieve a better product mix. The second factor is the broad-based and specialized input network which is constantly improving cost and quality. The benefits generated from specialized and cooperative input suppliers were mentioned by firms E.1, E.3 and E.6, which argued that products such as personal computers or monitors require hundreds of parts and components. A strong component industry is essential for providing quick delivery of low-cost quality components to downstream firms and critical for maintaining competitive edge. The unique character of the electronics components industry is that it is composed of many SMEs which must stay competitive in order to survive. To achieve an efficient scale, firms have become highly specialized and serve as many customers as possible. For example, TSMC specializes in foundry production and relies on various design houses to do 1C designs. Some plastic injection-moulding firms provide standard plastic parts for PC and monitor makers. Keyboard producers supply components to one another to utilize scale production and save costs. There are also specialized motherboard producers that can provide various kinds of boards to the specifications of different customers. Since component firms are highly specialized, they can accumulate skills and know-how from learning-by-doing and can thus achieve better economies of scale. Upstream firms work closely with downstream firms, and firms producing similar products cooperate with one another through the building-up of complementary relationships and the exchange of information and identification of market trends. The highly competitive and diversified structure of the electronics and computer industries has broadened the scope of the cooperative network and increased the competitive strength of firms. This cooperative network relationship also helps create an economic environment of low investment requirements in which Taiwanese computer firms are able easily to source needed components and do not have to produce everything themselves (Levy et al: 1987). The third factor is the abundant human capital, provided both by government education programmes and the reverse brain drain of recent years, supplying the country with many experienced engineers who know the markets and master the necessary technologies. Over the past 30 years, tens of thousands of well-trained college and vocational school graduates in electrical engineering have formed a strong workforce for the electronics industry. This highly-qualified labour force has also helped attract many FDI projects to Taiwan Province of China.3 At the same time, many graduates from the engineering departments of the top universities went abroad for graduate studies and stayed on afterwards in leading electronics firms in the United States. In recent years, however, partly as a result of the economic recession in the United States, and partly due to the promising future of the Taiwanese computer industry, many of these highly qualified engineers have returned. Some have gone to work for already-

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established computer firms, and others have started their own businesses.4 They have brought back with them knowledge about state-of-the-art technologies and valuable market information that have greatly improved local R&D capabilities and been instrumental in the development of new computer products. Contacts with Taiwanese engineers still working abroad have helped the industry link up with the global computer industry and enhanced its competitive power. This reverse brain drain, which is most noticeable in the computer industry, is a valuable asset to Taiwan Province of China.5 The fourth factor that has helped develop the Taiwanese electronics industry is the existence of the Industrial Technology Research Institute (ITRI), which has a close cooperative relationship with the Hsinchu Science-Based Industrial Park. The government had long been aware of the importance of R&D activities to economic development and industrial growth and in 1973 the ITRI was set up to conduct research on applied industrial technologies. Despite some controversy about the importance of technology transfer from the ITRI, it is commonly accepted that the ITRI has been the most important source of human capital for the electronics and computer industries over the past twenty years and an important source of technology, as well as product and equipment information.6 Even its failures have taught important lessons to firms and saved them a lot of time, effort and money by avoiding possible repetitions of the same mistakes. The role of the ITRI became increasingly important after September 1982 with the setting up of the nearby Hsinchu Science-Based Industrial Park. Most of the interviewed firms located in the Science Park said that they have frequent contact with the ITRI and firms E.1, E.3 and E.6 admitted that they had even lured away qualified and experienced engineers from the institute. The positive role played by the ITRI and the attractive incentives offered by the Science Park have prompted active investment in many computer product spheres which has helped the computer industry to become one of the most dynamic in the world. The fifth factor enhancing the competitiveness of the Taiwanese computer industry is the common use of strategic alliances in technology development and market arrangement. For instance, SUN wanted to establish its RISC architecture as a global standard and was willing to provide design tools to Tatung, which was also ready to establish a relationship with SUN to enable it to move into workstation production. This is a clear example of a strategic alliance between SUN and Tatung. A similar venture was the link-up between Acer and Texas Instruments for the manufacture of DRAMs. As Taiwan Province of China became the world’s major manufacturing base for personal computers, local demand for DRAMs had reached a high enough level to allow economies of scale in mass production. Acer was therefore willing to invest hundreds of millions of dollars to produce DRAMs. On the other hand, Texas Instruments could not only sell its rather mature DRAM production technology to Acer at a very good price, but could also establish a good production base in Asia which would enhance its customer-producer relationship. Clearly, the strategic alliance between Acer and Texas Instruments was mutually beneficial. Some strategic

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alliances have also been formed between domestic firms to develop products such as notebook computers. Such cooperation among local firms is likely to intensify in the future with the ongoing restructuring of the international computer market. Finally, an important strength of Taiwanese upstream computer firms is that they are able to link up with other consumer goods industries. For example, semiconductors and application ICs have been used widely in musical birthday cards, variable wind fans, air-conditioners with temperature control and sleep functions, toys, shoes, rice cookers, and many other products.7 These developments not only make traditional consumer products stronger, but feedback from the enlargement of the 1C market benefits the 1C industry itself as well. Factors which are unique to the textile industry The study identified several unique factors which are relevant to the textile industry’s export performance/technological capability. One of the common problems encountered by many of the interviewed firms was the lack of opportunity to engage in their own fashion design. Since the fashion industry is dominated by European designers, clearly there is no comparative advantage for local companies and so most of the garment firms in Taiwan Province of China concentrate solely on improvements in production engineering. However, there was one exceptional knitting exporting firm which has been able to transform itself from OEM to ODM (original design manufacturing). The owner of the company (T.2) began to work in a local knitting factory some twenty-seven years ago as a junior staff member. His nine-year association with the factory was followed by a period of eight years as marketing manager of another knitting factory. In 1981 he decided to set up his own knitting factory. In the early 1980s, the United States market accounted for roughly 70 per cent of his total exports; at that time it was a market of large volume and low prices which left very little room for product upgrade. One of the major drawbacks of the United States market was that, as the volume for a single order increased, so too did the risk borne by his company. In the late 1980s the company therefore redirected its marketing strategy towards the European market. The main strategy used by the company to penetrate the European market and to transform itself from OEM to ODM was to enhance its design capability. In 1973, the company set up a five-person design team, whose main task was to study European fashion trends. The design team is sent to Europe on a regular basis to obtain relevant fashion information. The company’s ODM products to total sales ratio increased from 12 per cent in the mid-1980s to 100 per cent in 1991 and ODM capability has clearly enhanced its comparative edge. The Taiwan Textile Federation (TTF), financed by a surtax of 0.125 per cent levied on every dollar of textile exports, has also launched a ‘Little Europe Plan’, the main purpose of which is to set up design centres in Milan and Paris and to

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give Federation members access to direct, firsthand information on fashion design trends in Europe. The centres also serve as an important channel for Taiwanese firms to understand and explore the European market; member firms can also send their own designers to these centres, thus reducing substantially the cost of training and information gathering. The TTF is an important non-profit, private organization. Although almost entirely privately funded and headed by a government-appointed official, its operations are supervised by representatives from the textile industry’s various sub-associations in such spheres as dyeing, garmentmaking, knitting, man-made fibres, etc. The TTF’s main functions include: (1) collecting information for the industry; (2) managing the quota distribution system; (3) providing and organizing industrial training; (4) compiling industrial statistical data and offering a library service; and (5) keeping member firms abreast of the latest technology and other industry-related information. The quota system is perhaps the most singular aspect of the textile industry. Each exporting firm owns a quota it has earned over the years and which it can sell to other local firms at negotiated prices. As the shortage of labour and soaring labour costs have become more serious, an intra-industrial division of labour has emerged with many Taiwanese textile firms moving their more labour-intensive segments of the production process to mainland China and then shipping back semi-finished products for final sewing, finishing and packaging. This not only enables these Taiwanese firms to make use of their quotas, but helps them to reduce their labour costs substantially and thus to remain competitive on the international market. Automation is one of the key factors enabling the industry to upgrade its technological capability. Although CAD machines have been introduced in some of the textile firms interviewed, the downstream textile industry is experiencing certain problems in fully automating production processes. One of the major strategies of Taiwanese downstream textile companies is to produce high value added products and thus small quantity and diversified styles have become the major characteristics of their production. A lack of economy of scale may actually limit a firm’s automation drive. The study identified another factor which is critical to the industry’s technological capability: in-service training. The owner of firm T.6 previously served as the chairman of the Taiwan Garment Association (TGA) which under his leadership established its own training centre for the industry. Interestingly, all the training costs of the programme are shared by the members of the Association, and the trained workers are then allocated to member firms in proportion to their contribution. In this way, firms are no longer forced to poach skilled workers. Technological cooperation with Japanese firms has been another important channel for the buildup of technological capability in the Taiwanese textile industry. Textile firm T.7 is a typical example. It was established about thirty years ago, when its main business was manufacturing woollen blankets in Taiwan Province of China for the ROC army, and even today the company still

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concentrates on wool-related products. The island could not afford to import new wool from abroad at that time and the company used discarded military blankets and other wool-related fabric and clothes as its main source for worsted. It finally obtained some very limited foreign exchange loans from the government in the early 1950s and began to import wool strips from Australia. To upgrade its technological capability, the company concentrated on the introduction of more advanced machinery. The founder was fluent in Japanese and naturally considered Japan as the best source for such technology. T.7 was able to establish a formal technological cooperation relationship with Japanese Diatobo, which sent out many technicians and even brought its own looms to Taiwan Province of China. During the 1950s and 1960s the company relied heavily on Diatobo for technological assistance. The excellent relationship with Diatobo was continued by the eldest son of the firm’s founder who hired several Japanese senior technicians and engineers who had retired from Diatobo to help the company ensure that the quality of its worsted could meet international standards. The company also maintains a very good relationship with other Japanese worsted producers and has established a sound information network in Japan. Assistance is also obtained from the International Wool Standard (IWS). One of the important achievements of the company is that its worsted has been exported to Japan at very good prices. Of the two kinds of worsted—worsted for woof and worsted for warp—only better quality worsted can be used for warp. The company’s worsted exports to Japan are mainly for warp, which enables them to make a handsome profit. Downstream and midstream companies in Taiwan’s textile industry are quite different, with the latter being more dynamic and more responsive to technological change, as can be seen from companies T.4 and T.9. T.4 is the largest polyester producer, accounting for 28.9 per cent of staple and 21.4 per cent of filament production at the end of 1992. The general manager of the fibre division of the chemical group said that in 1967 the group decided to produce polyester. In the early days, it produced polyester through DMT on a very small scale. Before the first oil shock, it gradually expanded its capacity, but at that time the market was primarily dominated by Japanese manufacturers. In 1967, the company made a bold and important decision to adopt a continuous production process for polyester from a West German engineering company, Zimmer. This was a very risky decision because the continuous production process was a newly developed technique that had never been tested on a commercial scale. However, the group thought that it offered production advantages and decided to adopt it. In what proved to be both a painful and rewarding experience, the prototype production plant ran into several unexpected production problems that the company had to solve itself by assigning a substantial number of engineers and R&D personnel to modify and redesign many parts of the original design. Thanks to a cross-financial subsidy from this chemical group and government tax-free financial incentive programmes, the division finally succeeded in establishing its first continuous process, a direct

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spinning polyester producing plant in Taiwan Province of China in 1969 (the first such plant in the world). In the late 1960s, the company decided to abandon DMT and adopt the latest PTA technology in conjunction with their latest continuous process. Through substantial efforts and firm commitment, the fibre division achieved efficient production and energy/cost savings by the mid-1970s. The advantage of a large-volume continuous process over the traditional batch process in producing polyester fibre as developed by T.4 is clear. In the traditional batch process, production cannot be operated on a continuous basis; raw materials such as monomer have to be fed into the machine by the batch and processed by the batch. The process is therefore less efficient. Furthermore, in the batch production process many additional production procedures and pieces of machinery are required for handling the melting, cooling and drying processes of the polymer chips which have proven to be both energy-consuming and cost inefficient. It is precisely its clear advantage in production process that enabled the group to become one of the world leaders in polyester fibre production. The group also managed to develop other important processing technology breakthroughs by itself. First, it succeeded in expanding Zimmer’s original production capacity of 20 tons per day per line to 55 tons per day per line by 1974. The group subsequently mastered the complete continuous processing technology for polyester fibre production. Then, in 1982, it developed its own fully automatic packaging, storage and delivery system for partial oriented yarn (POY), cutting down packaging and storage management costs substantially. It now claims that it has the most advanced POY packaging and storage management system available which has enabled it to achieve the lowest manpower utilization rate (or plant with the highest output per worker) in the world. The case of T.4 is unique in the sense that the firm is basically a chemical rather than a textile enterprise. Its objective in entering into polyester production was to capture the business opportunities offered by the fastgrowing textile industry. A more typical case is that of T.9, a textile firm which has engaged in backward integration of production by becoming involved in polyester production. T.9 is a textile company which moved from mainland China to Taiwan Province of China, along with the nationalist government in 1949. It soon encountered great difficulties in running its factory because foreign exchange was tightly controlled by the government and it had to request approval to import the raw materials to be processed locally. Thanks to timely United States aid in 1954, which provided needed capital to the local economy, the company was able to obtain loans through the United States aid programme to purchase machinery for the manufacture of cotton yarn and fabric which gradually set the company on the right track. As it grew rapidly, protected by the import substitution policies of the 1950s, the company also accumulated significant capital and machinery. One of the notable changes in the company in the 1960s was its decision to engage in the

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production of polyester. This was a natural decision since, at that time, the company’s volume of imports of both cotton and man-made fibre was very high, and the unit price for man-made fibre was as much as US$2 per pound. There was thus a considerable economic incentive for it to engage in import substitution production. The interesting story of how the firm planned the production of manmade fibre began in 1964. It first assigned a taskforce to go abroad to search out technological know-how, but to little avail. In 1968, the company sent another task force, which this time proved more successful. At that time, a Swiss-based company, Imventa, had developed technology for producing polyester through PTA (rather than DMT) which caught the company’s attention. Although polyester production through PTA was still considered an immature technology, and the sources of PTA were limited to a few chemical companies such as ICI and Dupont, the company, nevertheless, decided to import the entire technology from Imventa. After obtaining the technology from Imventa in 1969, the company became the first polyester producer using PTA in South-East Asia. The major advantage of producing polyester with PTA was that it enabled the company’s production costs to be reduced by as much as 15 per cent, thus providing a major competitive advantage. Relentless in its drive to upgrade its technological capability, after two years’ experience in producing staple with PTA the company acquired fully jointed processing technology from a European engineering company, Aurgi, enabling it to produce POY in one step at very high speed. The company signed a contract with Aurgi to buy six production lines. However, to ensure that the company could maintain its competitive edge in both the domestic and the international markets, the contract stipulated that Aurgi could not sell the same equipment to other domestic rivals for a period of one year. This story clearly shows that continuous upgrading of technological capability can play a significant role in the success of a company. In this case, the entrepreneur’s willingness and commitment to take the necessary risks were crucial factors. Furthermore, the case shows that the strong downstream demand made large-scale production of fibre feasible, while the superior production technology owned and developed by the midstream firms enabled them to supply quality polyesters to their downstream users at lower than international prices. Obviously a close industrial linkage has emerged in the Taiwanese textile industry from which mutual benefits are reaped.

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IV NEW CHALLENGES AND RESPONSES IN THE 1990s The electronics industry Despite its rapid progress, the Taiwanese electronics industry continues to be saddled with important weaknesses. The first weakness is the industry’s heavy reliance on OEM production. Because of their lack of financial resources and sophisticated marketing channels with after-sales service capabilities, Taiwanese electronics firms have long relied on foreign multinationals for OEM orders and concentrated only on production. As competitive pressure in the computer market intensifies, foreign firms will be constantly searching for lower-cost producers from other countries. As products become increasingly mature, the need for quick product development and design will become less important. This may put the smaller-sized Taiwanese firms in a vulnerable position as large Korean conglomerates take over those mature products with their economies of scale. Interviews with firms E.2 and E.7 indicated that Taiwan Province of China has lost its comparative advantage to Korea in monochrome and colour monitors, formerly two of its major export items in the computer industry. Many firms have realized the importance of developing brand-name products, but the resources and scale required to produce and market them at the international level are considerable. For example, firm E.1 has placed much emphasis on brandname sales, even using mergers and acquisition moves to facilitate the building of market channels, but it has been forced by market conditions to do more OEM production in recent years. Firms E.3 and E.6 recognized the limits of their size and have moved away from brand name products. The second weakness of the computer industry in Taiwan Province of China is its heavy reliance on imported key components.8 ICs, hard-disk drives, LCDs, CCDs and high resolution picture tubes all depend heavily on imports, which restricts the profitability of computer-product manufacturers. The availability of chipsets has further squeezed out the need for design and standardized computer products.9 If key components could be sourced from domestic firms, this would, of course, greatly increase the competitive strength of downstream firms.10 However, these key components usually require high entry costs that have discouraged Taiwanese SMEs. For example, one of the major strengths for firm E.2 in monitor production is that it owns a very efficient and competitive picture tube plant which can provide quality products at reasonable prices to the parent company. But before the picture tube plant became an efficient producer, there were 13 consecutive years of huge losses that ate up most of the profits of the parent company. But for the large size of the latter and its ability and willingness to accept huge losses over a long period, the picture tube plant could never have succeeded. In the future, some cooperative joint venture efforts by small local firms will have to be established to spread the risks and pool important financial and human resources.

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The third weakness of the Taiwanese computer industry is its continuous reliance on foreign technology. The increasing demand for technological development and the tighter technology market under stricter intellectual property right protection rules, have made the sourcing of new technologies very difficult.11 As the speed of new product development accelerates and as product lifecycles become shorter, the demand for technological improvement has intensified over the past two years. This has not only created a need for more R&D efforts by domestic firms, but has made the sourcing of up-to-date leadingedge technologies of crucial importance. However, there is not enough local supply of experienced researchers with expert knowledge of digital, analogue, optical, chemical, and mechanical technologies.12 As a result, Taiwanese firms may be able to improve their technologies only marginally through their own learning-by-doing experience either on product design or process engineering. Therefore, the sourcing of foreign technologies remains an important prerequisite for new product development. Consequently, the government of Taiwan Province of China has promoted strategic alliances among domestic firms, encouraging them to team up with foreign firms. Examples include an alliance between the ITRI and some local computer producers to develop notebook computers, and firm E.1 has teamed up with Texas Instruments to produce DRAMs. Firm E.1 has also joined the Advanced Computer Environment (ACE) led by MIPS, Microsoft, and Compaq etc. to develop workstations, while firm E. 2 has joined the SUN workstation alliance. The current international market situation in the computer industry poses another challenge. Intense wars have put great pressure on Taiwanese hardware producers, a situation compounded by slower growth in the computer hardware market.13 Since many key components are controlled by foreign firms and the number of firms in the market is growing, profit margins have been squeezed, especially for PC and monitor producers.14 This may adversely affect both the financial capabilities of firms and their R&D efforts, which may, in turn, jeopardize their long-term growth potential. This has led to a massive push of outward direct investment to lowercost locations in China and South-West Asia in an attempt to gain ground, but whether this will help to upgrade the Taiwanese computer industry is doubtful.15 Other firms have tried to move towards higherlevel workstations,16 but the uncertainty about which system will eventually dominate the market has posed many risks to participating firms. One strategy which has seemed to be quite successful so far is to focus on niches with special features. For example, firm E.12 has been relying heavily on its designs of personal computer and monitor circuitry to enable it to continue to export mother boards of these products even though it has lost the edge in final assembly. Other firms have had success with graphic cards and PC-LAN cards, some make huge profits from stepper and servo motors, and the ASIC business has been relatively successful for some time.17 Another strategy that has recently been receiving increased attention is the concentration on software development. Even though Taiwan Province of China has not been active in the software area

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so far and may have difficulty in catching up with the front-runners, there is still a lot of room for participation in application software, especially in the Chinese application software area. The build-up of such software expertise may then feed back to benefit hardware competitiveness. Firm E.2 has significantly increased the number of its software design engineers over the past two years, and firm E.3 also participates actively in the software market. Once again, it is important to stress that the international economic environment is of crucial importance to Taiwanese firms. Some electronic firms interviewed (such as E.1 and E.8) expressed concern about the Single Market in Europe, fearing that it might eventually create an even higher protective fortress against foreign trading partners. Among the various measures, the regulations on local content and the CE mark regarding safety and environmental protection have caused great concern in Taiwan Province of China. The local content regulation will inevitably force the electronics industry firms to consider seriously the possibility of establishing foreign subsidiaries in Europe. As a result, firms now face the challenge of how to internationalize their operations. As for the CE mark regulations, the main worry is that they could become an effective protective measure to block foreign competition. The time consumed in testing and certification, as well as the uncertainty about the transparency of the testing procedure, may constitute major entry barriers for foreign competitors. To meet the challenge of the Single Market in Europe, the government has worked actively with the relevant European industrial certification agents to enable mutually acceptable certification standards and processes to be recognized. It is hoped that this will minimize potential difficulties for Taiwanese firms. To cope with keener international competition in the world economy and to capitalize on intensifying contacts between mainland China and Taiwan Province of China, many Taiwanese firms and government-sponsored organizations in the electronics industry (such as E.11) are now establishing cooperative relationships with research institutions or with public/private enterprises in China to enable them to make full use of the low cost but high quality of engineers and researchers there. How to take full advantage of skilled manpower to engage in information-related software and hardware projects has now become a major topic of interest to both the government and private firms. It is possible that closer interaction between mainland China and Taiwan Province of China through joint development projects, contracted research, or technology transfers across the Taiwan Strait might develop as a response by Taiwanese firms to the challenge of technological change and the globalization and regionalization of the economy. The textile industry The major problem of the Taiwanese textile industry is rising labour costs18 which are directly related to the labour shortage. According to a 1988 survey by the Directorate-General of Budget, Accounting and Statistics (DGBAS) of the

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Executive Yuan, the labour shortage accounted for 10.2 per cent of total employment in the manufacturing sector (in other words, one in ten positions could not be filled). This problem is particularly serious for labour-intensive industries such as garments, knitting and electronics assembly. As noted above, this phenomenon has actually provided a strong incentive for firms to introduce automation. However, for firms which are adopting the small-quantity but diversified-style strategy, automation itself provides only a limited solution. The other important factor related to rising labour costs in Taiwan Province of China is the promulgation of the LSL. This legislation introduced strengthened labour standards such as over-time pay premiums, pension plans, paid holidays, and a severance pay system, substantially increasing the cost of labour. San Gee (1989) has compared these regulations with those of the United States, United Kingdom, France, Japan, Germany and Korea and found that the LSL provisions respecting the overtime pay premium, pension plans, paid holidays, severance pay and the outstanding wage settlement fund are in fact the highest among these developed and newly industrialized countries. It is therefore not surprising that labour-intensive firms have complained about the promulgation of the LSL. In addition to the labour costs and labour-related problems discussed above, another major concern is the appreciation of the NT dollar.19 Many textile firms (T.1, T.2, T.6, T.8, T.9) feel that the vast appreciation of the NT dollar has greatly reduced their profit margin and threatened their survival. During the period 1985 to 1988, the NT dollar appreciated against the United States dollar by more than 36 per cent, the highest rate among all the Asian NICs. Incidentally, as the NT dollar appreciated against the United States dollar in the late 1980s, European currencies such as the German mark, French franc, British pound and the Netherlands guilder all appreciated at an even faster pace, which meant that the NT dollar actually depreciated against these European currencies. This has helped exporting firms to diversify their markets away from the United States towards Europe and other regions. The successful ODM knitting company (T.2) discussed earlier also benefited from these currency variations, allowing it to diversify into Europe. According to some firms (T.1, T.3, T.6, T.7), another major challenge facing the textile industry is that they are unable to engage in in-house design. However, evidence was found that two firms (T.2 and T.4) are capable of ODM production. Nevertheless, lack of in-house design capability is still a major concern in the industry in its attempts to catch up on fashion trends. However, as discussed earlier, by setting up design centres in Europe as proposed by the TTF, establishing partnerships with European design houses and sending Taiwanese designers to Europe, Taiwanese firms will certainly go some way to resolving these problems. There have been a number of very rapid developments in fibre technology, with micro-fibre being seen by some as heralding a revolution in the industry. It is frequently argued that if firms fail to follow this new trend, they may well be driven out of the market. This question was put to selected firms and the

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responses were varied. Firm T.5 took a rather conservative view on the prospect for micro-fibre development. It argued that the fibre is used to make fabrics, and one criterion to determine the quality or the acceptability of fabrics is their feel. The marginal cost of moving from less fine micro-fibre (say 0.5D) to finer microfibre (say 0.2D) is very high, while there may be no significant feel difference between fabrics made from these two kinds of fibres; it is therefore market acceptability rather than the technology of micro-fibre itself that determines its market potential. Second, the textile industry was said to be a more consumer preference- and fashion-oriented business. The material itself is only one of the important factors determining the success of the product, with design, price, colour and ‘trendiness’ all being relevant to consumer choice. A technology-driven firm such as T.4 has taken a more serious attitude towards the development of micro-fibre and has actively pursued its production. The government-sponsored research institution ITRI is also actively engaged in the development of micro-fibre technology and has already achieved some technological breakthroughs in producing 0.4D micro-fibre. In conclusion, both speculative and accommodating attitudes toward the development of micro-fibre may perhaps describe the response of the textile industry. Finally, concern was also expressed by firm T.8 about the diminishing scale of the downstream textile industry. Due to rising labour costs, appreciation of the NT dollar and other factors discussed earlier, more labourintensive and lower value added downstreamers have been hard hit and many have begun to relocate some of their production to lower labour cost production sites in mainland China and South-East Asia. As the trend continues, many worry that once Taiwan Province of China loses its downstream firms, domestic demand will no longer be sufficient to support the operation of its very large-scale midstream and upstream suppliers. The diminishing scale of the downstream textile industry could therefore be a very serious warning sign to the industry. However, as one downstreamer (T.6) pointed out the only reason it is still operating in Taiwan Province of China is the protection provided by the existing quota system. The quota system has, in fact, slowed down the decline of the downstream textile industry and has, in turn, safeguarded the Taiwanese midstream and upstream textile industry. Despite the possible insufficient derived demand from downstream textile firms, many projects for expansion of the production of polyester and PTA are still actively under way in Taiwan Province of China. T.11 said that there are two possible explanations for this kind of risk-taking: first, many foresee that mainland China will become one of the major markets for textile products in the world; however, due to its limited capital, China will not be self-sufficient in supplying all its needed polyester or PTA and thus there will still be great market potential for these textile-related raw and intermediate materials. Second, Taiwan Province of China has superior technology in producing these products and has a good chance of becoming a main supplier for the growing South-East Asian market demand.

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V CONCLUSIONS Both the electronics and the textiles industry have played an important role in the industrial transformation of Taiwan. Yet, both industries differ in their basic structure. In the textile industry, strong domestic linkages have been established mainly through backward (or vertical) integration. From the late 1960s, many of the downstream textile firms began to invest heavily in the production of polyester fibres. Furthermore, since the early 1980s, Taiwanese textile entrepreneurs have set up factories for the production of upstream chemical material such as PTA and EG, and are still expanding. The competitive upstream and midstream firms provide a stable supply of raw and intermediate materials to the downstream firms at reasonable prices which enhances the competitiveness of the latter. On the other hand, the successful export-oriented downstream textile firms have also provided a large and stable demand for the products of the midstream and upstream firms, thus enabling them to operate efficiently at full scale. Economies of scale can therefore be achieved at all stages of production and the overall competitiveness of the textile industry enhanced. The structure of the electronics industry is quite different. Foreign direct investment in electronic components and parts, accompanied by local sourcing activities of foreign multinationals, joint ventures, and local companies in the assembly of downstream household electronics, has resulted in a broad-based and specialized input network surrounded by many independent SMEs. These SMEs can provide quick delivery of low-cost, quality components to the final assembly firms and strengthen their export competitiveness. This strong and sophisticated input network also enables downstream electronic firms to keep upgrading and diversifying their product-mix which may, in turn, benefit the electronics component sector. However, there has not been much vertical integration in the electronics industry, but rather horizontal industrial integration and cooperation. Through this kind of specialized and cooperative horizontal integration, the Taiwanese electronics industry has maintained its international competitiveness in the face of severe challenges from large conglomerates in other countries. The development of the textile and electronics industries has shown that the ability to upgrade and diversify product-mix in response to international competition and technological change has been one of the key factors in their success. In other words, competitiveness really depends on the entrepreneur's willingness to take risks, engage in product improvement and respond positively to rapid technological changes. The industrial development experience of Taiwan Province of China has clearly shown that government protection alone cannot foster sound industrial development. The Taiwanese macro-environment, characterized by (1) prudent control of the money supply and government spending; (2) a flexible labour market which leads to free labour mobility and firms' commitment to better wages and career

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opportunities; (3) positive and balanced attitudes toward investment promotion so that both domestic and foreign, large and small firms are all equally welcome; and (4) various export-promotion policies, such as the establishment of exportprocessing zones and export rebates, has significantly contributed to the development of the textile and electronics industries. Foreign direct investment was seen to be an important factor in promoting industrial development. First, most FDI has involved a significant amount of local sourcing, which has not only provided an extra boost to the local economies but to the technological assistance given to local firms. Second, the quality of local engineers has played a critical role in the success of FDI policy. The emphasis placed on education by both the government and individual families has meant that quality engineers and technicians are trained in large numbers who can then serve as an important medium for the acquisition and dissemination of various kinds of technology through the inevitable labour mobility generated by FDI. Third, the entire social and economic structure has encouraged skilled engineers and technical workers to set up their own businesses. Their readiness to learn various kinds of technologies is beneficial to both FDI and themselves, and they may in turn become the local supplier for FDI or may even engage in head-to-head competition with FDI when they think they are ready. As a result of family kinship, favourable government development policies and the emphasis placed on education and the promotion of exports, SMEs have become the backbone of the island’s economy. The SMEoriented industrial structure has in turn formed an important basis for the establishment of industrial linkages. Although SME-dominated industry may result in diseconomies of scale in R&D activities, it may nonetheless widen the scope of R&D activities and lead to better results. If each SME concentrates on the production and development of its own specialized products, it is likely that its R&D input will be smaller. But the greatest advantage of this decentralized R&D system is that it not only offers greater flexibility in information collection and processing, but provides quicker responses to new technology choices and different market demand situations. The cooperative network facilitates rapid exchanges of information among input suppliers and product manufacturers so that product R&D efforts can proceed in a more synchronized way. Consequently, it can be argued that this specialized and cooperative network in both production and R&D will enable the Taiwanese electronics industry to maintain its competitive edge despite its substantially lower R&D inputs when compared to many developed countries or Korea. There is no doubt that Taiwanese low-cost and diversified R&D activities under a broad-based and specialized input-supply network have provided a direct contrast to the more concentrated and centralized R&D organizations in Korea discussed in Chapter 3.

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NOTES 1 For example, the minimum size of order Tatung is willing to take for OEM production of personal computers is as small as 200 sets. 2 This point was emphasized by Keesing (1983). 3 For instance, one of the major factors helping firm E.6 to get started was that the brother of the entrepreneur had graduated from an electrical engineering department and was an expert in electronics circuitry. 4 China Development and Investment Corporation, set up by the government, has helped to raise capital for some investment projects, including in firm E.10. 5 This point was confirmed by firms E.2, E.3, and E.6. 6 Firms E.1–E.6 all confirmed this point. 7 Firms E.2 and E.5 have continuously replaced imported ICs with local ones to cut costs of their consumer electronics products. 8 Firms E.1 and E.2 both recognized the difficulties of too much reliance on foreign components. 9 Firms E.1 and E.3 both worried about the loss of leeway for PC products due to the standardization of chipsets. 10 The Taiwanese garment industry has long benefited from the efficient synthetic fibre industry which can provide much cheaper and good-quality fibres to downstream firms and greatly improves the competitive strength of the garment sector. 11 For a detailed analysis, see Ernst and O’Connor (1992). 12 This factor was stressed by firms E.1 and E.4. 13 Computer market information provided by Marketing Intelligence Centre of the Institute for Information Industry indicates that the world computer hardware market stagnated between 1990 and 1992, while the software market grew by more than 10 per cent. 14 Firms E.1, E.2, E.3 and E.6 all confirmed this point. 15 For a detailed analysis, see Ernst (1996). 16 Firms E.1 and E.2 have engaged in workstation production. 17 As indicated by the Marketing Intelligence Centre of the Institute for Information Industry. 18 Rising labour costs are also a major problem for the electronics industry, but an even more serious one for the textile industry. 19 This factor also affected the electronics industry, though to a lesser extent.

BIBLIOGRAPHY Chen, M.Phillip (1991) ‘The development of Taiwan’s textile industry’, Proceedingsof the Seminar on the R.O.C. Textile Industry: Development Experience andTechnology Transfer,International Economic Cooperation and Development Fund (IECDF) and Taiwan Institution for Economic Research (TIER), Taipei. Djang, T.K. (1977) Industry and Labour in Taiwan,Monograph Series No. 10, Institute of Economics, Academia Sinica, Taipei, Taiwan, pp. 68 and 71. Du, Wen-tien (Nov. 1970) ‘Industrialization and industrial protection policies’, No. 73, Council for International Economic Cooperation and Development (CIECD).

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Ernst, Dieter (1996) ‘Beyond truncated international production networks. The restructuring of Taiwan’s computer industry’, in D.Ernstet al. (eds) InternationalProduction Networks in Asian Electronics—Their Impact on Trade and Technological Capabilities, Oxford University Press, Oxford. Ernst, D. (1998), ‘What permits David to defeat Goliath? Inter-organizational knowledge creation in the Taiwanese computer industry’, paper prepared for the Asia-Pacific Journal of Management Conference on Knowledge Creation Strategies in Asia (Guest editor: Ikujiro Nonaka), Singapore, March 1998. Ernst, Dieter and David O’Connor (1992) Competing in the Electronics Industry:The Experience of Newly Industrializing Economies,OECD, Development Centre Studies, Paris. Gold, Thomas B. (1986) State and Society in the Taiwan Miracle,M.E.Sharpe Inc., London. Herderschee, H. (1995) Incentives for Exports: A Case Study of Taiwan Province ofChina and Thailand, 1952–1987,Ashgate, Avebury, Aldershot. Katz, Jorge M. (1984) ‘Domestic technological innovations and dynamic comparative advantage: further reflections on a comparative case-study programme’, Journal of Development Economics,Vol. 12, Nos 1–2, pp. 13–32, North-Holland. Keesing, Donald B. (1983) ‘Linking up to distant markets: South to North exports of manufactured consumer goods’, American Economic Review,Vol. 73, No. 2, pp. 338–342. Kuo, Wen-jeng (1987) ‘External learning effects and export-led growth: an investigation of the Taiwanese experience’, Ph.D. dissertation, Cornell University. Kuo, Wen-jeng, L.R.Wang and M.C.Liu (1992) The Marketing Ability of Smalland Medium-sized Enterprises in Taiwan,Chung-Hua Institution for Economic Research, Taipei. Lee, Teng-hui (1971) Intersectoral Capital Flows in the Economic Development ofTaiwan, 1895–1960, Cornell University Press, Ithaca. Levy, Brian and Wen-jeng Kuo (1987) ‘Investment requirements and the participation of Korea and Taiwanese Firms in technology-intensive industries’, EEPA Discussion Paper No. 11, Harvard Institute for International Development, Cambridge, MA. Li, K.T. (1988) The Evolution of Policy behind Taiwan’s Development Success,Yale University Press, New Haven, p. 61. Liang, K.S. and H.C.I.Liang (1981) ‘Trade and incentive policies in Taiwan’, Proceedings of the Conference on Experiences and Lessons of Economic Development in Taiwan,Institute of Economics, Academia Sinica, Taipei. Liang, Kuo-shu and C.I.H.Liang (1988) ‘Strategies for the development of foreign trade in the Republic of China’, in Symposium of the Conference onSuccessful Economic Development Strategies of the Pacific Rim Nations,ChungHua Institution for Economic Research, Conference Series No. 10, Taipei. Liu, K.C. and San Gee (1988) ‘Social and institutional basis for economic development in Taiwan’, Proceedings of the Conference on Economic DevelopmentExperiences of Taiwan and its New Role in an Emerging Asia-Pacific Area,Institute of Economics, Academia Sinica, Taipei. Ranis, Gustav (1995) ‘Another look at the East Asian miracle’, The World BankEconomic Review,Vol. 9, No. 3, pp. 509–534. ——(1979) ‘Industrial development’, in W.Galenson (ed.) Economic Growth andStructural Change on Taiwan, Cornell University Press, Ithaca.

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Rodrik, D. (1995) ‘Getting interventions right: how South Korea and Taiwan Province of China grew rich: discussion’, Economic Policy: A European Forum,Vol. 20, April 1995, pp. 53–103. San Gee (1992) ‘Taiwanese corporations in globalization and regionalization’, OECD Technical Papers, No. 61, OECD Development Centre, Paris. ——(1991) ‘Technology, investment and trade under economic globalization: the case of Taiwan’, in Trade, Investment and Technology in the 1990s,OECD, Paris. ——(1990) ‘The status and an evaluation of the electronics industry in Taiwan’, OECD Technical Papers, No. 29, OECD Development Centre, Paris. ——(1989a) ‘A comparison between Taiwan domestic and FDI electronic firms’ R&D activities and a study on the determination of their R&D inputs’, EconomicPapers,Institute of Economics, Academica Sinica, Taipei, Vol. 17, No. 1, pp. 35–62 (in Chinese). ——(1989b) ‘An evaluation and international comparison of labour laws and regulations which affect labour cost in Taiwan, ROC’, Proceedings of 1989 JointConference on the Industrial Policies of the ROC and the ROK,pp. 129–163, Chung-Hua Institution for Economic Research, Taipei. Schive, Chi (1990) The Foreign Factor: The Multinational Corporation’s Contributionto the Economic Modernization of the Republic of China,Hoover Press Publication389, Leland Stanford Junior University, Chapters 3 and 4

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UNCTAD (1996) Trade and Development Report,Geneva. Wong, Poh-Kam (1995) ‘Competing in the global electronics industry: a comparative study of the innovation networks of Singapore and Taiwan Province of China’, Journal of Industry Studies,Vol. 2, No. 2, pp. 35–61.

3 Catching up, keeping up and getting ahead The Korean model under pressure Lynn Mytelka and Dieter Ernst

I INTRODUCTION Along with Taiwan Province of China, Korea ranked among the first of the newly industrializing economies (NIEs) in the 1970s, when it became a model of the rapid growth to be achieved through exports. Many have told the story of Korea’s success with this industrialization strategy, particularly in the period from 1961, when Park Chung Hee came to power in a coup d’état, to the mid-1980s.1 But as Korea’s current crisis demonstrates, the future cannot be simply extrapolated from this past. During the early 1980s, when changing international competition made adjustments to entrenched habits and practices a necessity, Korean export competitiveness began to erode. This was obscured, however, by the continued upsurge in exports and the large trade surplus at the end of that decade.2 As the twin engines of Korea’s export success, the textile and clothing and the electronics industries are particularly revealing in this connection and both cases suggest that the roots of Korea’s declining competitiveness towards the end of the 1980s lay not in such factors as the cost of labour or the value of the won but in the technological weaknesses stemming from the very model that has been associated with the miracle of Korea’s export-driven growth. That model can be traced back to a series of major policy initiatives introduced in the late 1950s3 and extended under Park Chung Hee and successor regimes. While the exact nature of those policy changes has been subject to some controversy, there is no disputing the rapid growth in manufacturing output and exports from the mid-1960s. Korean export growth was particularly remarkable when contrasted with the ‘basket case’ image conveyed by foreign correspondents (FEER: 18 July and 8 August, 1963; Hamilton: 1986, 44) and by some economists during the 1950s and early 1960s.4 Yet that image, it is now clear, was based on a static and somewhat superficial assessment of the resources upon which the Park Chung Hee regime could draw. This was especially true with respect to literacy, the

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penetration of a market economy and familiarity with industrial processes— indicators traditionally associated with industrial development.5 The Korean manufacturing sector had also grown rapidly during the Japanese colonial period. This led Howard Pack and Larry Westphal to conclude that: Korea was not nearly as industrially backward in the late 1950s as the ‘basket case’ designation would make it seem… Manufacturing… depended heavily on the Japanese. Nonetheless, Koreans apparently acquired, mostly on the job, substantial knowledge about how to operate modern industries. This can be seen from the Korean ability to operate much of the existing industry just after the end of World War II, notwithstanding the tremendous disruption caused by the severing of ties with Japan and the division of the peninsula into two political entities… By 1948, with assistance from the United States—access to raw materials, replacement parts, and technical help—the Koreans were operating facilities to produce a wide variety of manufactured goods, including shoes, textiles, rubber tires, basic steel shapes and such engineering products as pumps, bicycles, tin cans and ball bearings. (Pack and Westphal: 1986, 91–92) Policy dynamics However, despite a massive infusion of United States funds during the 1950s,6 exports accounted for only 3.3 per cent of GNP in 1960 and GNP per capita grew at the low compound annual rate of 0.7 per cent during 1955 to 1960 (Kirkpatrick and Nixson: 1983, 41). In explaining Korea’s export success, therefore, most studies took as their point of departure the macroeconomic policies and reforms of the trade and exchange rate regimes that were said to have put Korea on the path towards liberalization at home and exports abroad. Four reforms are generally given prominence in this connection: guaranteed free access to imported raw materials and intermediate inputs for exporters from 1959; automatic and rapid access to export financing, bank loans for working capital and periodic devaluations,7 the first two of which were introduced in 1961 and 1964, respectively. To these were added a number of tax incentives and price reductions on such inputs as electricity to stimulate exports further and a purely Korean innovation, the domestic letter of credit, through which domestic suppliers of exporting firms and the domestic suppliers of these domestic suppliers had equal access to imported inputs and financing (Rhee, Ross-Larson and Pursell: 1984, 12). By reducing market distortions, such policies were expected to generate almost automatically an investment climate where ‘private domestic investment and rapidly growing human capital…[can act as]…the principal engines of growth’ (World Bank: 1993, 5). There is no doubt that this set of policies created a more propitious environment for exports. But they did not in themselves give rise to any exports

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or to the kind of macroeconomic stability that appeared to favour industrialization in Taiwan Province of China and Thailand.8 Largely due to its exports, however, Korea’s heavy borrowing during the 1970s9 did not lead to the debt crisis faced by the large Latin American borrowers. Korea’s policy reforms, moreover, were not directed at a liberalization of the domestic economy. On the contrary, given its relative autonomy from domestic social forces10 and its support by the military, the state (under Park Chung Hee and his successors, Chun Doo Hwan and Rho Tae Woo) now had considerable latitude to shape the growth process. Economic policy-making, for example, was centralized in a new institution, the Economic Planning Board, and in technocrats close to the Blue House.11 More importantly, policies were designed to preserve economic space for the emergence of domestic firms and to shape the very nature of those firms, their relationship to one another and to the state.12 As United States aid declined, Korea chose to borrow rather than rely on foreign direct investment (FDI). Like Japan earlier, the Korean government initially barred FDI and after a brief period of liberalization following recognition of Japan in the mid-1960s, exercised tight control over FDI and technology transfer until the 1980s.13 The FDI inflow rose from the very low base of US$24 million in 1962–1966 to US$117 million in 1967–1971 and US $536 million in 1972–1975. Over the latter half of the 1970s and the early 1980s, it slowed down and did not rise again until the end of that decade (Lee WonYoung: 1987, 13). Unlike the situation in most developing countries, FDI played a relatively small role in Korean development. Between 1962 and 1979, for example, it contributed an average of only 1.2 per cent to gross domestic capital formation (Korea Exchange Bank: 1980, 8) and its effect was limited to only a few sectors, such as chemicals and petrochemicals in the 1970s and electronics and transportation equipment in the 1980s. Much of this investment, moreover, was in joint ventures and only 31.5 per cent of cumulative FDI in 1978 consisted of wholly foreign-owned companies (Westphal, Rhee and Pursell: 1979, 368). Not until the Foreign Capital Investment Act was revised in December 1984 did the investment process become more transparent. By that time, however, the large diversified firms known as chaebols had become powerful economic forces both at home and abroad.14 With its control over the domestic banking system, the inflow of foreign capital (which accounted for a high percentage of the corporate borrowing in Korea) and interest rates in the formal banking sector, the Korean government could exercise considerable influence over private firms by rationing longer-term domestic and foreign loans (Rhee, Ross-Larson and Pursell: 1984, 14). Very high debt-equity ratios in these companies meant that domestic firms were constrained to return to the banks for loans, thus giving the latter considerable leverage.15 As a result, until the mid-1980s, government was clearly the ‘senior partner’ in its dealings with domestic firms (Johnson: 1987, 138).

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For nearly a quarter of a century, Park Chung Hee and his successors used these financial levers to combine ‘vigorous export expansion in highly labourintensive products, and selective import substitution in capital-intensive intermediate products and consumer durables’ (Westphal: 1979, 233).16 This was particularly important during the 1960s when export production remained less profitable than production for the domestic market and many exporters would have been operating at a loss without government subsidies (Amsden: 1989, 1992; Hamilton: 1986, 44; Kim Seung Hee: 1970, 99; Lim Youngil: 1981, 44– 45).17 The government was thus obliged to exert considerable coercion over business in the form of tax penalties, loss of import licences and access to credit during the 1960s and 1970s to achieve its export targets. But in exchange it offered subsidies and tax concessions, erected barriers to imports which protected the domestic market and granted exclusive import rights to manufacturing firms. Indeed, during the 1970s and 1980s, imports of textiles, automobiles, refrigerators, television sets, VCRs and other consumer durables were virtually prohibited until such time as they could be produced locally. Combining export promotion, the use of domestic letters of credit and selective import substitution thus stimulated the growth of exports and the development of backward linkages to the intermediate goods sector. By the end of the Third Five-Year Development Plan (1972–1976), which focused on the heavy and chemical industries, the textile industry was wholly integrated from petrochemicals to synthetic fibres, spinning, weaving, dyeing, finishing and apparel manufacture. Similarly, the Electronics Industry Promotion Act of 1969 made electronics a strategic export industry, which encouraged domestic firms to broaden their product range to include not only simple products such as radios but black and white and later colour television sets, both of which made use of locally manufactured components and picture tubes by the end of the 1970s (Bloom: 1992, 29). This dual system, however, also displayed weaknesses, notably in the way in which it conditioned the historical practices of Korean firms with respect to production and innovation. First, in order to meet export targets, large firms relied heavily on overseas subcontracting and OEM relationships to the detriment of product innovation. This delayed the emergence of inhouse R&D and encouraged the use of domestic subcontracting as a means of maintaining competitiveness through low wage production. Second, within the protected domestic market, a handful of the largest chaebols became dominant, thus diminishing the importance of price competition and narrowing still further a domestic market where growth was slowed by the very low wages prevailing throughout most of the 1960s and 1970s. Well into the 1980s, therefore, the domestic market played only a minor role in stimulating innovation within the textile and clothing and electronics industries and both remained highly vulnerable to fluctuations in international prices and tastes as well as to a host of other international market and nonmarket forces. Third, linkages to the

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machinery-building industry remained weak and the more a downstream sector exported, the more it tended to rely on imported machinery. Historical practices of firms Central to an understanding of both the successes and limitations of the Korean model is the relationship between the state and the chaebols. That relationship began in the 1950s when the Syngman Rhee government allowed selected local entrepreneurs to purchase Japanese colonial properties under highly favourable terms (Kim and Dahlman: 1992, 442) and permitted some forty private firms to reap windfall profits on the import and distribution of goods financed through foreign aid (Kim Kyong-Dong: 1976, 468). But the chaebols’ rise to prominence as industrial and commercial giants dates mainly from the 1970s and owes much to government policies.18 With Korea’s first and second economic development plans (1962–1966 and 1967–1971), both of which focused on building productive and export capabilities in light, labour-intensive industries, large companies became the preferred partners of the state. The government set export targets with data provided by these firms enabling it to anticipate their financial needs. In addition, the monthly national trade promotion meetings were chaired by the president and included ministers and businessmen who reviewed the progress made towards these export targets. This forged a closer partnership and laid the support base for the goal of development through trade (Rhee, Ross-Larson, Pursell: 1984, 16). As privileged partners of government, the emerging chaebols were also able to take advantage of the shift towards heavy and chemical industries promoted under the Third Five-Year Plan (1972–1976). Legislation was adopted to attract Japanese chemical and petrochemical companies, then in the process of internationalization, and loans were granted to large Korean companies to encourage their entry into these new industrial activities as licensers and jointventure partners. Shipbuilding, steel and automobile production were also encouraged by sector-specific policies in this period. Thus began a pattern in which Korean firms grew through diversification rather than by deepening their technological capabilities in any one domain.19 This also diminished the demand for technology generated by the local science and technology community (Kim and Dahlman: 1992, 445). The lack of demand for research scientists and engineers similarly affected the educational system. Korea’s strength lay traditionally in its well-developed middle and vocational school system and the early development of engineering training. But its universities were not research-oriented and when enrolment ratios were pushed higher in the early 1980s the tendency increased for all universities to become ‘primarily undergraduate teachingoriented rather than graduate researchoriented’ (Kim and Dahlman: 1992, 446). Not until the very end of that decade did links begin to develop between the universities and industry.

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The chaebols’ role in exports and their relationship to domestic subcontractors were also strengthened by two policy changes from 1975. First, the Korean government switched its export promotion policies from the dutyfree import of inputs used to produce export goods to a tariff rebate or drawback system under which tariffs were paid on these imports and a portion rebated at the time of export. The new system had both advantages and disadvantages for the domestic industrial structure and linkages. On the one hand, it further encouraged the use of domestically produced inputs because the formula for calculating the drawback tended to ‘overcompensate or undercompensate for duties and indirect taxes paid on inputs used in export production by an individual producer, depending upon whether that producer purchases relatively more or less of his input from domestic producers than the industry as a whole’ (Westphal: 1979, 267). On the other hand, it placed a burden on smaller firms which now had to finance customs duties on imported inputs from the time of import until after the finished goods were exported and the rebates paid. For small Korean firms this was a major disincentive to direct exporting. Second, the Korean general trading companies, modelled on the Japanese trading houses and tied to dominant industrial groups, were given legal status (Haggard and Moon: 1983, 1967) and, in a move to streamline the administration of export incentives, the government ‘provided additional incentives for establishing large trading companies which produce and export on their own account or act as exporting agents for smaller enterprises’ (Westphal: 1979, 268– 269). In this context, the shift to a rebate system accelerated the use of domestic subcontracting in which exports by smaller firms were intermediated by the large trading companies. Between 1980 and 1986, the number of small and mediumsized enterprises (SMEs) in Korea rose from 29,775 to 48,883 and the share of those engaged in subcontracting increased from 30 to 42.5 per cent (Lee KyuUck: 1988, 35). Crises and adjustment By the end of the 1970s, as income gaps widened20 and the economy, shaken by two oil price increases, began to succumb to debt, inflation and balance-ofpayments problems, the Korean model underwent its first shock. GNP fell by 6 per cent in 1980, corruption became more apparent and quiescence to exploitation gave way to rising opposition and political turmoil (Cumings: 1987, 79–80). In 1979, President Park was assassinated and replaced by General Chun Doo Hwan who outlawed strikes. ‘Thus in 1981 labour productivity increased 16 per cent while wages went down 5 per cent in real terms. GNP growth of 6.4 per cent recovered the low of 1980’ (Cumings: 1987, 80). Over the remainder of the decade GNP growth averaged 9.2 per cent per year (Amsden: 1989, 56; Bark: 1991b, 4) but exports increasingly came under pressure from newcomers in the ASEAN region able to produce good quality standardized products at low prices and from firms in several of the advanced industrial countries that had made

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impressive productivity gains and were accelerating the pace of new product development. Despite the repression, moreover, social unrest continued throughout the 1980s and was accompanied by mounting domestic pressure to democratize the political system, and rein in the chaebols with their ‘economic power and its resultant monopolistic abuses (e.g. creating scarcities, price gouging and ruining smaller competitors)’ (Kim and Dahlman: 1992, 446). Korean export growth accelerated towards the middle of the decade and as the balance of trade moved into surplus, international pressure for greater market access, notably from the United States, Korea’s major export market, intensified. This was to contribute to a series of major policy changes that rendered the relationship between the state and the chaebols even more problematic. During the 1980s, the Korean government attempted to speed up the technology acquisition process by changing the approval system for foreign investment and technology licensing from abroad to a reporting system.21 Nevertheless, Korean firms remained ‘at a disadvantage because of rising royalty payments and technology protectionism’ (Lee Hahn-Koo: 1992, 11).22 Stimulating innovation in Korean industry was thus essential to its continued export success, especially in electronics, yet pursuing sector-specific policies would conflict with external demands for market liberalization. In an attempt to respond simultaneously to pressures for liberalization and domestic innovation, the Korean government, in a major policy shift, abandoned its traditional sectorspecific policies for a more functional set of policy instruments. The Industrial Development Law of 1986 replaced directed credits by subsidies for R&D and changed the performance criteria from the promotion of export capacity expansion to productivity growth. The new legislation also placed greater emphasis on promoting joint R&D government laboratories and private firms, particularly in the electronics industry, as will be seen in section III. By maintaining its control over land use and its influence over the banking system, however, the Korean government hoped to retain its ability to influence the behaviour of Korean firms, particularly in declining industries and in those where size was thought to be necessary for export success.23 By the end of the decade, however, it was evident that the state’s ability to steer the process of change had considerably weakened. To stimulate the restructuring of labour-intensive industries, the outflow of foreign investment by Korean firms was also significantly liberalized. From a total outflow of US$457.4 million in 1981–1985 direct foreign investment rose to US$2,347.1 million in the period 1986–1990 and in 1991 alone reached 70 per cent of the outflow of the preceding five years. However, the case studies in sections II and III show that, as the chaebols internationalized, they became better able to resist policies designed to encourage specialization and promote modernization and R&D in Korea. As their export competitiveness declined and domestic wages rose, the chaebols now turned to the domestic market where they dominated the wholesale

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and retail trade and were heavily involved in insurance and financial services. Continued protection of the domestic market, by altering the trade-off between exports and local sales in favour of the latter, reinforced this trend. The Korean government was faced with a dilemma, since to liberalize the banking sector at that juncture posed the risk of having the chaebols ‘capture the banks and abuse their power’ (Petri and Leipziger: 1992, 32). Using its authority over tariff policy, the Korean government therefore gradually started to open up the domestic market to imports. Towards the end of the decade the import monopoly granted to manufacturers was also eliminated for certain products. Efforts to bring the chaebols under control also led to the introduction of a Fair Trade Act which included a prohibition of unfair cartel practices and mutual investment among the chaebols’ affiliate companies, set ceilings on the flow of credits to the chaebols and regulated their vertical and horizontal integration (Kim and Dahlman: 1992, 446). By 1991 this, too, had largely proved ineffective and, for the time being, attempts to reduce the power of the chaebols seem to have given way to a tactical alliance between the state and the latter to push through the internationalization of the Korean economy.24 With Korea’s export growth rate averaging less than 6 per cent in the early 1990s and its balance of trade once again in deficit, the weaknesses of the export sector could no longer be ignored. Ten years after it had weathered its first crisis, the Korean model was once again under pressure. This time, however, the competitive game had changed radically and cheaper wages could no longer restore Korean competitiveness. High interest rates and a tight credit policy introduced to dampen inflation, moreover, were cutting into domestic consumption and driving up the bankruptcy rate. Against this background, in 1993 President Kim Young-Sam prohibited the use of aliases in banking transactions and secured the agreement of Korea’s cashstrapped chaebols to reduce the period of paying on promissory notes—a major contributing factor to the liquidity problem faced by small businesses (Cheesman: 1993, 30). But these reforms alone are not sufficient to bring about the kind of restructuring that is required. The following sections examine in more detail the Korean model as seen through the lens of two very different industries: Korea’s traditional source of export strength, textiles and clothing, and the more recent leading export sector, electronics. After tracing the evolution of these two industries, the analysis will focus on their strengths and weaknesses as they confront a rapidly changing international competitive environment. II THE KOREAN TEXTILE AND APPAREL INDUSTRY Well before wages rose and the won appreciated in the late 1980s, the Korean textile and clothing industry was already in crisis. This section analyses both the emergence and persistence of that crisis into the 1990s.

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The growth of production and export The modern textile industry in Korea is over seventy years old. Its origins can be traced back to two cotton mills, the Chosen Spinning and Weaving Company, a subsidiary of the Mitsui Company of Japan, which began production with 152, 000 spindles and 610 looms in 1919 and the Koreanowned Kyungsung Spinning and Weaving Company, which was established a year later and began production in 1923 with 112 looms.25 Over the next two decades, the production of cotton textile goods expanded dramatically and by the end of the colonial period there were 20 spinning factories employing over 16,000 workers and producing some 137 million square yards of cotton cloth.26 During the 1940s and again in the 1950s the Korean textile industry was devastated by a succession of wars. But the factory discipline, mechanical skills and organizational capabilities that had developed during the earlier period were not lost. Thus when United States aid programmes provided funds27 for the purchase of new machinery and supplied the raw cotton, Korea’s textile industry rebounded. By 1957, ‘[t]he industry achieved complete import substitution for cotton, woollen, rayon and knitted textiles, allowing the government to prohibit the import of these goods’ (Kim, Y.B.: 1977, 35). This did not, however, mean that the industry’s products were competitive in world markets. Although labour productivity increased dramatically from 1954 to 1963, the industry suffered from excess capacity28 and its ‘relative importance… was actually declining during the late 1950s’ (Kim, Y.B.: 1977, 38). While this might normally have encouraged firms to export, Korea’s textile manufacturers had relied heavily on raw cotton supplied by United States aid during the 1950s which could not be used to manufacture products for export (Amsden: 1989, 66). From the outset, therefore, the Korean textile industry was shaped by provisions affecting its market access abroad. Devaluing the won against the United States dollar in 1961 and again in 1964, a traditional neo-classical solution to the competitiveness problem, merely exacerbated the difficulties faced by Korean spinners and weavers who were dependent on imports for their raw materials and machinery. The dramatic takeoff in textile exports which began in the late 1960s thus had to await the combined effect of government pressures on textile companies that had come to rely heavily on ‘government favours’ (Kim, Y.B.: 1977, 48) and a package of subsidies which would make exports profitable. Over the next two and a half decades, the Korean textile and clothing industry passed through a number of distinct phases. The period from 1968 to 1973 was one of exceptionally high growth in output and exports. The real rate of output growth averaged 26.3 per cent per year and exports increased at an annual average rate of 47 per cent.29 During this period wages were low and stable but the won lost 70 per cent of its value against the United States dollar, thus fuelling inflation which further accelerated in 1974–1975 after the first oil shock.

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Between 1974 and 1979, the real rate of output growth in the textile and clothing industry fell to 12 per cent per year. Exports, however, continued their climb, but at a lower average annual growth rate of 23.9 per cent30 and the won remained stable at 484 to the United States dollar. In addition to the problem of sharply increased prices for its oil imports, the Korean textile and clothing industry experienced its first set of challenges. These included an increase in domestic wages resulting from the absorption of surplus rural labour by the rapidly growing heavy and chemical industries and the signing of the Multi-Fibre Arrangement which would lead to ever wider and more restrictive quotas on imports of textile and clothing products by the United States, Korea’s major market. In 1980 and again in 1981, wages declined in real terms and the real rate of output growth continued to fall, reaching 6.4 per cent between 1980 and 1985, with textile exports growing at a still slower rate of 7.1 per cent per year.31 This was also the period during which the textile and clothing industry faced a second set of challenges as political instability, following the assassination of President Park in 1979, growing competition from China and a number of ASEAN countries and the emergence of new domestic competitors combined to put established producers under considerable pressure. It was the failure of Korean textile and clothing manufacturers to respond adequately to these pressures which laid the basis for a crisis towards the end of that decade. That crisis was marked by negative rates of output growth and a further drop in export expansion between 1986 and 1991. The depth of this crisis, however, was largely concealed by the steep rise in dollar-denominated textile and clothing exports between 1985 and 1989 despite significant increases in real wages, and in the value of the won. Not until the early 1990s, when sluggish domestic demand and intensified domestic competition combined to increase dramatically the bankruptcy rate and reduce capacity utilization among SMEs in the industry,32 was the crisis finally acknowledged. Even then, however, many of Korea’s larger firms preferred to exit rather than make the necessary effort to strengthen the technological capabilities required for competitiveness. Building production, investment, marketing and minor change capabilities To provide a better understanding of the forces that have shaped the development of technological capabilities and stimulated exports in the Korean textile and clothing industry, a broad sectoral analysis will be combined with case studies of nine textile and garment companies. Four of these firms were founded in the mid-1950s (T1, T3, T6, T8), three in the period 1965–1971 (T2, T4, T7) and two in the mid- to late-1980s (T5 and T9). Of the nine firms, five (T1, T2, T6, T7, T8) are very large-scale spinning and/or weaving companies which over the years have integrated downstream and diversified production outside the textile and clothing industry. T2 and T8 developed into chaebols in

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their own right. T6 is the textile and clothing division of an existing chaebol. All have invested abroad. The four smaller firms, T3, T4, T5 and T9, are far more specialized and none has any internationalized production. Table 3.1 provides data on these firms. During the 1960s and 1970s, Korean textile and clothing manufacturers made considerable progress in strengthening their production capabilities which would become a key element in their ability to survive the myriad changes that affected the industry in the late 1970s and 1980s. Labour productivity also grew at the respectable annual average of 10.8 per cent in textiles and 14.2 per cent in clothing between 1976 and 1980 (World Bank: 1987, 158). Three factors contributed significantly to the mastery of production technology by Korean textile and clothing manufacturers. Of primary importance was the increasing level of general education in the workforce, reflected in both the existence of universal primary education and an enrolment rate in secondary schools of 42 per cent of the male and 32 per cent of the female cohorts in 1970.33 Of equal importance was the increasing number of trained technical, engineering and managerial personnel who staffed these factories.34 Third, foreign buyers, in particular, Japanese trading companies and their Japanese subcontractors and, to a lesser extent, foreign equipment suppliers were also an important source of technical assistance for several of these firms (T2, T4) early on in their establishment.35 Korean firms differed from the many African and Latin American companies that had engaged in joint ventures with foreign partners or licensed technology from abroad by the extent to which they consciously sought to master production technology through these relationships.36 T4 is typical in this respect. Founded in 1970 by a man37 with textile experience in the silk business, T4 worked closely with a Japanese subcontractor in the hand-knit wool garment sector, with the Japanese subcontractor seconding two engineers for two years to the Korean company. A year after the engineers had departed, however, T4 no longer needed technical assistance, cut its ties with this Japanese firm and sought out other Japanese customers who could provide it with a larger market. To a large extent, Korea’s export success in the 1960s and the early 1970s was based on an expanding low-wage labour force and underwritten by the government’s export promotion policies. As Korean firms had not yet developed marketing capabilities, their ability to export was largely dependent on, and frequently initiated by, their overseas customers, notably Japanese trading companies then seeking low cost subcontractors38 (T2, T4, T7). Over the 1970s, as productivity rose and the quality of Korea’s products improved, and as United States firms increasingly sought out overseas suppliers, Korean firms were wellpositioned to move out on their own. Following the government’s programme to stimulate the development of domestic trading

Table 3.1 Basic data on the interviewed textile and garment companies

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Key: D=dyeing, FDI=foreign direct investment, F=finishing, JV=joint venture, K=knitwear, LG=ladies’ garments, MG=men’s garments, P=printing, S=spinning of cotton, SF=synthetic fibres, wool or blends, W=weaving

Table 3.1 Continued

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companies in the mid-1970s, several of the larger Korean firms developed distribution and marketing capabilities (T1, T2, T3, T8), thus replacing the Japanese trading companies as the principal intermediary between overseas clients and domestic producers. However, most of the knitters and apparel manufacturers, irrespective of size, remained true to their earlier practice of working as subcontractors for overseas firms. Only spinners and weavers have generally developed their own brand names and market directly abroad. T2 is a typical case. Established in 1965 as a small weaving company, T2, using yarn imported from Japan, specialized in the production of embroidered cotton and cotton/ polyester blend fabrics.39 In 1970, at the initiative of a Japanese trading company which handled all its marketing and distribution, T2 began exporting these fabrics to Indonesia and the Middle East. Domestic competition in fabrics in the mid-1970s and up to the early 1980s led T2 to develop its backward linkages to the spinning industry. In 1976, it built a cotton spinning mill using Japanese machinery, and with technical assistance from its supplier. Dyeing machinery was also purchased from Japan. In 1982, it began spinning polyester yarns using machinery purchased from a British supplier. As an integrated spinning, weaving and dyeing company, T2 was thus able to develop new yarns and fabrics to meet customer demand. During the 1970s, Indonesia, through joint ventures with Japanese firms, developed its own polyester fabric production, thus forcing T2 to look elsewhere for markets. By the 1980s, it had responded to this challenge by developing brand names for its yarns and fabrics and establishing 16 branch offices in North America, Europe, Asia and the Middle East.40 Over that decade, T2 successfully diversified its export markets and in 1992 its earlier markets accounted for barely one-quarter of its exports. Policy dynamics, historical practices of firms and the failure to modernize What is particularly interesting in an analysis of the Korean textile and clothing industry today, however, is not the way certain technological capabilities were initially acquired but why others were not developed as competitive requirements changed. This failure to strengthen production capacities and develop major change capabilities can be traced back to the mid-1970s when the high growth phase of the Korean textile and clothing industry began to draw to a close. The decline in output growth from 26.3 per cent per year in 1968–1973 to 12 per cent in 1974–1979 is usually explained by the wage increases resulting from government-stimulated investments in the heavy and chemical industries. Wages in the textile industry, however, remained very low in absolute terms41 and labour cost comparisons showed that the cost of Korean labour in the textile industry, US$0.78 per hour, compared favourably with US$1.26 in Taiwan Province of China and US$1.91 in Hong Kong (EIU: 1990, 46). Nonetheless, wages began to rise faster than labour productivity and this, it is argued, put

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pressure on profitability and thus contributed to a low rate of investment in the textile industry in the latter part of the 1970s (Lee Soon-Jae: 1984, 5). Yet this was also the period when three factors significantly modified the international environment within which Korean exporters were obliged to compete. First, the Multi-Fibre Arrangement (MFA) became increasingly restrictive, forcing producers to shift to new product categories in order to avoid quotas. In the case of the United States, the number of products subject to specific limits rose from 47 in 1982 to 69 in 1984. By the beginning of 1984, fully 70 per cent of Korean exports were under quotas and during the course of that year 62 per cent of the previously unrestricted imports were put under specific limits (ITCB: 1985, 24). A number of firms were thus induced to explore non-quota markets, particularly in Japan. By the end of the decade, Japanese efforts to limit Korean imports and growing competition from other suppliers reduced the overall share of the Japanese market in Korean exports. But some of the smaller, more innovative firms survived this shake out as will be seen below. Second, lower-wage countries such as Thailand, Malaysia, the Philippines and Indonesia were beginning to develop their clothing industries for export, putting additional pressure on Korean firms to move to higher value added products. Third, the more rapid diffusion of new textile machinery, such as the open-end (O-E) spinning frame and shuttleless looms, was restoring competitiveness to many textile firms in Germany, Italy and Japan and making them formidable rivals at the high end of the market.42 As a result, Korean firms could no longer count on their low labour cost advantage: investment in modern production equipment became a prerequisite for survival. Yet such investments were constrained by the low profit margins typical for Korean textile firms. In order to compensate for weak investments in modernization by the private sector, the state was needed to provide investment funds. Yet, once priorities had shifted away from light industry towards the heavy and chemical industries, textiles and clothing were considered as a sunset industry. It was only in 1981, when Korea was faced with a mounting external debt, while the textile and clothing industry still accounted for nearly 30 per cent of exports, that the government reversed its position and established a textile and clothing modernization fund. To sustain its export performance, modernization of the spinning and weaving sectors was of particular importance since they formed the basis for a flexible and innovative clothing industry. The US$1.34 billion modernization plan, initiated in 1982 but only partially funded,43 was designed to raise productivity in spinning and weaving by 10 per cent per year and double exports by 1986. To achieve these goals it focused on three broad areas: bringing costs down through the replacement of outdated machinery by automated, labour-saving equipment, raising product quality and design to match the level of Italian textiles, then regarded as the industry standard and encouraging innovation through R&D (Business Korea: June 1983, 31).

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Table 3.2 Modernization in the spinning and weaving industries in Korea, Taiwan Province of China and Hong Kong, 1974–1984 (cumulative shipments)

Source: International Textile Manufacturers’ Federation, MachineryShipment Statistics (Zurich: ITMF, various years)

International

Textile

By any indicator, the modernization plan was a failure. Between 1982 and 1986 Korean textile exports rose from US$2.5 billion to US$3.2 billion—a 28 per cent increase. They did not double. Worse still, Italian yarn and fabric exports increased in value by 48 per cent over the same period, Taiwanese textile exports went up by 72 per cent over these four years and Hong Kong, which was not among the world’s top 15 exporters of textile products in 1982, overtook Korea and moved into fifth place as a textile exporter in 1986 (GATT: 1987). Despite the availability of government funding for the purchase of machinery and equipment, the pace of modernization in the Korean spinning and weaving industries actually slowed down during the early 1980s. In Table 3.2 data on the cumulative shipments of new spinning and weaving machinery are broken down into two periods. The first pre-dates the government’s modernization plan and clearly shows that firms in Hong Kong and Taiwan Province of China were importing twice or three times as many new spindles as firms in Korea. In the second period, the investment gap in spinning widened and a substantial difference emerged in the rate of new investment by Taiwanese and Korean firms in the weaving industry. As to the type of equipment being acquired, between 1977 and 1986 the Korean spinning industry installed only 30,130 openend rotors, whereas the comparable figures were 82,070 in Taiwan Province of China and 113,212 in Hong Kong (ITMF: 1986, 14). At the end of the plan period, only 10.6 per cent of the looms installed in Korea were shuttleless, whereas the figure in Taiwan Province of China was 27 per cent and in Hong Kong 25 per cent. Instead of focusing solely on wage increases and a firm’s ‘bottom line’, a more fruitful approach to explaining both the decline in the rate of output growth and the lack of substantial new investment in spinning and weaving would be to look at the kind of structural changes then taking place in the textile and clothing

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industry. Of particular importance are changes in the pattern of concentration, vertical integration and diversification that were, to a large extent, stimulated by government policies in the 1970s44 but would become established practices in larger Korean firms during the 1980s. Thus, in line with the inducements offered in the Third and Fourth Development Plans and the stimulus to streamline exporting, larger textile and clothing firms began to set up their own trading companies (T1, T2, T3, T8), integrate backward into spinning and later synthetic fibres (T2) and forward into dyeing and printing and apparel manufacturing (T2, T3, T6, T7). Some also began to diversify production outside textiles and clothing (T6, T8), a practice that would continue into the 1980s (T1, T2). A number of consequences flowed from this. First, over time, the larger corporations came to control 80 per cent of the textile and clothing exports. From this vantage point, these firms became privileged recipients of MFA quotas allocated by the textile and the clothing federations on the basis of past export performance. These firms would then sell their quotas to smaller companies. Throughout the 1980s newer, smaller and more innovative companies were thus hard pressed to obtain MFA quotas. Second, the upstream part of the industry became increasingly concentrated. In 1988, four firms—Samyang, Sunkyong, Cheil (Samsung) and Daehan produced 72 per cent of Korea’s polyester fibre, Hanil accounted for 60 per cent of Korea’s acrylic yarn and 70 per cent of its acrylic fibre production, Tongyang produced 51 per cent of Korea’s nylon filament and Kolon and Kohap accounted for 55 per cent of its nylon fibre (EPB: 1988, 142). Cheil Wool dominated the woollen yarn sector with 40 per cent of the market45 and a handful of companies produced the bulk of Korea’s cotton yarn and fabrics (Interviews: KOFOTI and MTI). In 1983, 3 per cent of Korea’s textile and apparel manufacturers had over 300 employees. This 3 per cent produced 60 per cent of the value of Korea’s textile and clothing output (World Bank: 1987, Appendix A7, 185).46 Coupled with the government’s reservation of yarn and fabric imports to firms manufacturing these products, concentration in the upstream industries led to both higher prices and to a narrowing in the range of available inputs for the downstream garment industry. This was true for high quality yarns (T5), synthetic fibres (T1, T3)47 as well as fabrics, particularly high quality woollen and worsted fabrics used in the manufacture of men’s suits (T6, T8).48 A similar problem existed with dyestuffs produced by the oligopolistic chemical industry. Printing and dyeing firms, for example, pointed out that companies like Lucky Goldstar made dyes that were good enough for menswear but not for womenswear, obliging them to import dyestuffs from Germany and Japan (T2, T3). Third, although these firms were investing little in their traditional sectors, they did invest in both backward and forward linking activities within the industry and began to diversify outside textiles and clothing. The far slower pace of modernization in the Korean spinning and weaving industry, which can be traced back to the late 1970s, thus appears to have resulted less from a lack of

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investment funds in any absolute sense than from firmlevel choices as to how to spend the funds to which they had access. Tl is a case in point. Founded in 1954 by a lawyer with no prior textile experience, T1 had only 15, 000 spindles and 200 looms when it was taken over by its present chairman in 1970. Over the next five years production expanded enormously. With the exception of 12 open-end spinning frames, totalling 2,106 rotors, purchased in the late 1970s, however, labour-intensive ring spinners and traditional looms constituted the bulk of this firm’s 580,000 spindles and 5,500 looms until the late 1980s. Then, in order to increase productivity and cut labour costs it acquired several Murata air-jet spinning frames, air-splicing machines and winding machines, allowing the company to operate with 60 persons per 10,000 spindles, while for many of its competitors in both developed and developing countries the figure was only 35 persons per 10,000 spindles. It also bought air-jet looms, but as late as 1990, 50 per cent of the looms still had shuttles and less than 3 per cent of the spinning machinery was under five years old. Despite the lack of modernization in its primary activity, T1 established several other companies during the 1970s and 1980s, including a garment manufacturing enterprise specializing in knitwear exports using yarn produced by Tl. This subsidiary subsequently diversified into the tourist trade by purchasing a number of hotels. In 1982, T1 established a second clothing factory to produce ‘high fashion’ garments for the domestic market. The firm has since diversified into canned foods for the local market. Tl has also bought a company making pistons and autoparts as an OEM supplier, a nail manufacturing plant in the Masan Free Export Zone and set up a transportation company and a tourist services firm.49 Fourth, in addition to the low level of investment, which suggested that Korean manufacturers were continuing to rely on a low wage advantage, a historical practice of engaging in the mass production of low market end, standardized goods shaped investment decisions. Thus, a large part of the investment in the weaving industry which did take place in this period consisted of the purchase of water-jet looms to produce cheap polyester fabric for men’s suits. This choice flowed from the historical practice of Korean textile manufacturers to increase the volume of output rather than product quality (T1, T2, T3). Between 1979 and 1982, 3,000 water-jet looms were purchased. With loans from the modernization fund, an additional 2,000 were acquired between 1982 and 1984. However, this investment was made just as Europe was moving to more expensive but more flexible and efficient air-jet looms and as the market was shifting back to natural fibres, in particular wool. The result was a wave of bankruptcies in the Taegu area (Business Korea: December 1984, interviews with T1, T2, T3). Worse still, continued reliance on volume production limited the industry’s ability to respond to the new, flexible, small batch form of production which became a prominent feature of the industry during the late 1980s. In knitwear, the industry moved further in the direction of capitalintensive standardized simple products such as gloves, socks and T-shirts. The production

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of underwear rose from 179 million pieces in 1980 to 345 million pieces in 1987, an increase of 48.8 per cent, while the production of more difficult and fashionoriented outerwear items such as sweaters and dresses, increased by only 4.9 per cent over the same period.50 A similar process was evident in many of the larger apparel firms. Established as a knitwear company in 1971, T7 added women’s wear in 1975 and men’s wear in 1984, largely in response to growing domestic demand. Throughout the 1970s, however, T7 produced only basic clothing and not fashion goods. As the domestic market became wealthier and more discriminating, T7 began to build up its design staff and imported finer fabrics, especially woollens from Italy and the United Kingdom. By the mid-1980s, it had moved into brand name fashion garments for distribution through a widening network of locally franchised stores and employed nearly 100 stylists, three-quarters of whom had studied fashion design at university. T7 did not begin exporting until the 1980s and, like other Korean enterprises, the impetus came from an overseas client. Within a few years it had established agencies in Tokyo, Hong Kong, Paris and several United States cities to search out new customers. However, many of the fashion design capabilities which T7 developed for the domestic market were not applied to its exports. More than half the designs were customer-supplied in the case of Japan, for example, through large trading companies such as C.Itoh and Toyo Menka. In its major market, the United States, 80 per cent of its sales were OEM. As late as 1990, T7 did not use a CAD system, nor did it continue to strengthen its in-house production capabilities in the 1980s. Instead it mass produced its standard items using a network of domestic and, from 1989, Chinese, Indonesian and Hong Kong subcontractors. From 1988, T7 used overseas factories in Italy and France to produce its higher quality suits for sale in the Korean market and kept only a small volume of its production in-house. Like many Korean firms, T7 was highly leveraged and this contributed to the firm’s indebtedness. In 1989 and 1990, domestic competition intensified as other large firms shifted production away from exports in which they were losing competitiveness towards the domestic market. Given its failure to develop production capabilities for high quality fashion goods at home and its dependence on OEM production for overseas markets, T7 was ill-prepared to meet this challenge by tackling sophisticated overseas markets with brand-name products, as it briefly attempted to do in the 1990s. T7 has since withdrawn from the export market. Within the boundaries set by their historical practices, most large Korean firms sought to reduce costs by expanding their domestic subcontracting networks51 and in the mid-1980s began to move overseas. T7, for example, maintains only 7 per cent of its production in-house and T8 also relies extensively on subcontractors. Established as an apparel manufacturer in 1954, T8 is now a diversified chaebol. In its textile and clothing-related activities it produces chemical fibres, weaves, dyes and finishes in-house but has kept only one factory of its own to sew garments for the domestic market and has no in-house production at all for

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the export market. Thirty per cent of its garment production is exported, all of it OEM. In knitwear, T8 purchases fabrics from one of three medium-sized firms and then subcontracts sewing operations to 20 smaller firms, 10 of which it has worked with for many years. The remainder are spot companies, used when large orders come in. In the making-up of woven garments it works with 80 domestic subcontractors. Management costs, including quality control and merchandising have, however, been growing and within its present structure it has not been able to move to higher value added products. In 1987, therefore, T8 invested in its first garment factory abroad. At present it is a joint-venture partner in three Indonesian apparel firms, all of which are managed by Koreans and subcontract to five large factories in Viet Nam and several companies in the People’s Republic of China. As its overseas activities expanded, exports of textile products rose from US$5.9 million in 1987 to US$41.1 million in 1992. But this has not compensated for a decline in clothing exports as more of its locally made garments have been shifted to the domestic market. Restructuring of this kind has had a number of negative consequences on the competitiveness of the Korean textile and clothing industry as a whole. By continuing to interpose themselves between the real producers, for the most part small- and medium-sized garment manufacturers who serve as their subcontractors and the international market, larger firms limit the ability of these smaller firms to learn more about changing competitive requirements and ‘best practice’ elsewhere. As the larger firms came under pressure to reduce costs in the 1980s, moreover, they increased their demands for concessionary pricing from their subcontractors.52 With shrinking profit margins, these SMEs were unable to modernize and saw their own productivity fall. Meeting the new competitive requirements Under the Industrial Development Law of 1986, functional policies replaced sectoral policies except in the case of structurally inefficient, declining industries which were either to be gradually phased out or rationalized with a view to restoring competitiveness. In 1987, textiles were classified as a declining industry (Kim, Ji-Hong: 1991, 371) and a three-year rationalization programme (1989–1991) was put into place. Of the nearly US$4 billion in aid that now became available, only US$15 million was earmarked for R&D.53 Two new research and training institutes were set up in 1990 under this programme and partially funded by the government: the Korea Sewing Science Research Institute, with a mandate to develop new sewing technology, including ways of improving the organization of production and providing training programmes for firms in the apparel industry, and the Korea Academy of Industry Technology, modelled after KIST,54 but designed to work with SMEs and improve their technological capabilities. Post-graduate training in fashion design became available in 1988 through ESMODE Korea and the Fashion Institute of Kolon,

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both of which were private ventures. A number of firms also established inhouse R&D centres (T1, T2) and training institutes (T8). Among Korean textile manufacturers, T2 has given considerable attention to non-material investments. We have noted how foreign competition had pushed T2 into developing its marketing and distribution network in the 1980s. Because of its difficulty in finding enough trained marketers at that time, T2 was obliged to develop its own, in-house training programme. Potential marketers are recruited from among new university graduates, all of whom must have foreign language skills. Each then spends upward of three months rotating through each of T2’s divisions before specializing by product and country. T2 has also strengthened its design capabilities. Its printing plant employs ten university-trained designers, of whom four are men,55 who use a CAD system to design and print paper samples. Lastly, although not the first textile company to do so, T2 has established an R&D laboratory with five researchers at headquarters and separate R&D units with four to five chemists and engineers in each of its factories. Most of the research is on fabrics, particularly in the creation of a micro-fibre-like look in non-micro-fibre-based fabrics. But it is not easy to produce new fabrics unless a firm has access to improved yarns, which are not easily obtainable from abroad because foreign firms which develop them prefer to use them in their own fabric production and thus avoid the risk of competition before they have amortized their development costs. Because neither the Korean government nor industry associations have sponsored research on new yarns and there are no R&D linkages between this company and local universities, T2 is now moving towards developing in-house R&D in yarns and in dyeing micro-yarns. In contrast to other textile companies which continue to use subcontractors to maintain access to high volume mass production fabrics in the event of a boom period, T2, by investing in R&D, training and design capabilities has positioned itself for an upscale market. It has begun to reduce the number of its subcontractors and focus on those with high skills and the ability to produce quality fabrics. As other firms shifted production from exports to the domestic market, T2’s exports rose an average of 15 per cent per year between 1989 and 1991. The bulk of the rationalization funds, however, was earmarked for the modernization of plant and equipment, in particular in the spinning, weaving, dyeing and finishing sectors. This emphasis on automation was to a large extent a response to the rising wages and increasing number of strikes which many believed were the key factors eroding productivity in the industry. Labour cost comparisons in spinning and weaving, however, show that the cost of labour in the Korean spinning and weaving industry, which had been 15 per cent higher than that in Taiwan Province of China in 1984, fell to 80 per cent of that cost in 1989 and the differential between the lower labour cost in Hong Kong (87 per cent of that in Korea in 1984) widened only slightly to 85 in 1989 (EIU: 1990, 46). What really mattered, therefore, was the product-mix and the kind of machinery and equipment needed to produce more sophisticated yarns and fabrics. To encourage further the move to higher value added products within

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Figure 3.1 Growth rates of productivity in Korean spinning and weaving Source: Calculated from data supplied by the Korean Federation of Textile Industries Table 3.3 Foreign direct investment by Korean textile and clothing firms

Source: Korea Federation of Textile Industries Notes:a Up to April 1992. b Indonesia and the Philippines from 1987, Thailand and the People’s Republic of China from 1988, Malaysia from 1989 and Myanmar from 1990. c Includes Sri Lanka, Bangladesh, Pakistan, India, Oceania, Australia and Morocco. d Cumulative total 1978–1987

these sectors, the government prohibited other companies from entering the textile industry. But neither money nor restrictions on market entry were sufficient to induce a break with established practices. As can be seen from Figure 3.1, productivity growth rates in spinning and weaving, when measured in engineering terms, in fact declined in this period and a survey of cotton textile manufacturers in 1990 indicated that around 80 per cent of their machinery was outdated (Kim, J.H.: 1991, 406). Instead of improving their competitiveness, many Korean textile and clothing firms used the liberalization of foreign investment restrictions to internationalize production during the plan’s period. Among textile and clothing firms, the number of overseas investments rose from an average of 14 per year in 1986– 1987 to 41 per year in 1988–1989 and reached 81 per year in 1990–1992. Sixtyeight per cent of the US$487.3 million in FDI by Korean textile and clothing firms as of April 1992 was made during 1990–1992 (Table 3.3).

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T1 is typical of the larger spinning and weaving companies that pursued a strategy of limited investment at home and accelerated internationalization. T1’s average yarn count is now 40 and it acknowledges that it has lost competitiveness in yarns below 30 counts. Although it would like to move upscale in the yarn industry and produce yarns with counts of 50 and 60 and dye them to order, this would require small batch production. However, like most of Korea’s spinning and weaving firms, it is much bigger than comparable European Union firms, for example, and counts of 50 or 60 would still be below the 80 counts that now constitute the lower threshold of the finest cotton yarn. Tl is having increasing difficulty in raising its productivity and reducing costs. Automation is clearly one solution, but only in 1988 did the company begin to invest in air-splicing and winding machines that subsequently enabled it to reduce the number of persons per 10,000 spindles to 60, which is still quite far from best practice in the industry (35 persons per 10,000 spindles). To modernize more rapidly would require either changing plant layout or building a new plant. An alternative, the company has argued, is to move to lower-wage countries and, in 1990, it began to dismantle one of its old plants and to move to Indonesia. The process, however, required approval from banking creditors and the Ministry of Trade and Industry. Liberalization has now made this process easier and in 1992 the company opened a US$2 million factory in Ho Chi Minh City in a joint venture with a local partner. As the competitiveness of the chaebols eroded during the 1980s, small and medium-sized printing and dyeing companies which work as subcontractors to yarn, fabric and apparel companies and have traditionally been one of the strengths of the Korean textile and garment industry faced a severe profit squeeze. One possible solution for these SMEs was to market directly abroad. Some dyeing and printing firms have begun to work directly for Asian clients but for many this would require an expansion of capacity. The waste treatment plants currently serving the 111 dyeing firms in Taegu and the 63 in Banwol are too small to handle an increase in activity. Furthermore, the lack of financing had until the rationalization plan prevented these firms from investing in newer, less polluting equipment. As a result of these contradictory forces, larger printing companies also began to move abroad. Recognizing that the loss of crucial skills in dyeing and printing would seriously limit the textile and clothing industry’s ability to move up-market, the government prohibited the export of print screening plants from August 1992.56 Moving out alone has, however, been an important recipe for success in several of the smaller apparel manufacturers interviewed. T4 and T9, for example, share the following profile. Their owner/founder had textile experience, particularly on the marketing side, acquired while working for a larger company. Marketing capabilities were the key to penetrating non-quota markets such as Japan, increasing exports and thus qualifying for a share of the existing quota in later years. Both firms maintain strong domestic linkages. They buy yarns and fabrics locally, which speeds up the process from receipt of order

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to market delivery, thus enabling them to operate in higher fashion markets where delivery times are short. In the case of T9, turnaround time went from four months to two; orders which were placed twice a year in 1988 are now placed four times a year and the size of orders has fallen from an average of 10,000 to 2, 000 pieces per style. Although both make extensive use of subcontractors, each retains a large share of total production in-house, 40 per cent in the case of T9 and over 50 per cent in T4. In their own plants, they pay particular attention to upgrading their machinery on a regular basis. T4, for example, began with handknitting, which it phased out over the 1980s. In 1993, T4 had two full fashion knitting-to-form machines from Germany, 8 Italian computerized knitting machines and 10 older machines, some automated, as well as hand-knitting machines. Although these are small firms, T9 has university-trained engineers and T4 employs 10 full-time designers who have undergone extensive in-house training. Developing its own labels, while important for domestic market sales, has not so far been a significant factor in T4’s success in exports, only 20 per cent of which are under its own label.57 The real importance of its design capabilities as far as exports are concerned is the extent to which they have enabled T4 to shift rapidly to new products and move up market. Flexibility resulting from either buoyant production or strong design capabilities and well-developed marketing skills has also been central to the competitiveness of other small and mediumsized firms—T3 in fabrics, T5 in sportswear and T9 in shirts and blouses. None of these successful SMEs has developed its own labels but all of them pay close attention to fashion trends and maintain some design capability which they use to propose alternatives to clients. In the case of T9, sending samples of new patterns being developed by Korean printing and dyeing firms to their clients increases the possibility that some of them might be chosen, thus speeding up delivery times and reinforcing T9’s local linkages. These SMEs also maintain better relationships with their workers and their subcontractors. T9, for example, was established during a period of increasing labour disputes. As larger firms, in response to workers’ demands, began to abandon manufacturing, T9 engaged in a dialogue with its workers. Over the next several years, wages, which had been only 60 per cent of those in the large companies, increased steadily as sales expanded. In 1993, wages in T9 were equal to 90 per cent of those in larger firms. As a result of this dialogue, T9 argues, labour turnover at its factory is very low. T9’s subcontractors are mainly firms of the same size, but unlike T9, they manufacture but do not export. T9 assures quality control by visiting its subcontractors’ factories, and quality rather than price is what differentiates T9 from its domestic competitors. Similarly, as pressures on prices led to a shift away from hand-knitting in the late 1970s and early 1980s, T4 extended credit to workers made redundant through automation so that they could purchase the hand-knitting machines and set up their own subcontracting companies. These companies continue to work closely with T4 in knitting for the domestic market. With rising competitive pressures in its main

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overseas market—Japan—T4 is, however, currently negotiating with an ethnic Korean partner in China to set up a handknitting and sewing factory in Shandung and anticipates moving the factory to North Korea once relations with that country have been normalized. In contrast to these successful small and medium-sized exporters, larger firms have maintained their preference for mass production of standardized textile and clothing goods. Over the years, new challenges to their export competitiveness were met not by investing in new machinery and equipment that would facilitate a move towards smaller batch production or by strengthening their production capabilities in-house, but by relying extensively on a low-wage advantage prolonged through domestic subcontracting. Over the 1980s, the number of SMEs in the textile and clothing industry rose from 7,359 to 16,084 and the share of these operating as subcontractors rose from 36.4 per cent in 1980 to 71.5 per cent in 1989. Even when design capabilities for the domestic market might have enabled them to move into higher value added products in their exports, these firms continued their historical practice of serving export markets as large volume OEM producers. A survey conducted by the Korea Federation of Textile Industries and the Korea Institute for Industrial Economics and Trade revealed that the share of textile and clothing exports under Korean firms’ own brands fell from 34 per cent in 1991 to 28.9 per cent in 1993. Government policies reinforced this pattern by encouraging firms to diversify and by adopting at times contradictory attitudes to textiles and clothing from treating them as a sunset industry to stimulating their revival. Such policies contributed to the lack of sustained interest in strengthening technological capabilities in the sector which dates back to the late 1970s. Policy dynamics and the historical practices of large manufacturers thus combined to weaken seriously the industry’s competitiveness well before wages rose and the won appreciated. III THE KOREAN ELECTRONICS INDUSTRY From a meagre US$89 million in 1971, Korea’s electronics exports grew to US $20,683 billion in 1995, an increase by a factor of 232. In both the United States and Europe, it has become the second largest supplier after Japan, for a variety of consumer products, ranging from audio equipment to CTVs, VCRs and microwave ovens. Korean firms are also leading suppliers of PC monitors and have achieved a meteoric rise in Dynamic Random Access Memories (DRAMS) production, where the three main Korean manufacturers, Samsung Electronics (SE), Hyundai Electronics Industries (HEI) and Goldstar (LG), have succeeded in eroding the once overwhelming dominance of Japanese producers. Semiconductor exports are now the largest item in Korea’s electronics exports. An industry that barely existed more than twenty-five years ago has thus transformed itself into a credible international competitor.

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In addition to its success in international market penetration, the Korean electronics industry displays a second important feature. Since the 1970s, its exports have grown considerably faster than those of the country’s other industrial sectors. During the 1970s, electronics exports experienced a compound average annual growth rate (CAAGR) of over 43 per cent, while that for all manufactured exports was 35.6 per cent. Rapid export growth continued even after 1987 when rising wages and various appreciations of the won led to an erosion of Korea’s traditional labour cost advantage. By 1988, the electronics industry had replaced textiles and clothing as the main export sector. Electronics has been a major driving force behind Korea’s export success. Korea’s export performance today depends to a considerable degree on what happens to its electronics industry and whether or not it can sustain its earlier success in international market penetration. This raises two sets of questions. The first relates to the historical causes of Korea’s success; the second concerns possible limitations to the Korean model of export-led growth. We will examine the pattern of growth in the electronics industry and the factors which have shaped it and explore some of the weaknesses which are causes for concern as competition in this industry intensifies worldwide. The growth of production and exports The origins of the Korean electronics industry were humble indeed. Before 1959, a small number of electrical goods were being assembled from imported parts for sale in the domestic market. In that year a United States company gave the Goldstar Electrical Company an order for vacuum tube radios (Kim Hee-Nam: 1986, 4). By 1962, Goldstar was exporting radios and four years later had added black and white television sets to its exports. Between 1962 and 1971, the number of firms increased more than tenfold, employment more than doubled and production rose from an insignificant US$5 million to US$140 million. But, the real take-off in electronics production and employment occurred during the 1970s and exports were the primary engine of this growth. During that decade, most of Korea’s electronics exports were generated by foreign firms, either through export platform assembly lines or through international subcontracting arrangements. Four United States semiconductor companies, attracted by Korea’s cheap female labour, tough labour legislation and new policies to promote the electronics industry and export manufacturing,58 dominated Korea’s chip-assembly industry,59 and eight foreign firms accounted for roughly one-third of the country’s electronics production and 55 per cent of its exports in 1972 (Bloom: 1992, 28). The situation changed however in the 1980s when Korean firms, led by four chaebols (Samsung, Goldstar, Hyundai and Daewoo) took charge of the country’s electronics export drive. The changeover, it should be emphasized, neither interrupted nor slowed down the extremely rapid growth of both production and exports, although employment growth peaked in 1989 when

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rising wages and several appreciations of the won forced Korean electronics companies to cut costs through factory automation. It did, however, have an effect on industry structure which is today essentially characterized by a tight oligopoly as defined by Bain (1956, 1959 and 1966). Such an industry structure offers a number of advantages for latecomer industrialization (Bloom: 1992; Amsden: 1989; Hikino and Amsden: 1994; Ernst and O’Connor: 1989, 1992). But once the catch up phase is over, the structure of the Korean electronics industry has emerged as one of the factors constraining current efforts to keep up and get ahead. During the 1980s, the electronics industry’s share in total manufacturing production rose from 5 to 12 per cent, subsequently falling to 11.9 per cent in 1990 and 11.1 per cent in 1991. At the same time however, its export orientation continued to increase, despite rapid growth in the domestic market. Throughout the 1980s, over 50 per cent of electronics production was exported, rising to 59 per cent in 1991 and to almost 63 per cent in 1992. As a result, the share of electronics in total exports continued to rise throughout the period and accounted for 26.9 per cent in 1991. In terms of the product composition of production and exports, the development of Korea’s industry has closely followed the pattern set by Japan: consumer electronics was the initial entry point, while components soon became an equally important second pillar. This contrasts with the United States and European experience where industrial electronics, broadly defined to include computers, telecommunications and industrial automation equipment, was by far the most important driving force. Several characteristics, however, distinguish the development of the Korean electronics industry from that of Japan. The catching up process in both consumer electronics and components was much faster in Korea, at least if catching up is measured in terms of the pace and scope of expanding production capacity and international market share. The unprecedented speed of this process was made possible by the fact that growth in Korea was basically driven by continuous product diversification, while the depth of the underlying industrial structure, in terms of essential backward linkages and accumulated technological capabilities, remained quite shallow. Rapid capacity expansion was thus not matched by industrial deepening, a point which will be examined later. Korea was also different in the far smaller role that industrial electronics plays in the electronics industry as a whole. This, too, is problematic. Throughout the 1970s and well into the 1980s, consumer goods were the driving force behind Korea’s electronics exports. In 1981, the export share of consumer electronics reached a peak of 55 per cent, with television sets, both black and white and colour, being the leading products. In 1984, Korea finally succeeded in overtaking its main competitor, Taiwan Province of China, as the second largest supplier to the United States consumer electronics market, after Japan.60 Following the appreciation of the yen in September 1985, Korea’s consumer electronics exports experienced further expansion from US$1,860

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billion to US$6,436 billion in 1988, the year when Korean exports of low-end television sets and VCRs for the first and only time were able to gain some market share in Japan. Since then, however, Korean consumer electronics manufacturers have found it increasingly difficult to gain an international market share through exports to the United States and Europe. Two factors account for this: rising protectionism in the United States and Europe, which obliged Korean firms to locate assembly operations in these markets, although some of the components were still being imported from Japanese suppliers, and increased exports by Japanese competitors from low-cost manufacturing bases in South-East Asia, especially Malaysia and Thailand. These constraints encouraged a diversification in export markets away from the United States and Europe towards Asia. The share of Korean electronics exports to North America and Europe thus fell from nearly 75 per cent in 1985 to 49 per cent in 1992, with North America taking 34 per cent, Europe 15 per cent and Asia 35 per cent in that year (EIAK: 1993, 14; Dataquest: 1987, 7). After vying with consumer goods for first place among Korea’s electronics exports, components (mainly DRAMs) finally became the clear leader in 1989, accounting for 43 per cent of Korea’s electronics exports, compared to 36 per cent for consumer goods. Since then, the export share of components further increased, reaching 51 per cent in 1992, while that of consumer goods declined to 29 per cent. The pace and scale of the capacity and market share expansion of Korea’s semiconductor industry are unprecedented in the history of the electronics industry. Never before has a country been able to move so rapidly from the position of insignificant outsider to that of market leader in a highly capital-intensive industry with incredibly high risks and entry barriers. The magnitude of Korea’s achievements in this sector can be summarized in two simple examples. In the seven years between 1985 to 1992, the country’s semiconductor industry grew fivefold, from US$600 million to US$3.3 billion, and in the five years from 1988 to 1992, its worldwide semiconductor market share doubled from 2.5 to 5 per cent. While assembled chips were responsible for the largest share of Korea’s IC exports until 1987, since then the share of ICs produced in Korean wafer fabrication lines has substantially increased. Korea’s latecomer market penetration strategies experienced their most dramatic success in DRAMs, the main market segment for computer devices. From less than 8 per cent in 1988, its worldwide market share in DRAMs increased more than threefold to 24.5 per cent in 1992. In 1992, Samsung overtook Toshiba as the world’s largest DRAM producer with a world market share of 13.5 per cent. In the same year, Goldstar and Hyundai for the first time entered the group of the top ten DRAM producers, capturing a market share of 5. 8 per cent and 5.1 per cent respectively. These are impressive achievements for companies from a medium-sized country on the periphery of the world market. It should be remembered, however, that beyond DRAMs and some other memories such as SRAM and EPROM,

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Korean firms have played no role at all in international semiconductor markets. In other words, Korean firms are able to compete only in a particular segment of the world market (DRAMs) which, in 1992, generated roughly 22 per cent of worldwide semiconductor revenues. Korea’s competitive position in semiconductors thus remains very fragile. The three leading Korean producers are all in fact heavily dependent on computer memories. In 1992, 80 per cent of Samsung’s semiconductor revenues came from memories and this share was even higher (87 and 90 per cent) for Goldstar and Hyundai. It is this heavy dependence on memories which clearly distinguishes the Korean semiconductor industry from its international competitors. In contrast, only 35 per cent of semiconductor revenues in the largest Japanese semiconductor producer, NEC, are generated by MOS memories.61 The fragility of Korea’s electronics industry is also reflected in the slow development of industrial electronics. Between 1981 and 1992, industrial electronics increased its share in production and exports from 13 to 22 per cent and from 8 to 20 per cent respectively. Yet, most of this increase occurred between 1981 and 1985, and has since stagnated. By 1992, Korea’s production of industrial electronics, which amounted to roughly US$7.2 billion, was lagging well behind that of Singapore (US$9.4 billion), Brazil (US$8.3 billion) and Taiwan Province of China (US$8.1 billion), let alone the US$9.5 billion production value of Japan.62 Computer peripherals (most of them computer monitors) are by far the largest product category of industrial electronics. Telecommunications equipment plays only an insignificant role in Korea’s electronics exports. In contrast, Taiwan Province of China experienced rapid growth in the production and export of PCs and related peripheral equipment throughout the 1980s. Between 1985 and 1988, compound average annual growth rate of production for PCs reached 100 per cent, while that for keyboards, monitors and computer terminals came close to 50 per cent.63 For some of these products, such as computer motherboards and scanners, firms in Taiwan Province of China controlled nearly 70 per cent of the world market in 1991.64 In terms of overall changes in the composition of production and exports, the Korean electronics industry thus continues to depend, to a very large degree, on assembly-type mass production of lower-end consumer products and standard electronic components. The following section examines the forces which have shaped the particular pattern of production and exports and how government policies and firm strategies have interacted in this process. Government policies Initially at least, the electronics industry contradicts the common perception that foreign investment played only a minor role in the development of the Korean model.65 By opening up export channels for assembled chips and simple consumer devices, FDI did indeed play an important catalytic role during the

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critical early phase of the development of the Korean electronics industry. During this same period, FDI also exposed Korean workers and managers to new organizational techniques which, while not necessarily ‘best practice’, certainly contributed to a gradual erosion of the traditional highly authoritarian and rigid nature of Korean management practices.66 Cost-cutting and the need to comply with minimum international quality standards undoubtedly produced some limited indirect learning effects related to the formation of production and investment capabilities. Yet, this was about all that foreign investment was able to contribute during this early stage. For that to change, Korea needed systematic and well-coordinated government policies which could promote the development of Korean firms. Two arguments can be advanced for an active role of industrial and technology policies in the development of the Korean electronics industry. First, the by now widely accepted ‘late industrialization’ argument which shows that, without complementary government interventions, developing countries would have limited opportunities to begin any sustained industrialization process.67 Second, industrial and technology policies have played a prominent role nearly everywhere in providing externalities and helping firms to overcome entry barriers. There is now a rich literature which documents how critical such policies were in the United States, Europe and Japan.68 Table 3.4 provides a list of the main policies adopted by the Korean government to promote the electronics industry between 1967 and 1987. One of the most interesting features of these policies is how closely they followed the Japanese pattern of policy interventions. The selective and at the same time synchronous approach to import restrictions and export promotion was the basis for Korea’s catch up strategy in electronics. To this was added a rich arsenal of complementary legal supports designed to increase the effectiveness of the 1969 legislation to promote the electronics industry, including an Act for the promotion of national investment, an Act establishing preferential tax treatment, a special Act granting tariff rebates for raw materials used for exports and an Act respecting the promotion of small and medium-sized enterprises.69 Sectoral and product-specific targeting also played an important role from the outset, becoming more sophisticated during the Fourth Five Year Plan (1977– 1981), when the following products were identified as ‘strategic development products’ for the electronics industry:70 radios, black and white television sets, tape recorders, colour television sets, VCRs, digital watches and microwave ovens for the consumer electronics sector, minicomputers, computer peripherals (especially monitors), electronic telephone exchange equipments, lasers and electronic measurement equipment for the industrial electronics sector, and memory chips and connectors for the electronics components sector. The analysis of the product composition of Korean electronics exports has illustrated the effectiveness of such policies in promoting the rapid expansion of production capacity and exports in consumer electronics and for components. But there was no comparable development in industrial electronics, an important flaw

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in the otherwise excellent reputation of Korean-style industrial policy which needs to be explained. The types of policies that were conducive to the development of mass-production capabilities for consumer goods and components may not necessarily have been the most appropriate ones for developing a sound industrial electronics sector. It certainly cannot be argued that the government neglected the development of industrial electronics. Ever since Park Chung-Hee’s ambitious plans to move beyond labour-intensive assembly and to develop a broad industrial base during the 1970s, Korea’s industrial planners were convinced that, in order to sustain their earlier success in chip-assembly and low-end consumer electronics, industrial electronics would have to be substantially strengthened. In 1981, the Electronics Industry Promotion Act was revised to emphasize the production of electronic goods for industrial purposes rather than for household appliances, and the development of more advanced technology (Kim Hee-Nam: 1986, 4). By the mid-1980s, the prevailing feeling was that Korea was now strong enough to try to upgrade its electronics industry and to transform it into a Table 3.4 Continued strategic industry to push forward the modernization of its economy. It was also assumed that in this new stage of its industrial transformation, Korea could once again rely on its proven formula of tight cooperation between the state and the chaebols.71 These expectations were centred on two main spheres: the development of public switching systems and the promotion of a Korean computer industry, with particular emphasis on micro- and mini-computers. As part of the cross-national comparison undertaken in this volume, the focus here will be mainly on computers and semiconductors.72 Until 1987, Korea’s attempts to develop an internationally competitive computer industry appeared to be moving ahead satisfactorily. Both for 8-bit and 16-bit PC desktop machines, Korean firms rapidly increased their OEM exports, and growth was even faster for computer terminals and monitors. Competing in PC clones and computer monitors seemed scarcely different from competing in television sets or in chip assembly. What mattered was a reputation as a reliable low-cost producer. Assembly unit labour costs remained extremely low and the appreciation of the yen after the Plaza Agreement in September 1985 meant that Korean assemblers could now outcompete Japanese firms and attract a large segment of the rapidly growing OEM demand for cheap PC clones. In 1987, 15 of the then leading international computer firms were importing PCs from Korea on an OEM basis, including Epson, NCR, Computerland, Leading Edge and Olivetti (The Korea Development Bank: 1988, 188). Towards the end of that decade, however, drastic changes occurred in the nature of competition in the PC industry.73 On the supply side, technological change led to an increase of entry barriers; competitive success increasingly depended on a firm’s capacity to differentiate its product by sophisticated circuit design and system integration capabilities. As will be seen, these are precisely the areas in which Korean firms are weak. In addition, the shift from desktop to

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Table 3.4 Policies to promote the Korean electronics industry

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Source: Lee and Lee (1989) Note:a MTI: Ministry of Trade and Industry

laptop computers increased substantially the importance of certain bottleneck technologies, such as liquid crystal displays (LCDs) and batteries, which once again were not strong points of any of the Korean PC cloners. Finally, new competitors emerged in other countries, in particular in Taiwan Province of China. As late as 1987, the Korean government totally underestimated the

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magnitude of this threat, its only concern being that cheap Taiwanese PCs would ‘rush to the Korean market targeting low-end users such as students’ (The Korea Development Bank: 1988, 186). Due to their smaller size,74 computer-makers in Taiwan Province of China were able to react much more quickly to changing market trends. In addition, some of them were able to assemble strong circuit design teams through a reverse brain-drain from the United States and spin-off s from the government’s Industrial Technology Research Institute (ITRI), enabling them easily to outcompete the Korean chaebols.75 Probably the most important indicator of the extremely weak foundation of the Korean PC industry is its dependence on imported key components, which is much higher than in any other segment of the electronics industry. In 1994, for instance, almost 90 per cent of the key components used in Korean PCs were imported: processing units, chips and hard-disk drives from the United States and Taiwan Province of China, and LCDs from Japan.76 Even worse, many of the second-tier Korean computer firms were ‘merely selling finished products imported from Taiwan Province of China to Korean consumers’ (interview in the Korean Electronics Industry, November 1993). When Hyundai Electronics Industries Co. (HEI) decided in May 1992 to move all of its PC-related activities, including design, development, production and sales from Korea to San Jose in California, it became clear that something had gone badly wrong with the Korean PC industry. These earlier failures did not pass unnoticed by Korea’s industrial planners and learning from earlier mistakes actually has led to far-reaching changes in the basic thrust of many policies in the electronics industry. As can be seen, these shifts in policy approach closely followed the sequencing of industrial and technology policies in OECD countries, albeit with a certain time lag. Originally the focus had been on ‘industry-specific’ and ‘mission-oriented’ policies, with the former targeting a particular sector or even particular national champions, and the latter defined as focusing on ‘radical innovations needed to achieve clearly set out goals of national importance’ (Ergas: 1987, 52). A typical example was the decision of the Economic Planning Board (EPB) in May 1980 to target the semiconductor industry for promotion. Since the mid-1980s, however, the focus has gradually shifted to more ‘generic’ and ‘diffusion-oriented’ policies, where the main objective is the extension of ‘technological capabilities throughout the industrial structure, thus facilitating the ongoing and mainly incremental adaptation to change’ (Ergas: 1987, 52). Take the Korean Institute of Electronics Technology (KIET) and its successors, the Electronics Technology Research Institute (ETRI) and the Korea Electronics Technology Institute (KETI). In the late 1970s, KIET, with the help of a US$30 million World Bank loan, set up a pilot wafer fabrication facility for integrated circuits in collaboration with leading Korean electronics firms. It is very probable that the learning which resulted from this process made the subsequent entry by those firms into commercial circuit fabrication considerably easier. The facility itself was eventually sold off to Goldstar which turned it into

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a commercial wafer fabrication line. In 1989, the Ministry of Trade and Industry (MTI) initiated a programme to subsidize the development of ‘key technologies for the electronics industry’, some of which represented mundane bottlenecks in existing production capabilities—for example, heat treatment, printing, and moulding technologies—while others constituted frontier technologies—for example, 16-Mbit DRAMs. The development of the Korean approach to joint consortia for the development of DRAM technology is a good example of this shift from missionoriented to more diffusion-oriented policies. While the 1-Mbit and 4-Mbit consortia focused on the rapid development of engineering samples, the main purpose of the 16-Mbit consortium, initiated in 1989, has been the establishment of a new government laboratory in collaboration with the three major DRAM manufacturers, Samsung, Goldstar and Hyundai. This shift to providing the necessary externalities was to be even more explicit in the new 256-Mbit consortium established in November 1993. Unlike earlier consortia, the newer consortium was aimed at developing the equipment and materials needed to produce circuits and thus followed quite closely the shift of emphasis which occurred in the Sematech and JESSI projects.77 For the development of engineering samples and the accumulation of related patent portfolios, each of the three major Korean DRAM producers has entered into international technology alliances—Samsung Electronic with NEC, Hyundai with Fujitsu and Goldstar with Hitachi.78 This shift towards a more selective focus in governmentindustry consortia is a substantial improvement and indicates a growing realism on the part of the Korean government as to which areas it should best address. The shift to diffusion-oriented policies is even more evident in two recent government programmes related to the electronics industry. In August 1993, the government announced a plan for the installation of a broadband ISDN information highway that would address the increasingly demanding communication requirements of government agencies, educational and research institutes and corporate research centres (Electronics, 23 August 1993, 10). This plan is seen as an essential prerequisite for spreading the use of information technologies, which could, in turn, help improve the sophistication of domestic demand and thus perhaps reduce the Korean electronics industry’s excessive dependence on foreign markets. The increasing emphasis on diffusion-related policies is also reflected in the programme to establish an information-processing industry complex in Yongin (Kyonggi Province), announced by the now renamed Ministry of Trade, Industry and Energy (MOTIE) in January 1994 (Electronics, 10 January 1994, 10). The main purpose of this won 35 billion (US $43.75 million) project is to encourage the formation of SMEs active in software development and system integration which have been identified as the main bottlenecks for the development of a local computer industry. While the shift from high-risk sectoral targeting to broader diffusion-oriented policies is real, it is probably fair to say that those favouring the latter policies still constitute a minority among policy-makers and bureaucrats. Old habits die

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hard and this is also true for traditional targeting policies to promote the Korean electronics industry.79 Firm strategies and industrial structure While Korea’s export growth in electronics was originally spearheaded by foreign firms, the Korean government and the chaebols played an increasingly important role, especially from the mid-1970s. This was due to a number of factors. In semiconductor assembly, for instance, American firms were attracted by new low-cost locations in the Philippines and Malaysia and gradually shifted most of their assembly activities to those two countries. Confronted with the rising cost of capital, most of these companies were also keen to reduce their equity participation and began to shift to much looser forms of contract assembly, subcontracting and OEM arrangements (Ernst: 1983). This created new opportunities for Korean companies; Anam Industrial, for instance, has become the world’s largest independent SC contractor assembler. Government policies also played an important role. The gradual withdrawal of foreign firms from assembly operations in Korea was also a response to the increasingly demanding requirements imposed by the Korean government on foreign firms to contribute to local value added and to increase the transfer of technology. Japanese firms in particular were reluctant to open up their closed international production networks and became concerned about a possible ‘boomerang effect’ through involuntary technology leakages. At the same time, rising competition from the increasingly powerful chaebols put further pressure on foreign firms. Confronted with the choice of either upgrading existing operations beyond the assembly stage and doing so in cooperation with local firms, or shifting production elsewhere within East Asia, most firms opted for the latter. As a result, Korea now has one of the lowest rates of inward investment in East Asia,80 despite serious attempts by various Korean governments to bring foreign investment back into the country as a vehicle for accelerated technology diffusion. Since 1988, the country has failed to appear on the list of the preferred ten foreign investment locations for both United States and Japanese electronics firms. Another important feature is the extreme degree of concentration which is much higher than Japan (Kohama and Urata: 1993, 152). Korea’s electronics industry is controlled by four companies—Samsung, Goldstar, Hyundai and Daewoo. In 1988, 56 per cent of the country’s electronics production came from these four groups, with the first two alone accounting for 46 per cent of production (Bloom: 1992, p. 12). The figures are even more remarkable on an item-by-item basis with Samsung, Lucky Goldstar and Daewoo accounting for 100 per cent of the VCRs, microwave ovens, refrigerators and washing machines and 82.2 per cent of the CTVs produced locally (Bark: 1991, 32).81 Sellers’ concentration ratios in the domestic market are even higher: until the early 1990s, Samsung, Goldstar and Daewoo had control over roughly 70 per

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cent of the Korean market (author’s interviews). For CTVs, VCRs, microwave ovens, refrigerators and washing machines, the Big Three’s domestic market share came close to 100 per cent. Due to the gradual liberalization of the domestic market for consumer goods and industrial electronics, this tight control of the domestic market is beginning to erode. Yet while the chaebols may lose control over final product markets, their dominant position in components, and especially DRAM memories, may last much longer. In 1992 for instance, the total semiconductor and electronics sale of one company alone, Samsung Electronics, accounted for 20 per cent of the Korean electronics industry’s exports.82 None of the big electronics groups in Japan comes close to such an overwhelming position of dominance. In short, the Korean electronics industry retains a structure which, according to textbook wisdom, is no longer supposed to exist: a tight national oligopoly controls both domestic production and the domestic market. This has given rise to a peculiar form of competition strategy focusing on incessant product diversification, often into technologically unrelated areas as already noted for the textile and clothing industry. Each time a chaebol has reached the limits of ‘easy’ capacity and market share expansion for a particular product, it moved on to a new product group promising rapid market expansion. Rather than using diversification as an instrument for deepening their involvement in a particular sector or group of related products, the chaebols have typically used diversification as a short-cut to rapid market share expansion, without much concern for the depth of the production system that can be generated by such shallow forms of diversification. This ‘octopus-like’ process has made it very difficult for most Korean electronics companies to accumulate systematically a broad range of technological capabilities for a given set of products.83 Here lies one of the most important differences between chaebol-type business strategies and those pursued by the Japanese electronics firms, which typically have been reluctant to engage in product diversification. A survey of the 200 largest Japanese industrial firms undertaken by Fruin84 shows that only 40 per cent of them engaged in a limited amount of diversification, with 41 per cent of new goods being in the same two-digit SIC category as the firm’s established products.85 Gerlach has also shown that Japanese diversification has predominantly resulted in the ‘spinningoff ’ of new subsidiaries that retain a certain degree of decision autonomy from the parent company.86 At least for the electronics industry, there are grounds for challenging Amsden’s claim that constant ‘diversification into many technologically-unrelated mature product markets was one of the essential “pillars” of Korea’s successful late industrialization and that, in doing so, it was dutifully following the earlier Japanese example’ (Amsden: 1993, 17–18). The chaebol’s dominance in the electronics industry has also had a negative effect on the role of SMEs engaged in the supply of parts and components and other complementary support activities. Although formally independent, most of

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them are tightly integrated into the production networks of one of the four major chaebols. Until the early 1980s, this had resulted in an industry structure where the leading chaebols tended to produce almost everything in-house, from electronics components and electrical accessories to transistors, semiconductors and precision engineering parts (Wong Poh Kam: 1991, 53). Since then, they have been forced to increase their reliance on domestic subcontractors for two main reasons. As a result of the proliferation of labour disputes since the famous wave of strikes in June 1987, the chaebols are now eager to shift the burden of increasing labour costs onto the shoulders of formally independent domestic suppliers. At the same time, the growing sophistication of Korea’s electronics production has led to an increasing demand for local support industries and services. With increasing cost constraints, the chaebols are now more willing to outsource some of these activities. Unlike textile and clothing subcontractors, however, subcontractors in the electronics industry work for only one manufacturer and are thus locked into a fairly closed production network controlled by a particular chaebol. Small and medium-sized suppliers have very limited decision-making autonomy, which significantly limits any attempts to improve their international competitiveness. In recent years, the government has started to give greater attention to the promotion of SMEs capable of developing their own component designs. This has led to a variety of new policy instruments designed to improve the competitive conditions for innovative start-up companies.87 Most observers agree that such policies have had only limited success. A recent survey by the School of Small Business at Soongsil University indicates that 70 per cent of government-allocated credit goes to a few relatively large SMEs with strong ties with the leading chaebols through subcontracting arrangements.88 One particularly ironic finding is that many of these small businesses are becoming ‘mini-chaebols’ by branching into various businesses but keeping each of the companies small to maintain access to cheap credit. Once again, old habits die hard, and the pervasive reliance on government-funded horizontal diversification seems to be particularly resistant to change. The independent SME sector will probably remain weak and vulnerable for some time to come. This sets Korea apart from the Japanese production system, with its sophisticated multi-tier supplier networks, where small companies can be found at all levels with sound design and engineering capabilities for components and materials.89 This lack of a strong domestic supplier network of SMEs also marks a major difference with Taiwan Province of China, where highly flexible domestic subcontracting networks based on SMEs have played a crucial role in the development of Taiwanese electronics exports.90 Squeezed in between the chaebols and the myriad of SMEs are a handful of independent, medium-sized second-tier firms, each of which is basically organized again as a mini-chaebol. Typical examples of these second-tier firms include the Anam group, with Anam Industrial as its flagship company, and Trigem Computer. In an industry dominated by chaebols with their privileged

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access to government bureaucrats, both companies are able to survive only by identifying smaller, but lucrative, niche markets that the chaebols have neglected. An additional prerequisite, it seems, has been a long-term relationship with a foreign company: Trigem Computer through its joint venture with Seiko Epson, and Anam through its link with its United States marketing affiliate, Amkor, the original founding company of Anam Industrial. While Japan’s electronics industry includes a number of originally small or medium-sized, highly innovative start-up companies like Sony, Kyocera, Canon, Minebea or Uniden, the tight oligopoly governing the Korean electronics industry has made this almost impossible.91 Building technological capabilities the Korean way When Korea entered the international electronics market in the late 1960s, its main concern mirrored that of the Japanese electronics industry in the early 1950s: to master as quickly as possible those types of production technology enabling it to capitalize on its low labour costs and, at the same time, to reap economies of scale. Logically, this implied a focus on rapid capacity and market share expansion. Almost by definition, this in turn meant that growth would have to occur primarily through borrowed technology. Offshore assembly by foreign firms in the 1960s and 1970s provided relatively limited learning possibilities. Building domestic technological capabilities based on foreign technologies therefore required a different approach. Rather than letting foreign firms establish local subsidiaries and decide on the speed and scope of technology diffusion, Korean firms focused on learning and knowledge accumulation through a variety of business networks with foreign equipment and component suppliers, technology licensing partners, OEM clients and minority JV partners. By licensing well-proven foreign product designs and importing most of the production equipment and crucial components, Korean electronics producers were able to concentrate most of their attention on three areas: (1) the mastery of production capabilities, initially for assembly, but increasingly also for related support services and large mass production lines for standard products; (2) some related minor change capabilities, ranging from ‘reverse engineering’ techniques to ‘analytical design’ and some ‘system engineering’ capabilities that are required for process re-engineering and product customization; and, (3) some investment capabilities, especially the capacity to carry out at short notice and at low-cost investments in the capacity expansion and/or modernization of existing plants and the establishment of new production lines. Korean electronics firms also borrowed from the earlier Japanese experience and pursued a particular type of innovation management. The main objective was to master and implement, as quickly as possible, imported production and process technologies. This required a willingness on the part of Korean firms to absorb foreign management practices and organizational routines and adapt them

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to their own needs. Learning from foreign experience was of critical importance. Conscious efforts were also needed to develop the necessary knowledge and skills to monitor, unpackage and absorb foreign technology, with a strong emphasis on shop floor experience through learning-by-doing and on gradual improvements of imported process technologies. But the most important prerequisite was the willingness of most Korean electronics manufacturers to mobilize the financial resources required for the considerable technology licensing fees and for importing ‘best practice’ production equipment and leading-edge components. Most Korean electronics firms, already in the 1970s, had to spend roughly 3 per cent of their sales on technology licensing fees, a share which has since increased to more than 12 per cent (Lee Jinjoo: 1991, 132 and 139). Left on their own, most Korean electronics producers would arguably have hesitated to pursue such high-cost, high-risk strategies, had they not been induced to do so by a variety of selective policy interventions that were ‘marketaugmenting (reducing risks and uncertainties) rather than market-repressing planning (increasing fragmentation of the market or rent-seeking opportunities)’ (Johnson: 1987, 141). Getting relative prices ‘wrong’ (Amsden: 1989) proved to be the only way to motivate the chaebols to engage in the high-risk investment required for technology acquisition and the improvement of production and investment capabilities. It is due to these particular and historically conditioned circumstances that Korea’s electronics firms were able to reverse the sequence of technological capability formation (Dahlman, Ross-Larson and Westphal: 1987). Rather than proceeding from innovation to investment to production, they could take a shortcut and focus on the ability to operate production facilities according to competitive cost and quality standards. Production capabilities were thus used as the foundation for developing capabilities in investment and adaptive engineering, while product and market development and process innovation were postponed to a later stage of development. Through judicious ‘reverse engineering’ and other forms of copying and imitating foreign technology and by integrating into the increasingly complex global supply networks of United States, Japanese and some European electronics companies, Korean electronics firms were able to avoid the huge cost burdens and risks involved in R&D and in setting up international distribution and marketing networks. While this approach was very successful during the technological catching up phase, it has now become an important constraint. Because of an overriding concern with production technology, Korean R&D, product design and market development capabilities have lagged well behind those of their international competitors. In what follows, we will focus on the example of semiconductors.92 Korea’s involvement in the semiconductor industry began in the late 1960s as a low-cost assembly base for export-oriented semiconductor multinationals.93 At the time, assembly was a highly labour-intensive process with more skill- and

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capital-intensive design and wafer fabrication stages of production performed exclusively in OECD countries. Under the Heavy and Chemical Industrialization Plan, the government had targeted semiconductors as a strategic industry. The chaebols were certainly eager to profit from the government’s spending spree in the mid-1970s and firms which had never had any contact with the electronics industry now declared their interest in diversifying into wafer fabrication. They included textile groups, such as Sunkyung, Wonjin and Samdo; Lotte, the powerful food processing and real estate group; and a variety of other chaebols engaged in heavy industry and construction, such as Korea Explosive, Ssangyong, Donga Construction, Dongkuk Steel, and the Kukje group (Soh Changrok: 1991, 271). However, although they received substantial subsidies, none of these firms invested seriously in wafer fabrication lines. The situation changed in the early 1980s. By that time a handful of Korean chaebols had become serious contenders in the world electronics industry for a variety of consumer goods. While on the surface everything seemed to be going well, two dark spots did not escape the attention of the chaebol strategists. The first concerned Korea’s heavy reliance on component imports. The second resulted from the proliferation of protectionist measures in OECD countries against Japanese electronics consumer goods that it was clear would soon extend to Korean exports. Chaebol planners thus felt that it was time to consider further product diversification, with semiconductors being an ideal candidate, since their production requirements (high capital intensity, mass production of standard products) matched well with the strengths of the chaebols.94 The chaebols were confident that they could leverage their mass-production capabilities to establish a strong position quickly and achieve reasonable profits. The shift into the mass production of computer memories was spearheaded by Samsung and Goldstar, with Hyundai in the role of the aggressive latecomer. In 1983, the government introduced its Semiconductor Industry Promotion Plan which, in addition to a wide range of tax incentives, provided substantial policy loans to ‘activities related to the development of domestic wafer fabrication’.95 In the same year, Samsung announced that it would spend US$1.5 billion on its entry into the mass production of computer memories (DRAMs) and make large additional investment outlays in the long term.96 The goal was to enter mass production of 64k DRAM computer memories as quickly as possible to reap the high profits typical of the early product innovation phase.97 This was a tough challenge even for a cash-rich conglomerate like Samsung which could only be met as a result of a number of very specific circumstances. Having decided to rely on a proven foreign chip design, Samsung’s first challenge was to find a foreign company willing to license the design. For both the initial 64k DRAM and for the next generation of 256k, Samsung was able to obtain a licence from Micron Technology. This medium-sized United States DRAM producer was, along with Texas Instruments, the only survivor of the successful conquest of the DRAM business by Japanese semiconductor firms. For

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Micron, licensing technology not only brought a desperately needed cash infusion but provided a potential low-cost second source that would act as a buffer during periods of rapid demand growth thus enabling it to keep its own investments to a minimum. A second and more important challenge was to develop the sophisticated process technology which is the key to success in DRAM competition. Integrated circuit fabrication consists of a large variety of extremely complex chemical processes—for the 64k DRAMs, for instance, 309 individual manufacturing steps were required. Each of these different processes sequentially defines the circuit elements on the silicon wafer by introducing and diffusing the appropriate impurities into the defined areas. Many of the steps occur at high temperatures (almost 1,000° C) and all involve the precise repetition of almost identical, but slightly different steps. There are over 1,000 variables, the handling of which requires knowledge of the distribution pattern resulting from a change in each variable. Yet such knowledge is still at a very rudimentary level. Improving yields, i.e. the number of saleable devices as a percentage of devices started, thus requires an extremely tedious process of ‘trial and error’ which often borders on alchemy rather than scientific engineering. Moving from a circuit design to mass production thus normally requires much time and effort, with little control over whether the deadlines for market entry can be effectively met. In order to speed up time to market, therefore, Samsung chose to license CMOS process technology. Sharp (Japan), an innovative consumer electronics and appliance producer that had pioneered the world’s first liquid crystal display (LCD) in 1973 and become the world leader for LCDs, was willing to share this technology for several reasons. Although Sharp has been a long-term producer of DRAMs with excellent process technology, with a world market share of hardly 3 per cent, its strategic focus was quite different from that of the ‘Five Sisters’ (Toshiba, NEC, Hitachi, Fujitsu and Mitsubishi), the core members of the Japanese DRAM oligopoly. The main purpose of Sharp’s involvement in DRAMs was not market share expansion but to use the process technology developed for DRAMs to improve the yields of its LCD production. Licensing its DRAM process technology to Samsung thus generated the cash required for its very capital-intensive LCD production, while at the same time helping to erode the overwhelming dominance by the ‘Five Sisters’ over the world DRAM markets. In addition to licensing the process technology, Samsung hired, on fairly attractive terms, a group of young engineers trained in semiconductor process technology right after their graduation from leading United States universities and assigned independent foreign consultants to assist with their in-house training and integration into a highly motivated project team. The project was finished in the record time of 6 months and, equally important, Samsung was able to construct its wafer fabrication line in only 6 months, substantially faster than the 18 months normally required. As a result, Samsung began its mass production of the 64k DRAM chip for export to the United States and Europe in the spring of 1984.

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By late 1984, the 256k DRAM had been developed and production was launched in 1986. Although Samsung had again licensed a design from Micron for this second generation of DRAM devices, its own design efforts this time went much further, with Micron’s design being submitted to extensive ‘reverse engineering’. Samsung pursued a dual strategy by carrying out development work simultaneously at its headquarters laboratory and in its affiliate in Silicon Valley, with development including chip design. The explicit goal of combining ‘reverse engineering’ with parallel work on chip design was to maximize inhouse learning possibilities and to develop as quickly as possible its own design capabilities. This strategy worked extremely well: the headquarters team completed its task at record speed, but the Silicon Valley team produced a qualitatively better design in terms of performance features and manufacturability which was used for production purposes. This small example says a lot about the strengths and weaknesses of the Korean way of building technological capabilities. Within the highly regimented environment of a chaebol, absolute dedication to meet a target and to do so at breakneck speed could be taken for granted, at least until very recently.98 At the same time, however, there appears to be a deeply entrenched habit of following the benchmarks set by technology leaders, with very limited effort to attempt any new or unconventional solutions. In many cases, therefore, the quality of domestic development results cannot compare with that of those of a United States-style research environment, whether in the United States itself or in Taiwan Province of China or Israel. But this example also reveals something about the pragmatic approach of Korea’s strategic planners in seeking innovative solutions to bridge the time needed to build up the necessary capabilities at home. The 256k DRAM development was clearly a breakthrough and from then on, Samsung was able to rely on its own design efforts for DRAM devices. In 1987, it began the production of 1-Mbit DRAMs and has been able to catch up since then with the Japanese industry leaders NEC and Toshiba. While in June 1990 Samsung was still reported to be about one year behind NEC and Toshiba, in April 1992, it claimed to have drawn even with its 16-Mbit design. According to another source, NEC was reported in March 1993 to be six months ahead of Samsung with its 64-Mbit design (Electronic Engineering Times, 29 March 1993). However, the real issue today is the variety of designs that a company can offer for any particular DRAM generation and here NEC clearly continues to lead. This was also acknowledged by both companies when they announced their agreement for the joint development of 256-Mbit DRAMs in March 1994 (Computergram, 2 March 1994). Two external factors help to explain the dramatic success of Korean companies in expanding international market share. First, the unintended yet very consequential side effects of the September 1986 United States-Japanese agreement on trade in semiconductors. Due to the unrealistically high price floors set for DRAM imports into the United States, Korean producers were able to outprice their Japanese rivals at price levels that, in 1989, began to generate

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substantial profits (Ernst: 1987). Second, the strategic decision of United States semiconductor producers and computer companies to create an alternative, lowcost source for DRAMs to counter oligopolistic pricing and supply behaviour by the Japanese majors (Ernst and O’Connor: 1992). But the opportunities offered by these external factors cannot detract from the willingness and the capacity to spend huge amounts of money on investment and technology acquisition that led to the building of technological capabilities in Korean semiconductor firms.99 Between 1983 and 1989, the three chaebols were reported to have invested more than US$4 billion on production equipment. This amount was the entry fee. But if catching up was already quite costly, keeping up and getting ahead bring an even higher fixed capital cost burden. Annual capital spending increased from US$800 million in 1987 to an estimated US$1,350 billion in 1993, more than 20 per cent of the world’s total semiconductor facility investment. In the same year, Samsung alone had the third largest capital expenditures on production equipment (US$930 million), after Intel (US$2.1 billion) and Motorola (US$973 million), but well ahead of Toshiba (US$519 million), NEC (US$482 million) and Hitachi (US$409 million). Even Goldstar’s and Hyundai’s capital expenditures of US$417 million and US$401 million, respectively, came close to or even surpassed those of their Japanese rivals (Electronic News, 6 December 1994, 4). In sum, keeping up is costing a veritable fortune. Between 1988 and 1992 the accumulated capital spending of Korea’s semiconductor chaebols came to US$5.7 billion out of a sales total of US$10.2 billion (Dataquest, September 1993). To this must be added the substantial licensing fees that Korean semiconductor producers have to pay for United States and Japanese technology. It is estimated that, in 1992 and 1993, the Korean semiconductor industry spent 14 and 16 per cent of its annual turnover on royalty payments, i.e., US$281 million and US$322 million, respectively. Keeping up and getting ahead have also required a judicious combination of three technological acquisition strategies which enabled the chaebols to participate in international technology networks and maximize their internal learning possibilities. Early on, all of them established subsidiaries in Silicon Valley which served as listening posts for intelligence-gathering on technology and market trends. Their R&D activities were also used to complement, direct or correct similar efforts at home. Each of the firms also continued to rely on ‘second-sourcing’ agreements, licensing DRAM designs from leading United States and Japanese semiconductor producers. Examples of second-sourcing include the following link-ups: Goldstar with AT&T (for 256k DRAMs) and Hitachi (for 1 Mbit and 4 Mbit DRAMs), Hyundai with Texas Instruments (for 256k and 1-Mbit DRAMs), and Samsung with Micron Technology (256k DRAMs) and Intel (microcon trollers, microprocessors, DRAMs and EPROMs). The chaebols also used a third approach to technology acquisition through contract manufacturing, the so-called silicon foundry services provided for leading United States ASIC companies, such as LSI Logic and VLSI

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Technology. Based on the gate array or standard cell designs received from these foreign companies, the chaebols used their strength in process technology and capacity to improve yields rapidly to produce such devices at short notice. Being forced to comply with the stringent design rules typical for ASIC devices, the chaebols were in this way able to deepen their knowledge of process improvements. As the chaebols expanded their share in international DRAM markets, their bargaining position with regard to licensing agreements improved. This led to cross-licensing and mutual patent swaps which now link all the chaebols with the leading Japanese semiconductor producers. Today the chaebols are involved in increasingly complex international technology sourcing networks that include links with other firms (inter-firm networks) and attempts to tap into and use key elements of the national innovation systems of other countries (interorganizational net works). Table 3.5 documents some of the inter-firm technology networks that Samsung Electronics, for example, entered between 1982 and 1992. These networks now cover a great variety of different arrangements and involve Samsung in the development of frontier products. Today, Korea has excellent assembly capabilities over a broad range of products. Its wafer fabrication capabilities are state-of-the-art for a limited number of products, i.e., DRAMs, SRAMs and ROMs. There are, however, some glaring deficits, in particular for circuit design. Korea’s semiconductor industry, however, is based on an extremely weak foundation, in terms of the necessary materials and production equipment. In 1991, 90 per cent of production equipment had to be imported, with 50 per cent coming from Japan. It will be extremely difficult to reduce this dependence, only joint production with leading overseas manufacturers is likely to help. There is some evidence now that this pragmatic strategy may work. As Korea has become the ‘hottest market’ for semiconductor production equipment, leading United States producers such as Applied Materials, Lam Research and Varian Associates have concluded such local joint ventures (author’s interviews). This, in turn, may help overcome the deeply ingrained resistance of Japanese equipment manufacturers, especially Canon and Nikkon, to establish similar joint ventures with Korean partners. Levels of import dependence are also quite high for semiconductor materials, particularly high value special materials. Korea’s current annual consumption of semiconductor materials is approximately US$600 million, with 70 per cent of total consumption being imported (40 per cent from Japan and 20 per cent from the United States). Some progress has been made in the domestic production of silicon wafers, using foreign technology obtained either through licensing or joint ventures. Most domestic production, however, is still restricted to relatively simple materials like lead frame, bonding wire and packaging materials for chipassembly. Probably the major weaknesses, however, relate to circuit design and the limited capacity of Korean firms to broaden their product portfolio and develop

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Table 3.5 Inter-firm technology networks, 1982–1992

Source: Dataquest (September 1993)

new products and markets. The absence of Korea from most international semiconductor markets has led to a very unbalanced international trade structure that may not be sustainable for long: Korea continuously has an enormous trade surplus for memory chips, while at the same time accumulating equally huge deficits for microprocessors, ASICs and video image chips.

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The narrow focus on memory products also has negative repercussions on the overall structure of the electronics industry. Korea continues to export more than 90 per cent of its total semiconductor output, while at the same time importing more than 87 per cent of its domestic demand. Such an extreme imbalance between supply and demand makes it very difficult to broaden and deepen forward and backward linkages within the electronics industry and to place it onto a more viable basis. It is probably fair to say that Korea’s semiconductor industry represents today a modern version of the classical mono-product export enclave characterized by a minimum of linkages with the domestic economy. There is, however, one important difference: the exceedingly high costs of entering the semiconductor industry. The key issue for the Korean semiconductor industry today is whether or not it will succeed in broadening its product portfolio and move beyond computer memories. No chaebol, as of the mid-1990s, has yet found a promising approach to achieving this goal. One of the main reasons why this process is so slow is that Korean firms have been able to accumulate only a small number of patents. Although they qualify for cross-licensing agreements for process technology and are also now more interesting partners for international coalitions to fix standards, they are in a very weak position in their search for technology alliances in microprocessors and ASICs. Overall, our interviews have shown that innovation management in the electronics chaebols is still overwhelmingly dominated by a production bias, which raises questions about the degree and speed with which design and product development capabilities can be developed in the future. Samsung, Goldstar and Hyundai have been unable to move beyond their strength in mass production and establish a firm foothold in highly R&D-intensive forms of industrial production. The very high entry barriers typical for DRAMs are due less to their R&D requirements than to their capital-intensity, very high economies of scale and the extremely volatile nature of demand. The minimum efficient scale for production is now more than US$1 billion of annual sales, which means that only firms that have reached the critical threshold of 5 per cent of world production are likely to be able to compete successfully. In contrast to other segments of the semiconductor industry such as microprocessors and logic devices, competition in DRAMs centres on the capacity to invest in huge mega-plants turning out a limited variety of standard products and on the capacity to improve yields and productivity as quickly as possible. Wafer fabrication lines for MOS memories thus come very close to the archetypal mass production line. Nor is R&D any guarantee for success in DRAMs where designs are not very complex when compared to microprocessors, logic and analogue devices. The main focus is on improving process technology, exploiting learning economies and increasing yields, primarily through continuous improvements on the shopfloor and tedious trial and error. DRAM designs need to be simple, repetitive and safe enough, so that the risks and complications entailed in production with complex process

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technologies are minimized. The device should be easily testable in order to isolate defects. With progressive miniaturization, this last requirement becomes even more important: circuits are so tiny that if defects cannot be located by electrical testing, finding them becomes prohibitively expensive. To compete in the DRAM market, a firm must be able to mobilize huge investment funds, implement complex investment projects quickly and at low cost, and have sufficient financial clout to discount the periodic huge losses that result from extremely volatile demand and the periodic emergence of huge surplus capacities. Once these fundamentals are in place, a firm needs to organize its production in such a way that it can rapidly improve yields and be the first to the market as the lowest-cost supplier. These are precisely the strengths of the semiconductor chaebols and it is these strengths which led to the impressive achievements of Korean companies in catching up and keeping up in the mass production of computer memories. But they are not the strengths needed to broaden their product portfolio and get ahead in more R&D-intensive devices such as microprocessors or ASICs. Weaknesses in the Korean innovation system and the challenge of gettingahead in electronics Since the beginning of the 1990s, important changes have occurred in the nature of international competition in the electronics industry. Probably the most serious immediate challenge is that demand growth in the major export markets in the United States and Europe has slowed down drastically, with Japan still failing to provide a compensatory stimulus. Given the extreme export dependence of Korea’s electronics industry, this obviously poses a serious challenge. In a situation where rapid demand growth is no longer assured, price competition continues to play an important role, although on its own it is not sufficient to sustain, let alone expand, market shares. Product differentiation capabilities thus become an essential prerequisite for competitive success, a challenge which is more difficult to meet as the speed of technological obsolescence accelerates. Korea has to cope with these new requirements in a substantially more hostile international environment. In contrast to their Japanese, American and European counterparts, a medium-sized country like Korea, which only recently joined the international market, is less well-equipped to cope with the restrictions imposed on international trade, investment and technology flows by the proliferation of ‘high-tech neo-mercantilism’ (Ernst and O’Connor: 1989, 26 passim). Head-on competition with market leaders in ‘high-end applications’ is out of the question. An alternative approach, chosen in particular by Taiwanese firms, is to pursue a number of indirect entry strategies which focus on niche markets related to specialized needs and capabilities. The flipside of this approach is that profit margins are normally quite low and, if they increase, this invites raiding by larger companies. Once this happens, size and the capacity to mobilize financial

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and human resources become critical factors and smaller firms find themselves stuck in a ‘niche market trap’. A second approach, which has been that chosen so far by the chaebols, is to try to implement ‘quick follower’ or ‘fast second’ strategies right behind the back of the market leaders. This approach normally comes in two versions: a focus on low-end or mid-level applications for final goods, especially consumer durables such as colour TVs and VCRs; or a focus on the production of standard components that are heavily dependent on economies of scale and scope and thus require large fixed capital outlays. In Korea, this approach has produced impressive results, but the costs are enormous; and even the most powerful chaebols are finding it difficult to implement such a strategy. In consumer electronics and computer peripherals, this is due to proliferating price wars and the emergence of new low-cost high-productivity competitors in South-East Asia, most of which are part of the expanding Japanese supplier network in the region.100 While the chaebols have been able so far to cope with this new challenge, sooner rather than later they will have to upgrade their competitive position. This poses a major dilemma for the Korean electronics industry. How can it upgrade its competitive position through improved product differentiation and market development capabilities, by shifting its focus towards the first approach —without losing the strengths that have been developed over time in the second approach, i.e., the formidable mass production capabilities resulting from superior size and oligopolistic market control? Weaknesses in the national system of innovation have drawn particular attention in this regard. With a large number of well-trained engineers and technicians and relatively low wages, the Korean electronics industry became a prime OEM source for Japanese, American and European companies in the 1970s. Yet Korean firms have lagged behind in their R&D expenditures. During the first half of the 1960s, for instance, Korean electronic firms spent barely 1 per cent of their turnover on R&D (Kim Hee-Nam: 1986, 11). Writing towards the end of the 1970s, Larry Westphal characterized the electronics industry as shallow: ‘Electronics production is largely an assembly operation, and little infusion of the basic technological know-how has taken place’ (Westphal: 1979, 252). Over the 1980s, Korea’s comparative labour cost advantages eroded, product lifecycles shortened and competition intensified in the electronics industry. In response to these changes, the country slowly began to develop its own R&D capacity stimulated by ‘specific promotion policies for the electronics industry [which] provided preferential financial loans for R&D projects, new product development and facility investment funds for selected firms’ (Bark: 1991, 29). Tax concessions for R&D were also offered and between 1980 and 1984, the number of industry-managed R&D institutes increased from 8 to 32. In addition, three government research institutes and 11 cooperatives run by SMEs were operating by mid-decade. The increased attention to R&D was also reflected in

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the growth of company spending, which reached over 3 per cent of turnover in 1985. The real growth in R&D activity, however, dates only from the late 1980s and follows upon increased R&D support through linkages between enterprises and between firms and research institutions under the Sixth Five Year Economic and Social Development Plan and the preferential financial treatment and taxsupporting measures made available for R&D and facility investment under the Industrial Development Act of 1986. These measures and the increasing pressure on the chaebols to move beyond a catch up strategy led to a substantial increase in R&D activity. In 1985, for example, 5,249 persons were engaged in R&D in the electronics industry, accounting for 32 per cent of research workers in all Korean industry. By 1990, the number had risen to 12,865 (37 per cent) and a year later, to 15,923 (41 per cent) (EIAK: 1992, 6). Over the same period, the share of R&D investment in GNP increased from 1.8 per cent in 1985 to 2.5 per cent in 1991. Important changes have also occurred in the funding of Korea’s R&D investments, with the public sector share falling dramatically from 68 per cent in 1978 to 16 per cent in 1990 (Kim Linsu: 1993, 5–11). The private sector has become the driving force behind the country’s R&D investments. In constant prices, R&D spending in the manufacturing sector more than quadrupled between 1976 and 1990, and firms expanded their R&D expenditures substantially faster than their sales: R&D spending as a ratio of total sales increased from 0.36 per cent in 1976 to 1.96 per cent in 1990. While this is an impressive achievement, it is still less than half of the current ratio of United States and Japanese manufacturing companies and substantially lower than the critical threshold level required for moving beyond the technology catching up stage. Recent research on the national system of innovation in Korea has identified a number of basic structural weaknesses, the most important of which is that science and technology decisions continue to be overwhelmingly shaped by the strategies of the leading chaebols.101 Chaebols control the key assets and capabilities of Korea’s innovation system. They can hire the best scientists and engineers, most of them with foreigneducated Ph.D.s, often with extensive experience at major MNCs in the United States and Japan. This obviously puts Korean SMEs at a major disadvantage. Serious problems have also been detected concerning the effectiveness of the chaebols’ innovation management. While external technology-sourcing strategies are highly sophisticated, the organization of innovation within these firms remains ineffectual and organizational conservatism continues to prevail. In contrast to the progressive decentralization of R&D which is typical today for Japanese, United States and European firms and has led to an increasing outsourcing of technological development, ‘the Korean manufacturing industry is still at the stage of establishing centralized R&D laboratories with the objective of concentrating scarce resources in R&D’ (Kim Ilyong and Chung Sun

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Yang: 1991, 6). The most important reasons for Korea’s technological weaknesses in the electronics industry are home-made and reflect the highly concentrated industry structure and the resultant neglect of serious R&D efforts. This is particularly true of the leading electronics companies. As they face growing restrictions in international technology markets, these firms have shifted to quite extreme forms of centralized in-house technology generation. Debates within the OECD context (OECD: 1992, Chapters 1–3) have indicated that innovation today is characterized by continuous and numerous interactions and feedbacks among a great variety of economic actors and across all stages of the value chain. Organizing R&D in a centralized manner is bound to produce rigid procedures for information management and decision-making, with the result that product-design cycles and speed to market become much too long. Furthermore, centralized R&D organizations are ill-equipped to coordinate the complex requirements of innovation. Feedback loops across the value chain thus remain weak and unreliable, and design, marketing and manufacturing often proceed in an asynchronous way. A bias for centralized R&D organizations also has quite negative implications beyond the boundaries of the firm. It is probably one of the main reasons for the still very weak status of domestic technology networks among the different actors in the process of technology generation and diffusion. This applies, in particular, to such linkages between the large electronics manufacturing companies and their suppliers of parts and components, most of which are either with foreign companies or internalized by the leading chaebols (Bloom: 1992). Both cases have considerable disadvantages. Reliance on imported components not only contributes to a continuous foreign exchange drain, but has substantially reduced the local value added and learning possibilities in the design and manufacturing of the relevant components. In the second case, excessive vertical integration leads to very high fixed capital cost burdens and limited flexibility. As long as components are only for in-house consumption, chances are low that they will correspond to only ‘world class’ standards. There is now a rich body of theoretical and empirical literature which shows that both end product manufacturers and component suppliers can reap substantial benefits from technology networks in the vertical chain.102 In addition, such technology networks have been an essential prerequisite for upgrading existing national production and innovation systems by making possible a shift to a new division of labour in R&D. Thus, manufacturing firms are able to concentrate on systems design and final assembly and can restrict their R&D primarily to product design and process innovations for final assembly. Suppliers in turn can focus their limited resources on product and process innovations for parts and components and thus aspire to the accumulation of specialized technological capabilities. A further important weakness of the Korean innovation system, paradoxically enough, relates to the established educational system. The marked emphasis placed on the training of mid-level managers, engineers and technicians was an

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important prerequisite of success during the catching up phase. Yet today, as the focus shifts to research, product design and market development, the educational system is poorly equipped to meet these new requirements. One of the major mistakes made by the Korean government in developing a national system of innovation has been its under-investment in higher educational institutions…making all universities primarily undergraduate teaching-oriented rather than research-oriented… As a result, Korea has failed to develop a stock of highly trained scientists and engineers who will be necessary in the 1990s in order for Korea to sustain its international competitiveness. (Kim Linsu: 1991, 26–27) In short, as a result of its earlier success, Korea’s innovation system is now faced with new challenges. There are a number of structural weaknesses which have been well identified and extensively debated by both government and management circles. Yet the inertia resulting from previous success and established power structures appears to constrain the ability to adapt to the new competitive environment. The search for a new policy doctrine and new corporate strategies is impeded by the highly unequal distribution of economic and political power, severe resource limitations and the lack of a viable consensus. IV CONCLUSIONS Over the last two-and-a-half decades, Korea’s export performance has been remarkable. Exceptionally high growth of exports from the textile and clothing industry in the late 1960s and into the 1970s were followed by a dramatic increase in electronics exports into the 1990s. Compared to the historical export performance of each of these industries during similar phases in their development in other countries, the speed of Korea’s expanding international market share has been simply mind-boggling. During 1992, however, electronics exports, which had then replaced textiles and clothing as the leading export sector, declined and production growth fell to 3 per cent. As the push of domestic demand growth was also weakening, production grew by only 3 per cent. Between 1993 and 1995, however, exports expanded again rapidly. This unexpected resurgence of export growth appears to indicate that, at least in the electronics industry, export-led industrialization has not yet run its course. Yet a closer look at the factors explaining this surge—the yen appreciation, cyclical upswing in the DRAM market and an open China market—suggests that this may only be conjunctural. The substantial appreciation of the yen against the United States dollar, for example, improved the competitiveness of Korean electronics products. With the

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won’s 18 per cent fall against the yen in 1993, Korean electronics firms enjoyed an export boom, taking business from Japanese competitors, particularly in pricesensitive market segments like DRAMs and lower-end consumer devices. Korean firms were able to increase their penetration of the Japanese market and when the floodgates to the huge Chinese market were pushed open in 1992, Korean electronics companies with their focus on cheap household goods and audio-visual equipment were able to reap substantial windfall profits. But the rise of the yen did not last, as the current plight of the Japanese economy did not provide a convincing rationale for sustaining a strong yen. With the yen depreciating again since late 1995, there is no room for complacency. Furthermore, because of the cyclical nature of the DRAM market, this source of the Korean export boom has now also been eroded and exposes ruthlessly the danger of overreliance on DRAMs. Finally, the easy phase of penetrating the Chinese market through direct exports also seems to be rapidly drawing to a close as the central government begins to clamp down on imports. Korean companies, which have invested in the Chinese market far less than their competitors from Hong Kong, Taiwan Province of China or Japan,103 are likely to be seriously affected. Just how vulnerable they are can be seen from the following two figures: during the first half of 1993, Jardine Fleming reported exports to China provided half of the 7.1 per cent growth in Korea’s total exports (FEER, 9 February 1993), and in 1993 as a whole, China’s share of Korean exports amounted to 28.2 per cent (Electronics, 10 January 1994, 4). It could, of course, be argued that while the export boom did not last, it might still have had a positive effect, provided that the unexpected increase in export receipts have led to a growth of productive investment. There is evidence to show that, between 1993 and 1995, all four Korean electronics giants have drastically increased their capital expenditures (EIAK: 1996). What is important, however, is not the actual amount of investment expenditure but its allocation among different types of products and production activities. The real question is to what degree such investments are being used to address some of the basic weaknesses of the Korean electronics industry. Here the empirical evidence speaks for itself. Capital spending was overwhelmingly concentrated on the rapid expansion of mass production lines for two products— computer memories and LCDs. Samsung, for instance, planned to spend 80 per cent of its 1994 investment total of US$1.87 billion on these two product groups alone. The respective ratios for Goldstar and Hyundai are even higher. Since 1993, both Samsung and Goldstar also increased their R&D spending and the former undertook yet another internal reorganization. However, octopus-like diversification—Samsung into automobiles, Hyundai into telecommunications— is still well alive. This suggests that, despite the temporary nature of the factors behind the recent surge in exports, the easy export success to which they gave rise has weakened the resolve of Korea’s electronics firms to address some of their main competitive weaknesses—their heavy dependence on imports of components and capital equipment from Japan; their product mix; the

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organization of production and the management of the innovation process. The huge capital-spending binge of Korean electronics firms in essence has reinforced existing patterns of product specialization and production organization. It has only marginally acted as a catalyst for the substantial changes that are long overdue.104 In this chapter we have traced the strategies of large Korean firms to a broad congruence of interests between government and the leading chaebols that gave rise, over the 1960s and 1970s, to a very close and reasonably consistent interaction between both actors. This became a powerful recipe for mobilizing huge investment funds and for channelling them into a few sectors and product groups that were identified as priority targets. It enabled large firms to emerge and to practise a particular form of oligopolistic market competition in which incessant diversification across sectoral boundaries replaced a focus on continuous innovation in both quality improvements and the selective and gradual introduction of product differentiation within a given product category. There are, of course, exceptions to this generalization, but they are most remarkable for their rarity. Many of the institutional structures put into place at that time—large diversified firms dominating the export sector and working through a network of domestic subcontractors—appear, moreover, to have outlived their usefulness in today’s fast changing world. The extensive use of domestic subcontracting networks, for example, was a source of strength in the textile and clothing industry in the past which ensured cheap, high-quality products and the flexibility to adjust to fluctuations in demand. Yet these subcontracting networks cannot be equated with networks for innovation. On the contrary, the very existence of these hierarchical networks today hinders the development of independent, innovative small and medium-sized enterprises. In the electronics industry, where collaborative supplierclient networks have not been built up, Korean firms are also at a disadvantage relative to rivals in Taiwan and Japan. The weak inducement mechanisms for domestic R&D that characterized the upstream segment of the textile industry have also emerged as a bottleneck for the continued growth of the downstream clothing industry. Unlike Taiwan Province of China, Korean textile manufacturers have not pursued a strategy of continuous innovation which might have enabled them to move into higher quality yarns and fabrics. Their current efforts to develop new types of synthetic yarns with special properties and superior chemical dyes are still in the early stages. Yet the foundations of an innovative clothing industry lie precisely in these basic inputs. In the electronics industry, a similar problem exists with respect to R&D on ASICs and microprocessors, display technology, system design and other key inputs that will make future products more competitive. In conclusion, Korea has reached the limits of the old export-led industrialization model with its emphasis on standardized production, OEM exporting and catch up mentality. These limits are the result of fundamental changes in the nature of international competition and in the incapacity of the

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traditional Korean growth model to cope with these new challenges. They are systemic in the sense that, with a limited variation in timing, they apply with roughly equal force to different sectors of the Korean economy. The international environment in the 1990s is not nearly as welcoming to latecomers as that of the 1970s and early 1980s. Competition has globalized and become more innovation-based, making it more difficult for firms to identify market niches and grow within them. Standards are more often than not set elsewhere and firms are under pressure to match quickly best practice in product design, productivity, quality and speed to market. Under these competitive conditions, the static comparative advantage on which latecomers based their export success erodes more rapidly. Catch up strategies based solely on building production and investment capabilities can no longer enable individual firms or whole industries to keep up as competitive requirements change. Moving beyond the catch up phase, as Korean firms must now do, will require a process of technological deepening that places emphasis on strong product innovation capabilities, closer attention to client needs and the development of new markets. Building a culture of innovation within the firm and linking firms to a network have thus become critical elements in a strategy that supports and sustains the continuous process of innovation needed simply to keep up. While Korean firms and the state are aware of these changes, they have yet to take the necessary action to complete this transition. NOTES Professor Mytelka gratefully acknowledges the financial support of the Social Sciences and Humanities Council of Canada during the initial stages of her research on Korea. Professor Ernst gratefully acknowledges the support of the Centre for Partnership (GCP) and the Alfred P.Sloan Foundation which enabled him to conduct an in-depth case study of the Korean electronics industry. 1 Amsden (1989), Enos and Park (1988), Haggard and Moon (1983), Jones and II Sakong (1980), Luedde-Neurath (1986), Rhee, Ross-Larson and Pursell (1984), Westphal (1979) and Kim Linsu (1997). 2 Figures from the Economic Planning Board show that the trade surplus rose from US$4.2 billion in 1986 to US$7.7 billion in 1987 and to US$11.4 billion in 1988 before dropping back to US$4.6 billion in 1989. It then plunged to US$2 billion in 1990 before rising to US$8.7 billion in 1991 (Kim, Chong Man: 1992, 29) and falling again in the mid-1990s. 3 Export promotion policies, for example, were initiated under the Syngman Rhee regime at the end of the 1950s in response to threatened reductions in United States aid (Cumings: 1987). 4 See, for example, the work of Gustav Ranis. 5 Such factors have been associated with industrial development from the first industrial revolution through to the late industrializers, such as Germany and Japan (Landes: 1969; Gerschenkron: 1962, 1968; Horie: 1964). Using data from the early

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7 8 9

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1960s, Harbison and Myer, for example, show that Korea was much further ahead in education than was to be expected from its GNP per capita when compared to 78 other developing countries (Kim and Dahlman: 1992, 441–442). A total of US$2.3 billion in United States foreign economic assistance was granted to Korea between 1951 and 1960. Compared with Taiwan Province of China between 1946 and 1976, ‘the United States provided US$12.6 billion in American economic and military aid to Korea (for Taiwan, it was $5.6 billion)…[this] gives a per capita assistance figure of US$600 for three decades (Taiwan, US$425 per capita)’ (Woo: 1991, 45). This assured that high rates of domestic inflation relative to world inflation rates would not be translated into an anti-export overvalued exchange rate. See Chapters 2 and 4. To offset the savings-investment gap caused by the government’s policy of controlled interest rates and subsidized credit during the Third Five-Year Plan which favoured the heavy and chemical industries, Korea borrowed on international capital markets. Haggard and Cheng define this relative autonomy or what they call ‘insulation’ to mean ‘that the activities of autonomously organized social and political groups are limited and that these groups lack effective access to centres of decision-making power within the state structure. Where corporatist channels do exist, they tend to be state-controlled rather than societal’ (Haggard and Cheng: 1987, 101). Summarizing the factors that contributed to the relative autonomy of the Korean State, Amsden wrote: ‘The Korean state was able to consolidate its power in the 1960s because of the weakness of the social classes. Workers were a small percentage of the population, capitalists were dependent on state largesse, the aristocracy was dissolved by land reform and the peasantry was atomized into smallholders’ (Amsden: 1989, 52). (See also Cumings: 1987; Hamilton: 1986; and Koo: 1987.) The Blue House is the presidential mansion. For a more detailed discussion of the state in Korea, see Haggard and Moon (1983); Jones and Sakong (1980); Cumings (1987); Hamilton (1986); Luedde-Neurath (1986); Enos (1984). Agricultural producers’ cooperatives and manufacturers’ associations, for example, were formed under government auspices and interfaced closely with the bureaucracy and, as we shall see below, the state played an important role in the emergence of the chaebols, their relationship to one another and to their domestic subcontractors. The history of the petrochemical, synthetic fibre and steel industries in Korea, for example, is marked by a continuous pattern of government intervention to ensure that technology was transferred and that plants achieved high output and foreign exchange savings (Enos and Park: 1988). In 1985, the top ten Korean chaebols ranked as follows among the Fortune 500: Samsung Group (23), Hyundai (25), Lucky Goldstar (43), Daewoo (49), Sunkyong (67), Ssangyong (137), Korea Explosives (180), Hyosung (204), Pohang Iron and Steel (206) and Doosan (412), Fortune (4 August 1986), pp. 181–197 and 203. In addition, the state could reward well managed companies with new licences to expand or to enter new sectors, refuse to bail out poorly managed firms in healthy industries and allow better managed firms to take them over (Amsden: 1989).

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16 Similarly, Luedde-Neurath (1986) demonstrates that the liberalization of the 1963– 1964 period to which many neo-classical economists had earlier attributed the Korean ‘miracle’ concealed an intricate system of import controls that protected the domestic market. 17 Amsden, for example, argues that ‘As late industrialization has unfolded, it has become clear…that low wages are no match for the higher productivity of more industrialized countries…governments have to intervene and deliberately distort prices to stimulate investment and trade. Otherwise industrialization won’t germinate’ (1992, 53). 18 In 1973, the five largest chaebols contributed 8.8 per cent to GDP in the manufacturing sector. The top 10 accounted for 13.9 per cent and the 20 largest for 21.8 per cent. Five years later, the five largest contributed 18.4 per cent to manufacturing GDP, while the top 10 and top 20 accounted for 23.4 and 33.2 per cent, respectively. 19 In 1975, Goldstar became the first to establish a central research laboratory, although adaptive and problem-solving activities did exist in other companies such as Samsung which, however, did not complete construction of its integrated R&D centre until 1980. In the textile industry, the Kolon Technical Research Institute was established in 1975 for research on production techniques for nylon and polyester fibres and the Choongnam Spinning Company established a technical research institute in 1983. For further details, see Bloom (1992) and Enos and Park (1988). 20 Much of the increase in income inequality comes from wage inequality in the manufacturing sector. This, Koo argues, was due to four sets of policies which influenced the pattern of income distribution during the 1970s—policies that: (1) favoured big business; (2) controlled the labour movement; (3) involved inflationary financing; and (4) regressive taxation (Koo: 1984, 1,032). 21 Interview with senior official in the EPB, May, 1990. Under this system, ‘the firms which want to import foreign technology merely have to report their intention to the ministry concerned. If the ministry makes no objections within twenty days, the technology import was considered acceptable’ (Kim, Chuk Kyo: 1989, 467). The state thus maintained its right of veto over foreign technology imports. 22 Samsung, for example, spent $100 million on royalties to United States semiconductor firms in 1989 (interview with senior researcher at the Korea Development Institute (KDI), May 1990). 23 Interview with senior official in the MTI, February 1993. 24 The Samsung group seems to have been particularly successful in winning over the government. It has been repeatedly praised by President Kim YoungSam as a role model for the modernization of the public administration, and the Blue House is reportedly sending its staff for training at Samsung’s private management institute (Financial Times, 23 February 1994, 13). 25 (Kim Yung Bong: 1977, 24; Lee Soon-jae: 1984, 1.) As in Japan the traditional textile industry in Korea was based on silk yarns and fabrics. It continued to account for the bulk of the enterprises and employment in the spinning industry until World War II. 26 The figures are for 1941 and come from the Chosen Statistical Yearbook. See the tables in Kim Yung Bong (1977, 16, 17, 23). The rapid growth of the cotton textile industry in Korea during the colonial period can be attributed, in large part, to

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Japanese Government policies that limited excessive competition in the textile industry at home. Since neither these controls nor the regulations governing employment and working conditions in Japan applied in Korea, Japanese textile capital was used to develop factories there (Kim Yung Bong: 1977, 22). United States foreign aid, excluding military assistance, amounted to US$270 million over the period 1953–1958 alone. ‘This was nearly 15 per cent of the average annual gross national product…and over 80 per cent of foreign exchange (Cole and Lyman: 1971)’, cited in Amsden (1989, 39). See also note 3. Bank of Korea figures show that the capacity utilization rate was 66 per cent for cotton yarn and 50 per cent for cotton cloth in 1961. The excess capacity was apparently created by textile firms that had access to United States aidsubsidized loans and according to J.B.Kim, used these funds to create capacity ahead of demand (Amsden: 1989, 65). It should be remembered that the domestic market was exceptionally weak in this period. Exports thus accounted for nearly 70 per cent of the clothing industry’s output. This is still a remarkably high rate of export growth. A dramatic fall in the value of the won from 484 won to the United States dollar in 1980 to 828 in 1985 had the contradictory effect of boosting exports but reducing their dollar-denominated value. Because of growing internationalization of production by larger firms, smaller domestic subcontractors now suffered a sharp fall in capacity utilization. World Bank Development Report 1993, Table 29, p. 295. Among the textile and clothing firms, ‘technology embodied in Korean labour and management’ with a frequency of 33 per cent and 31 per cent, respectively, was the most commonly cited ‘source of technology’ (Rhee, Ross-Larson and Pursell: 1984, Table A-22-1). ‘Foreign suppliers of capital equipment or raw materials’ (12 per cent) was an important source of technology for the textile firms and ‘foreign buyers’ (15 per cent) were also frequently cited as a source of technology for garment manufacturers in the World Bank’s 1976 survey (Rhee, Ross-Larson and Pursell: 1984, Table A-22-1). On the textile industry in Africa, see Mytelka (1985). Because it is customary for middle-class women to withdraw from the workforce on marriage, Korean women, unlike those in Thailand and Indonesia, play almost no role at all as managers or owners of textile and clothing companies, although the workforce in these plants is heavily female. Precursors of the Multi-Fibre Arrangement, the Long and Short Term Agreements limited Japanese imports of textile and clothing products into the United States market. Labour-intensive, high-quality hand embroidery was also a point of entry for some Thai clothing manufacturers (see the case of CTG) and is currently playing a role in the development of export production in Viet Nam’s clothing industry, as the case of TG5 illustrates. These include New York, Los Angeles and Montreal in North America, Paris and Frankfurt in the European Union, and Osaka, Hong Kong, Shantou SEZ (PRC), Singapore, Jakarta and Sydney.

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41 Between 1972 and 1982, moreover, they averaged only 79 per cent of wages in the manufacturing sector as a whole during the second period (Lee Soon-Jae: 1984, 10). 42 In the early 1970s, for example, Germany became the world’s top exporter of textiles and remained the leading exporter of textile products until the early 1990s. Italy rose from fifth place among the world’s textile exporters in 1973 to third place in 1982 and to second place in 1986 where it remained until the 1990s. Japan, which had ranked second from 1973–1982, fell to third place in 1986 and then to fifth place after Hong Kong and China in 1989 (Mytelka: 1991, 116). 43 The government had initially planned a fund of 120 billion won in a fifty-fifty partnership with industry. Low profits during the early 1980s reduced industry’s willingness to contribute to this fund, while tight fiscal policy to ensure macroeconomic stability in the wake of two oil price hikes and rising inflation reduced the ability of government to contribute its full share. Ultimately only 23 per cent of the anticipated funds became available. Nonetheless, this could have made a major difference in the stock of machinery and equipment during the 1980s. 44 See section I for a discussion of these policies. 45 Kyungnam accounted for a further 25 per cent (Kim Ji-Hong: 1991, 401). 46 It has been suggested that already by the late 1960s the cotton textile industry was an oligopoly dominated by some 15 integrated cotton spinners and weavers (Kim Yung Bong, cited in Amsden: 1989, 65). 47 Tl, for example, argued that in 1990 it had been trying to import polyester from Taiwan Province of China where prices were lower than those charged by Korea’s synthetic fibre manufacturers who sold in Korea at prices higher than those abroad (67 United States cents vs. 50 cents/pound). Between February and May 1990, local suppliers cut their price by 9 cents. While this closed the gap between domestic and export prices, the local price was still higher than the price of polyester from Taiwan Province of China although the quality of Korean polyester was better. 48 This was confirmed in interviews with officials from the Korea Federation of Textile Industries (February 1992). See also the complaints by Samdo Corporation’s Paik Boo Ung to this effect (Jang: 1984, 26). 49 T8, which began as a garment manufacturer in 1954, rapidly moved upstream into the chemical industry in 1957, subsequently becoming an important synthetic fibre, specialty chemicals and pharmaceutical manufacturer; it became very active in engineering and construction and in the international trade in commodities in the 1970s and moved into machinery manufacture and electronics. The group currently includes 30 affiliate companies. 50 Data supplied by KOFOTI. 51 See section I for details. 52 See section I for a more detailed discussion of this practice. 53 ‘Heavy South Korea aid for textiles’, Financial Times, 28 November 1989. 54 The Korea Institute of Science and Technology (KIST) was opened in February 1966 and has as its mission the carrying out of industrial research, development, testing and evaluation. In January 1993, it employed 847 researchers and 61 engineers. In addition to divisions of applied science and engineering, environment and welfare technology and advanced materials, KIST currently includes a Science

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and Technology Policy Institute, a Systems Engineering Research Institute and a Genetic Engineering Research Institute. To a large extent, the best designers are fashion forecasters. To hone that skill requires years of experience. In Korea, most graduates of fashion design programmes in local universities are women, who generally spend several additional years in training, including one or more visits abroad each year while serving as junior designers in a company. Just at the point at which they begin to acquire the necessary experience to become forecasters of fashion trends, most of them leave to marry. This was a limiting factor in the development of design capabilities in Korean textile and clothing firms during the 1980s. Information on the dyeing and printing industry comes from interviews with senior staff at the Ministry for Trade and Industry and KOFOTI and with the Managing Director and Sales Manager of T3. This is primarily because Korean and overseas tastes differ significantly, making it difficult for designers based in Korea to forecast fashions in foreign countries. The closest for them, however, is the Japanese market and Korean designers follow fashion trends in Japan quite closely. In the case of T4, own brand exports are exclusive to Japan. Table 3.4 sets out a list of the policies which have affected the electronics industry. Of most importance at this early date were the Electronics Industry Promotion Act of 1969, which made electronics a strategic export industry, and the opening of the Masan Free Export Zone in 1970. These included Motorola, Signetics, Fairchild Semiconductor and the Komy Semiconductor Corporation. For political reasons, Japanese firms were late to invest in offshore chip-assembly in Korea. Electronic Market Data Book (Taipei), various issues. For a detailed assessment of the nature of the Korean achievements in the semiconductor industry, see Ernst (1994a and 1998a). Calculated on the basis of data provided in the Yearbook of World ElectronicsData 1993. Ho: 1992, p. 27. See Chapter 2 by San Gee and Wen-jeng Kuo in this volume. See, for example, Haggard (1990) and Amsden (1992 and 1993). For two historical case studies of these changes in the Samsung Group, see Janelli R. and Yim Dawnhee (1993) and Lee Jinjoo (1991). Gerschenkron (1962), Abramovitz (1986), Amsden (1989), Ernst and O’Connor (1989), Haggard (1990), Wade (1990), the contributions in Nelson (ed.) (1993), and Hikino and Amsden (1994). For the United States, see Flamm (1988), Borrus (1988) and Tyson (1992). For Europe, see Malerba (1985) and for Japan, see McMillan (1985), Anchordoguy (1989) and Fransman (1991). See section I for a discussion of these policies. For a detailed discussion, see Dataquest (1987), Industrial Policy—South Korea. Some interesting examples of these debates can be found in the special issue of Electronics Korea, August 1988, entitled ‘Painful steps toward maturity—industry after 30 years’. The following discussion is based on interviews held in Korea over the last ten years, on Ernst and O’Connor (1992, chapter 4) and Ernst (1997).

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73 For a detailed analysis, see Ernst and O’Connor (1992, Chapters 1 and 2). 74 With the exception of Tatung, all major PC makers in Taiwan Province of China are SMEs and even Tatung, one of the largest business groups, pales in size when compared to the Korean chaebol. 75 For an analysis of the causes of success of Taiwan’s computer industry, see Ernst, (1996a). 76 EIAK, 1995. 77 For a critical assessment of Sematech and Jessi, see Grindley, Mowery and Silverman (forthcoming). 78 For a comparative assessment of these three different alliances, see Ernst (1994a). 79 A typical example of such inertia can be found in a project of the Ministry of Trade and Industry in 1992. Following negotiations with the ailing United States mainframe computer company, Unisys, the Ministry accepted Unisys’ proposal to transfer, for a hefty yet undisclosed fee, its mainframe manufacturing technologies to Korea. As part of its general localization effort, the Ministry then, in 1993, announced a five-year mainframe localization programme which, in the words of the Ministry, would enable Korea’s computer industry ‘to move into high-end computers and away from price-competitive personal computers’ Yearbook of World Electronics Data 1993, p. 178. 80 UNCTAD, World Investment Report, 1996. 81 Hyundai, a latecomer to the electronics industry, has concentrated on components and industrial electronics and has no activities in consumer electronics. 82 Dataquest Vendor Profile Samsung Electronics Co. Ltd, 20 September 1993, 1. 83 For an in-depth analysis, see Ernst (1991a). 84 Fruin (1992, 318). 85 The latter figure would in fact be higher—46 per cent—if the United States SIC code did not classify computers in a different category (35) from other electrical devices (36 and 38). 86 Gerlach (1993). 87 For example, the government has designated 205 business territories, the so-called ‘SME sanctuaries’, where neither chaebols nor their affiliates may intrude. Attempts are being made to increase the share of total commercial bank loans for SMEs to 35 per cent through the so-called ‘compulsory lending ratio’ and the government has initiated aggressive venture capital funding for product development by SMEs. 88 These findings were reported in FEER, 19 November 1992, p. 70. 89 Of the rich literature on the Japanese production system, see, McMillan (1985), Fruin (1992), Kenney and Florida (1993), Gerlach (1993) and Abo (ed.) (1993). 90 For additional evidence, see Chapter 2 on Taiwan. 91 A telling example of the constant frustration that innovative start-up companies encounter is that of a small computer design company, run by a group of eight engineers and computer scientists who knew each other since high school and who no longer wished to work in the highly regimented environment of the chaebol. After trying, without success, to sell some of their designs for pen and pocket computers to the chaebol, they ended up selling them to a second-tier Taiwan Province of China PC assembler which, at least for a few months, is reported to have made healthy profits with these machines (author’s interviews).

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92 For a detailed analysis of the Korean approach to innovation management, see Ernst (1998). 93 For a detailed historical analysis, see Ernst (1994a). 94 This rather mundane interpretation of Korea’s entry into semiconductors, offered by those involved in the original decision-making, contrasts with much of the academic debate on Korea’s role in semiconductors which continues to talk about ‘leap-frogging’ into a ‘leading-edge’, ‘high-tech’ industry. 95 Dataquest (1987), ‘Industrial policy—South Korea’, p. 2. Policy loans are a specific Korean policy innovation that are designed to accomplish various social objectives of the government. See Kwon Okyu (1994), ‘Financial liberalization and the environment for United States investment’, in Korea’s Economy 1994, Korea Economic Institute of America, Washington, DC. 96 Details on Samsung’s entry strategy into DRAMs are based on interviews with Samsung in November 1987. Samsung represents the most sophisticated approach to the formation of technological capabilities in this industry, and at the same time nicely illustrates some of the main weaknesses of the Korean way of building technological capabilities. For information on the DRAM entry strategies of Goldstar and Hyundai and why Daewoo decided to stay out of this race, see Jun Yong-Wook and Kim Sang-Gook (1990), Bloom (1992) and Ernst and O’Connor (1992). 97 For an analysis of the economics of semiconductor manufacturing, see Ernst (1990). 98 While many of the established authoritarian organizational and behavioural patterns are currently challenged by increasing demands for grass-root democratization, a recent case study of the Samsung group (Janelli: 1993) shows that old habits die hard and that serious reform attempts will have to face substantial barriers. 99 Unless otherwise indicated, the following figures are provided by the Korea Semiconductor Industry Association (KSIA). 100 The development of the Asian production networks of Japanese electronics firms is analysed in Ernst (1994a, 1994d, 1996b and 1997). 101 See in particular Kim Ilyong and Chung Sun Yang (1991), Kim Ilyong and Kim ChiYong (1991), and Kim Linsu (1993) and (1997). While Bloom (1992), agrees with much of the diagnosis of the aforementioned authors, he proposes a quite different therapy. For him, strengthening the chaebols would be the safest way to upgrade technological capabilities to the new competitive requirements. 102 Pioneering contributions include those of Antonelli (ed.) (1989), Imai and Baba (1991), Ciborra (1991), Antonelli and Foray (1991), Bongardt (1991), Doleschal (1991), Sabel et al. (1991), Bieber et al. (1991). See also review in OECD (1991, Chapter 3). 103 In 1992, the lion’s share of China’s total inward FDI of US$11.3 billion originated from Hong Kong (nearly 70 per cent), Taiwan Province of China (more than 9 per cent), Japan (6.6 per cent), the United States (4.6 per cent) and the EU (2.2 per cent), with Korea’s share far behind at around 1 per cent. (TheEconomist, 16 April 1994, 71, quoting findings of a recent study by the Economist Intelligence Unit). 104 It also helps to explain why Korea, despite its successful catch-up strategy, has remained vulnerable to the crisis of international financial and currency markets. For a more detailed analysis see Ernst (1998).

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4 Technological capability building and the sustainability of export success in Thailand’s textile and electronics industries Nipon Poapongsakorn and Pawadee Tonguthai

I INTRODUCTION Since the 1960s, GDP in Thailand has grown by an annual average of almost 7 per cent. As non-agricultural growth was more than twice that of agriculture, the country’s production structure became increasingly based on industry and services. By 1991, the manufacturing sector accounted for over 28 per cent of GDP, up from 12.5 per cent in 1960 (Table 4.1). Thailand’s rapid economic growth has mainly been attributed to exports, particularly manufactured goods, which now account for almost 65 per cent of total exports. As a percentage of GDP, exports rose from an average of 20 per cent in the period 1971–1980, to 26.8 per cent in 1981–1990 reaching 36.9 per cent in 1991–1994 (UNCTAD: 1996, 110). Most of this production comes from the labour-intensive and raw material-based industries and until the late 1980s, Thailand’s success in export manufacturing depended largely on the low cost of labour and the country’s macroeconomic and political stability. However, as Thailand is now experiencing rapidly rising labour costs and increasing competition from other countries with cheaper labour and abundant raw materials, there is growing doubt about the sustainability of its manufactured exports. But export success does not have to depend entirely upon comparative advantage based on relative factor endowments. Technological factors also affect a country’s competitiveness. This chapter analyses the extent to which technological capability-building in Thai-based manufacturing firms has contributed to past export success and whether it provides a basis for meeting the challenges currently faced by the country’s exporting firms. The study focuses on the textile garment and electronics industries—the top export sectors which, in 1992, accounted for 35 per cent of total exports. Firms do not necessarily build technological capabilities unless there are sufficient inducements and pressures, which are determined by policy dynamics, market forces and the historical practices of the firms with respect to competition and innovation. Technological capabilities are also

Source: Textile Intelligence Unit, Textile Industry Division, Dept. of Industrial Promotion Note: Excluding other textiles

Table 4.1 GDP manufacturing value added and exports (current prices: baht millions, %) NIPON POAPONGSAKORN AND PAWADEE TONGUTHAI 159

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affected by the surrounding environment, which includes the physical institutional, scientific and technological infrastructure. Within this conceptual framework, this study examines the following hypotheses: 1 The export success of Thai-based manufacturing firms does not depend only on cheap labour and stable exchange rates, but on the technological effort of the exporting firms and the surrounding environment. 2 Through their influence on technological behaviour, market forces, policy dynamics and the surrounding environment have been important determinants of export success. 3 The dualistic structure of the textile and the electronics industries in the 1990s is a result of policy dynamics. Export firms have been able to build technological capability, unlike most import-substituting firms, which have remained heavily protected. 4 Thai firms have still not developed the capability to make major changes in products, processes or organization techniques, in large part because the incentive system has not motivated them to do so. Their technological capabilities are thus still limited to minor changes. II OVERVIEW OF THE THAI ECONOMY Since the early 1960s, Thailand’s economic policies have undergone substantial change in response to variations in both the external and internal environments. Throughout the period, however, sound macroeconomic management policy was strictly maintained and became the hallmark of the bureaucratic, economic policy-making process. Thus, relatively high economic growth has been sustained with low inflation and stable exchange rates. Since sectoral policies did not undergo any extensive reforms (Christensen, et al.: 1992), protectionistic policies have never been discarded. The modern history of Thai economic development can be divided into three phases: import-substitution industrialization, export promotion and the boom in manufactured exports. Import-substitution industrialization (1957–1971) After a decade of state capitalism following the war, the government was finally toppled by a military coup d’état in 1957. The new regime quickly adopted the first National Economic Plan which, acting upon recommendations by the World Bank, put into place an import-substitution industrialization strategy based on private-sector initiatives. An Investment Law was promulgated and a Board of Investment set up to promote importsubstitution firms through tax and importduty exemptions or reductions. Forty-five categories of industries were eligible for promotional privileges, including spinning, weaving, dyeing and finishing as well as consumer electronics. High tariff rates were imposed on imported

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finished products in order to protect the import-substituting firms. To facilitate private investment, the government also invested heavily in infrastructure and primary education. A number of public enterprises and government offices were created in the early 1960s to provide supporting services. Since 1961, the government has been effective in maintaining a macroeconomic environment conducive to trade, investment and the growth of private firms (Christensen et al:. 1992). Fiscal policy was overhauled to prevent overspending. Monetary policies were strictly applied to achieve economic expansion without excessive disruption of price stability and the baht was successfully pegged to the United States dollar.1 As a result of these policy changes, investment soared in the 1960s, with joint ventures between Thai and foreign investors being the principal beneficiaries of the various investment privileges. However, studies have shown that the rapid growth of the 1960s was largely due to an increase in domestic demand. The import-substitution policy had only a marginal effect on growth (Wongkanlayanut: 1986; Akrasanee: 1973) and the efficiency of importsubstitution production soon reached its limit, in part because the increasing resultant demand for imported capital goods and raw materials led to a deterioration in the balance of trade. Export promotion and structural adjustment (1972–1985) The worsening balance of payments in 1969–1970 prompted a policy shift towards export promotion. In 1972, the Investment Promotion Law was amended to give greater incentives to export industries, which lured three major United States producers of integrated circuits to Thailand in the early 1970s and encouraged a number of textile producers to export. Measures to protect importsubstitution firms, however, remained intact and in some cases were even strengthened. Tariff escalation, for example, occurred throughout the 1970s because of the government’s concern about the widening trade deficit. Although this was also the period when the government paid most attention to the textile industry, policy inconsistencies led to the emergence of a dualistic structure, as will be seen below. Both external and internal factors combined to make this the most difficult period in Thailand’s post-war economic history. The first oil shock and political unrest of 1973 resulted in a high inflation rate. The second oil shock, which led to a world recession and political unrest in Thailand in 1976, slowed down real GDP growth and created a persistent current account deficit that significantly increased Thailand’s external public debt. The government reacted quickly by adopting a series of adjustment policies and reforms, the most important of which included tax rebates for export firms that were not promoted by the Board of Investment (BOI), the establishment of bonded warehouses in 1974 and an export processing zone (EPZ) in 1979, streamlining of customs procedures and a policy of zero growth in public

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expenditure. Although the baht was floated, the Bank of Thailand maintained its stability by tying it to a basket of currencies in which the United States dollar carried the most weight, significantly reducing the risk of currency devaluation which would have seriously hurt importers of machinery and raw materials. Trade and investment were thus facilitated, with currency devaluations in 1981 and 1984 providing a further stimulus to exports. The 1970s were a decade of education expansion, especially vocational training, which in turn resulted in serious unemployment among vocational and university graduates in the early 1980s. In the mid-1970s, the government also launched a successful educational reform which resulted in nearuniversal primary education (enrolment rate of 97 per cent). Export boom and the influx of direct foreign investment (1986–1992) For the first time in the country’s post-war history, double-digit growth was achieved for three consecutive years between 1988 and 1990, the driving forces of which were trade, private investment and a surge in income from tourism. Manufacturing exports rose by an annual average of 26.5 per cent over the period 1985–1990. While this boom was most directly triggered by a 30 per cent depreciation in the real effective exchange rate since 1984, it also reflected a longer-term shift in the Thai economy towards export-oriented production, particularly in manufacturing (World Bank: 1989). The share of manufactured exports in total merchandise exports rose from 32 per cent in 1980 to 64 per cent in 1990. The role of foreign trade thus became vital to the domestic economy as the share of exports and imports in GDP exceeded 100 per cent in 1990. The private investment boom in the period 1987–1991 was stimulated by both the expansion in exports and a sharp rise in the flow of foreign direct investment resulting from the relocation of industries from Japan and the newly industrialized countries (NICs), where firms were losing export-price competitiveness. Investor confidence was also high because of the Thai government’s record of sound macroeconomic adjustment and political stability in the early 1980s. The adjustment effort which, since 1980, had focused on reducing the fiscal deficit by avoiding large national projects, curbing external borrowing and making the baht more competitive did however create serious infrastructure bottlenecks later in the decade. By the early 1990s, moreover, there were signs that Thailand might be losing its competitiveness in the labour and raw materialintensive industries, as real wages began to increase and natural resources were depleted. All these constraints will have to be resolved if Thailand is to sustain its current rate of growth and transform itself into a dynamic industrial economy.

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III EFFECTS OF THE INCENTIVE SYSTEM ON INDUSTRIAL STRUCTURE AND EXPORT PERFORMANCE This section describes the current structure of the textile and the electronics industries and their successful export performance and analyses how they have been shaped by the incentive system. Government policy was the most important factor in the incentive system influencing the industrial structure, while the supply of cheap labour and currency devaluation were the key factors behind the export growth. Sound macroeconomic management also played an indirect role in achieving this export success. Development of the textile and clothing industries Modern, privately owned textile factories were established in Thailand after World War II by local entrepreneurs in response to the war-time shortage of textile products. As several firms went bankrupt in the 1950s, when they were unable to compete with the cheap supply of cotton and textiles from Pakistan, the Thai government stepped in to protect the industry. Textiles were one of the first industries targeted for support under the government’s import-substitution industrialization strategy launched in 1961. In the three decades that followed, the industry went through cycles of hardship and prosperity, including ‘the golden years’ of the late 1980s, when textile exports headed the list of foreign exchange earners for four consecutive years. The significance of the textile and clothing industries in the Thai economy is best summarized by three main indicators: value added, employment and export contribution. In 1991, the industry accounted for one-quarter of manufacturing value added and employed 1,038 million workers, i.e. one-third of all manufacturing employment. Since 1987, textiles and clothing have been the country’s leading export products, accounting for 115 billion baht in 1991 (Table 4.2), i.e. 15.8 per cent of total exports of 726 billion baht. From the early days of the modern textile industry, the Thai government has been involved in its development, initially through the granting of tariff protection against cotton yarn imports, although subsequent promotional measures were inconsistent and in some instances contradictory. This led to the emergence of a dualistic industrial structure and unnecessarily delayed the development, modernization and competitiveness of the industry. Structure of the textile and clothing industries The structure of Thailand’s textile and clothing industries is summarized in Table 4.3. Spinning factories were among the first textile firms to be established

Source: Textile Intelligence Unit, Textile Industry Division, Dept. of Industrial Promotion Note: Excluding other textiles

Table 4.2 Trends of textile and clothing exports, 1980–1993 (baht millions)

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Table 4.3: Structure of the Thai textile and clothing industries, 1993

Source: Thai textile statistics 1991/1992, Textile Intelligence Unit, Textile Industry Division, Department of Industry Promotion, Ministry of Industry

in Thailand in the late 1940s and expanded rapidly under the government’s promotional efforts in the early 1960s. Man-made fibre firms were granted promotional privileges in 1969 to substitute for imports and natural fibres. This is the most capital-intensive activity of the entire textile sector and the large investment and advanced technology which it requires have kept the level of competition down. Most of these firms are either Taiwanese or Japanese joint ventures and many of the larger weaving and knitting firms have integrated upstream into spinning, thereby guaranteeing control over the supply and quality of yarn. The dyeing, printing and finishing sector is a major bottleneck in the effort to move towards high value added products in both textiles and clothing. Most of the firms are small, with low productivity and efficiency, due mainly to the use of outdated equipment and installations, the absence of an inspection system and the use of low-grade dyes and chemicals. A serious shortage of trained personnel at all levels of the production process has contributed to a lack of concern for quality. Most clothing producers still rely on low cost labour and simple technology, with only a few of the larger export-oriented firms investing in advanced microelectronic equipment, such as computerized machines for pattern-making and grading. The use of subcontracting, moreover, is becoming widespread especially among the smaller firms producing goods for the medium to low end of the market. Three major policy measures are used to protect firms in the textile industry: tariffs, an import surcharge and an outright ban on imports or on capacity expansion. In the 1960s, nominal tariffs were relatively low, with finished and intermediate goods subject to similar rates. In the 1970s, however, tariffs increased to about 30–60 per cent, with considerably more protection for finished goods. Tariff reform was attempted in the 1980s, but progress was very slow because of the government’s reluctance to lose its most important source of revenue. A major step was taken in 1990 when import taxes on machinery and equipment were reduced to only 5 per cent, although tariffs on three textile products were increased and the reduced rate on clothing remained relatively high at 60 per cent.

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Restrictions were periodically placed on capacity expansion in textile firms, ostensibly to prevent surplus production, although they in fact reflected lobbying strength by large firms intent on retaining or capturing economic rent. The government, however, had difficulty keeping track of firms’ operations and machinery imports due to several loopholes in the actual regulations. For example, an exemption was made for ‘export-oriented’ firms. In anticipation of forthcoming restrictions, firms would rush to order machinery and thus overexpanded their capacities. Furthermore, a large number of small weaving firms were set up illegally, importing second-hand machines and producing for the lucrative, highly protected local market. Since the middle of 1987, special attention has been paid to dyeing, printing and finishing to enable the midstream sector to modernize and catch up with the fast growing requirements of the downstream clothing industry and increase the domestic value added of textile and clothing products. Uncertainty about the regulations affecting waste water treatment, however, has delayed the entry of new firms. Two types of tax measures have been used by the government since 1971 to help reduce the production costs of exporters: rebates and compensation. Subsidized credit is also provided through the government’s rediscount facilities. Rebates are given for taxes paid on raw materials used in export production. The import tax must however first be paid either in cash or by bank guarantee and after the introduction of value added tax in 1992, only in cash. Delay in paying rebates has tied up a large amount of manufacturers’ funds and, in many cases, seriously affected their cash flow. Effects of the incentive system on duality and linkages within the textile andclothing industries The textile and clothing industries in Thailand have grown quite distinctly from each other. In the 1960s, the textile industry was promoted as part of Thailand’s import-substitution industrialization strategy and its growth was nurtured by various policy regulations and privileges. Three decades later, many features of the import-substitution strategy still remain, delaying the industry’s successful conversion into an export-oriented sector.2 In addition to extensive and extended protection, restrictions on plant expansion have also hindered development. At various times, the government not only suspended the application for promotional privileges, but restricted the establishment of new factories, which had the effect of creating an ‘economic rent’ for existing companies. Although these firms were also forbidden to expand their plant, overtime work could be used to increase production. Measures aimed at supporting one stage of the textile production process frequently had a negative effect at another stage. For example, a surcharge on imported man-made fibres, introduced to protect domestic fibre producers, raised the cost of yarn to the weavers. Similarly, protection afforded to the chemical

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industry increased costs for dyers. This contributed to the use of low-quality dyes in domestically dyed fabrics, which reduced the ability of export-oriented clothing producers to source fabrics locally. Yet the high tariffs on imported yarns and fabrics which remained in place throughout the 1980s3 effectively shielded textile producers from competition in the domestic market and reduced the pressure on producers to make improvements. Textile exports, therefore, consisted mostly of low-value grey cloth, some of which was reimported after being dyed, printed and finished abroad and most of the domestically finished fabrics sold in the local market were of poor quality. This reinforced the reluctance of clothing exporters to use locally produced fabrics. The import tax exemption for fabrics used in clothing export, moreover, made imported fabrics both cheaper and more convenient, creating an additional disincentive to the development of linkages between the textile and clothing industries. While the textile sector enjoyed the privilege of a high wall of protection, much of the output of the clothing industry which developed during the 1970s was immediately directed towards the export markets. From the outset, therefore, it had to adapt itself to foreign competition by building new plants or recruiting more permanent workers. But as demand grew and pressure mounted from low cost producers in developing countries, many clothing producers in Thailand chose to limit the risks of new investment or recruitment by engaging in subcontracting arrangements. As a result, thousands of sewing shops sprang up all over Bangkok. Registration is required only for those with more than two horsepower machines or employing more than seven workers. While 2,029 clothing firms registered with the Department of Industrial Work, it is estimated that the real number could easily be around 20,000. Effects of the incentive system on export performance The Thai textile industry was initially set up to replace imports, but its expansion was so rapid in response to promotional privileges that the government had to suspend new applications temporarily. Manufacturers thus began searching for new outlets for their surplus production, with efforts to promote textile exports beginning in the late 1960s. In 1971, the government stepped in and announced tax rebates on several export items, including textile products, and the Textile Association began to grant direct subsidies to those of its members who managed to obtain export orders. By 1972, Thailand had become a net exporter of textiles for the first time. Since then, the surplus in the textile and clothing trade balance has climbed steadily, achieving an unprecedented growth rate in the latter half of the 1980s from 31.5 billion baht in 1987 to 76.2 baht in 1991. Over the period 1987 to 1991, the value of textile and clothing exports increased by around 30 per cent per annum, with garments accounting for 76.3 per cent in 1991, followed by fabrics and yarn (13.4 and 5.6 per cent, respectively) (Table 4.2). The success of Thai clothing exports, in particular, has been phenomenal, with an average

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annual growth of 40 per cent in value and 25 per cent in volume between 1977 and 1987. Thailand’s textile products are sold on both quota and non-quota markets. The quota markets include 17 countries—United States, Canada, the member states of the European Union, Norway, Finland and Austria. Quota allocations are negotiated through bilateral agreements under the Multi-Fibre Arrangement (MFA) of which Thailand has been a member since its establishment in 1973. The Department of Foreign Trade in the Ministry of Commerce is responsible for the allocation of quota rights among potential exporters. Quota rights are further divided into two types: performance or basic quota and central pool quota. The basic quota, which represents 70–80 per cent of the total, is allocated in accordance with the net export history of the applicant. The central pool quota consists of the yearly growth rate agreed upon under the MFA and the unused performance quota. It is available to both new and old firms, with allocation being based on such criteria as the use of local inputs, unit price, share of domestic value added and time period between order and delivery dates. Thailand has successfully expanded its share in the highly competitive nonquota market, with the value of exports reaching 67,499 million baht out of a total of 114,969 million baht in textile and clothing exports in 1991. This market covers a large geographical area where the major trading partners include Japan, the Middle East, Eastern Europe and the ASEAN countries. However, the direction of exports for each category of textile products varies. Yarn exports are confined mostly to the quota market, while clothing exports have clearly shifted away from quota countries following penetration of new markets in such countries as Saudi Arabia, United Arab Emirates, Panama, Singapore and Japan. When quotas were first introduced, firms with a strong export performance were the main beneficiaries and they continue to enjoy the economic rent thus created. The criteria for allocating the central pool quota may seem to be fair to firms of all sizes, but large firms or those which are part of a vertically integrated company stand to gain a disproportionate share. Export orders received by small independent clothing firms often come with specifications that leave them little choice about the sourcing of raw materials. The small lot size of their orders, for example, makes it unfeasible to source their inputs locally. Yet if they import their fabrics, they are unable to meet the MFA criterion concerning local content. The need to import fabrics also means that these firms often encounter delays and fail to meet the delivery time criteria established by their clients. The requirement to turn out high quality, high value added products is thus scarcely applicable to new export firms which usually begin by producing simple, low-priced items. Ironically, the MFA’s protective measures and the Thai government’s quota allocation system have helped Thailand’s clothing entrepreneurs diversify their export market. Large firms find it easier to capitalize on the rent created from their past performance, while smaller firms or newcomers have to be very resourceful in penetrating the non-quota markets.

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The latter are thus forced to build up their marketing capabilities quickly after establishing their production capabilities. A feature of non-quota markets is the instability of orders and, in many countries, the market is heavily concentrated in segments with low prices, low quality and simple styles that change frequently. Firms producing for these markets cannot afford to invest in expensive, specialized machinery or even recruit regular workers. Very often they accept any kind of order and then search for appropriate subcontractors. This has contributed to the proliferation of thousands of small clothing firms, some with as few as five machines, working for large exporting firms. They serve mostly the low-end producers whose main requirements are low cost and quick delivery times. The electronics industry During the 1960s, there were 11 electronics companies employing 6,415 people in Thailand (Table 4.4). In the 1970s, radios and a few passive components were the only products being exported (Table 4.5). By the end of the 1980s, there were 102 electronics firms employing 41,328 people and an export boom was underway. Production in the electronics industry can be classified as follows: (1) electronic components; (2) consumer electronics; (3) computer hardware products; (4) communications equipment; (5) computer software services; and (6) industrial electronics equipment. The following section is mainly concerned with the first three categories and, in particular, television sets, integrated circuits (ICs), printed circuit boards (PCBs), miniature ball-bearings and disk drives. Structure of the electronics industry The electronic component industry is the largest sector in the electronics industry in terms of number of firms (more than 41 per cent of all firms), employment (67 per cent) (Table 4.4) and export value. In 1988, there were 42 firms in this sector, most of which were foreign subsidiaries or joint ventures exporting and/ or re-exporting all their production. Recently, these firms began to supply components to local firms, especially those assembling PCBs. ICs produced by the United Sates firm, National Semiconductor (NS), were the first electronic components to be manufactured in Thailand. Over time, NS has become the main training ground for personnel in the electronics industry, and there is now at least one former employee of NS in almost every large electronics firm, including engineers, technicians, senior executives, personnel managers and financial managers. At present, there are seven IC firms in the country which, until 1992, were all foreign subsidiaries or joint ventures4 exporting all their production. IC firms in Thailand merely package ICs. In the early days, these firms employed manual IC packaging methods, but advances in technology have led to the introduction of a new vintage of production equipment for automated IC assembly.

Source: Board of Investment Notes: a Data 1960–1988 compiled by Shiowattana (1991). b Data 1989–1993 compiled by TDRI. c Year 1993, for one month (January)

Table 4.4 Distribution of electronics firms by subsector and start-up year

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Table 4.5 Export value of electronics (baht millions)

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Source: Data compiled by Science and Technology Development Programme, Foreign Trade Statistics, Customs Department

Table 4.5 (Continued)

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The entire production process is now computerized and requires the intensive training of employees. The PCB sector consists of two distinct groups of producers: 50 local firms which produce low-end products such as single-sided PCBs and nine modern firms which produce double-side, plated-through-the-hole and multi-layer PCBs. The second includes four joint ventures and five Thai companies which have received BOI promotion status. But only two of the Thai firms have the same level of production capability as the joint venture firms, where production processes are always updated with the latest automated machines and testing equipment. These firms also employ other new production management methods, such as production planning, critical path production method (CPM), engineering process, QCC and SPC. Finally, there are three miniature ball-bearing companies, all of which are affiliated to MINEBEA (Japan). Their total exports amounted to 5,593 million baht in 1991. As with PCB production, dualism is also evident in the consumer electronics sector where the 51 constituent firms can be broadly classified into two groups: those which are domestically oriented and those which export. Of the 21 large and medium-sized television set producers, 8 are major exporters: they include wholly owned subsidiaries such as JVC, Tatung, Samsung and World Electric, joint ventures, such as Thompson Television, Thai Tele-Tech and NEC and one Thai-owned firm, Family Electro.5 The remainder sell exclusively in the domestic market. They include six Japanese joint venture firms, recipients of BOI promotion privileges during the import-substitution period, which account for 80 per cent of the domestic market. National Thai is the largest of these, with a domestic market share of 30 per cent, followed by Sony (16 per cent), Toshiba (8 per cent), Hitachi and Mitsubishi (7 per cent each) and Philips, Sanyo and Singer (4–5 per cent each).6 The market is oligopolistic. These companies also produce other electrical appliances for both the domestic and export markets, but only a few of them export television sets. Dualism is also a characteristic of the technology used: export firms use automated machines while small local firms employ manually operated machines. In the computer hardware and peripherals sector, 30 firms had had their projects approved by 1990, and at least 20 firms were in operation by 1993. There are also a number of small Thai firms which import CKD parts to produce personal computers. Most of the BOI-promoted firms are joint ventures with, or subsidiaries of, major Japanese and United States firms and export all their production. Major producers include Seagate, Fujikura, Read Rite and Micropolis, which produce a wide range of computer parts and peripherals such as stepper-motors, fan-motors, keyboards, printers, hard disk drives, floppy disk drives, computer cords and cables. Although the computer component industry is largely dominated by foreign firms, there is a niche for small local and small joint venture firms in the production of graphic computer cards. However, as software and VLSI technologies evolve rapidly, the production structure of the graphic computer cards for the Thai language also changes (TDRI 1992a: 102). Foreign

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firms in this sector use the latest automated machinery and equipment and replace it every 3–5 years and workers, technicians and engineers receive intensive training because of the rapid changes in technology. The industrial electronics sector is the smallest in the industry, with only 13 firms in 1988, 11 of which were promoted by the BOI. Most are small local or joint venture firms producing uninterruptible power supply coils, transformers and meters. Local firms are mainly owned by engineers with extensive experience in the field, and thus have higher design capability than those in the consumer electronics firms, with many able to make a number of minor changes, particularly to bring products into line with local needs. The industry employs relatively skilled technicians who work with standard machines and testing equipment.7 In summary, the component sector of the electronics industry is the largest, followed by consumer electronics, although the computer hardware sector is growing rapidly. Most large producers are foreign companies, while local producers are small and use a low level of technology. The industry, therefore, has a dualistic structure with foreign and joint venture firms dominating the export market, and local firms and import-substitution joint ventures capturing most of the domestic market share. As will be seen later, the former are efficient producers while the latter have high production costs. The production process still consists largely of the assembly of parts and components with a low level of design capability. Although foreign investors have always played a key role in the electronics industry, ownership structure varies from product to product. Foreign subsidiaries dominate the assembly of ICs and disk drives and the production of ballbearings; whereas for other electronic products, medium-scale joint ventures are the rule and there are a few Thai-owned firms. Most of the latter, however, are small and concentrated in low-end products such as single-sided PCB or in the software industry, JVCs. Foreign subsidiaries and Thaiowned firms co-exist in the television sector. Effects of the incentive system on industrial structure Although the electronics industry has evolved over the last three decades from import-substitution of consumer products into diversified electronics where most firms export, it is still characterized by a dualistic structure. Export firms are very efficient, while the domestic market is dominated by a few high-cost firms. Moreover, as in the textile and clothing industries, there are few linkages between upstream and downstream firms. The first electronics firms were joint venture companies manufacturing black and white television sets, attracted to Thailand in the 1960s by the investment incentives granted to import-substitution industries, the highly protected domestic market and public investment in infrastructure. Since then, the industry has remained strongly protected by a variety of policy measures. First, there were several tariff escalations in the 1970s and an import surcharge of 10 per cent on imported television sets and parts in the 1980s. The high tariffs of the 1970s led to a sharp increase in the smuggling of television sets, which prompted the government to reduce import duties on CBUs and CKDs.8

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However, since the tariff on spare parts was lower than that on CBUs and CKDs, a large number of small television set assemblers sprang up in the early 1980s. At the request of large television producers, the government subsequently increased the tariff on spare parts and reduced that applicable to imported CKD kits, which meant that small television set assemblers went out of business in the mid-1980s and only a few large firms now remain. Second, wholly foreign-owned companies enjoying investment privileges under the export promotion scheme are not allowed to compete in the domestic market and must export their production. Although joint venture companies with a minimum 75 per cent Thai share are now permitted to increase the share of their domestic sales from 20 per cent to 50 per cent, many do not sell in the domestic market because of the cumbersome accounting procedures required since, unlike inputs imported for use in export production, imports for domestic products are subject to high import duty.9 Moreover, protected firms cannot export television sets because their Japanese partners also have television assembly plants in other developing countries with similar import-substitution policies. Thailand’s import-substitution policy is aimed at protecting not only the producers of final products, but firms which manufacture parts and components. It thus transfers part of the economic rent from television set producers to the producers of television parts. The main measures which provide protection to these firms include an import ban on television set cabinets (in order to protect a BOI-promoted cabinet factory), the BOI’s policy of granting privileges to only one producer of colour picture tubes for the domestic market (which led the established television producers to become partners in the firm producing picture tubes) and the placing of a high tariff on imported parts. Although export promotion measures were introduced in 1972, no consumer electronics firms applied for export promotion privileges until the late 1980s. Most of the export-oriented television set producers were either Japanese joint ventures or subsidiaries of firms from Japan and the Asian NICs that had been encouraged to move abroad because of rising labour costs and appreciating currencies. By 1990, a dualistic structure had thus emerged in the consumer electronics industry. Because of the protected nature of the domestic market, import-substitution firms continued to earn high profits on their domestic sales and had no incentive to enter the export arena. Moreover, although there is strong competition in the domestic market, there are no significant market pressures on import-substitution firms to be as efficient as exporters, because production always remains not far above domestic consumption. Export firms, on the other hand, earn a thin profit margin in a highly competitive market and thus stress mass production and strict quality control. While export promotion policies did not induce established firms to become more innovative and to export, they did serve to attract joint ventures and wholly foreign-owned subsidiaries into the electronic components and computer products sector. This does not, however, mean that the import-substitution policy has successfully generated domestic economic linkages. Domestic television set

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assemblers buy parts locally only because they are marginally cheaper than imported parts, which are subject to tariff rates of between 10 per cent and 40 per cent. The most important part produced locally is the picture tube, although television set producers claim that the locally made tubes are of inferior quality. Because these tubes are purchased domestically, the local content of television sets now represents about 30–45 per cent of total cost. The second most important part—the main PCB chassis—is still imported because of weaknesses in the Thai semiconductor industry. Export-oriented television set manufacturers still rely heavily upon dutyfree imported parts, although in recent years, they have begun to buy some parts locally.10 These are mainly produced either by their own subsidiaries or by a number of small and medium-sized firms which had been supplying parts and components to these MNCs from their production plants based in Taiwan Province of China and Hong Kong and which had been moved to Thailand in the late 1980s. After the BOI simplified the procedures for duty exemptions on imports for the export parts suppliers who sell their parts to the locally based electronics products exporters, the cost of doing business between the parts suppliers and the product producers was reduced, which resulted in wider backward linkages. Interviews with several BOI-promoted producers of computer parts such as PCBs and semiconductors, however, revealed that a large percentage of the sales of these PCB firms were ‘re-exports’, whereas the re-export share of semiconductor firms is only moderate. When linkages are generated, they seem to be due to the lower transaction cost of purchasing some parts and components from exporters located in Thailand. Effects of the incentive system on export performance The boom in electronics exports in the 1980s can be largely explained by the influx of foreign direct investment. Foreign export-oriented electronics firms came to Thailand for a variety of reasons. IC producers—the first to arrive— were attracted by the government’s new export promotion policy introduced in 1972, the availability of cheap unskilled labour, technicians and engineers, as well as the country’s political stability. Their very presence shifted production in the industry away from import-substitution towards exports. By 1980, ICs constituted more than 92 per cent of the export value of electronics products, equal to 6.7 million baht or 5 per cent of total exports (Table 4.5). Reforms introduced in response to the chronic balance-of-payments problem that resulted from the second oil shock increased the attractiveness of Thailand to foreign electronics firms. Currency devaluations in 1981 and 1984, the establishment of bonded warehouses and EPZs, the streamlining of customs and import tax rebate procedures, a reduction of 20 per cent on the cost of electricity for BOI-promoted firms and enterprises located in the EPZ area, and the availability of infrastructure all stimulated exports and made prompt delivery possible.11 In addition, the government aggressively offered special incentives to

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attract MNCs to Thailand. Minebea, for example, was awarded lifetime duty exemptions on imported raw materials and machinery. Once Minebea, Seagate and Data General had moved to Thailand, a large number of smaller producers of electronic components followed suit to take advantage of the reduced transaction costs of doing business with the large MNCs already established there. Throughout the recession years of 1980–1985, labour costs remained low mainly because the government kept minimum wage adjustments below the inflation rate. There was also a large pool of unemployed but trainable graduates of secondary, vocational and commercial schools and newer export-oriented firms could easily find experienced engineers and supervisors already trained by the electronics companies established earlier in the 1970s. The availability of experienced personnel also allowed these firms to set up training programmes for their newly recruited workers, thus improving productivity and reducing production costs more rapidly. By the end of the decade electronics had become one of the largest industrial providers of in-house training (Poapongsakorn and Suzuki, 1992). As a consequence, exports of electronics products rose sharply from 6.6 billion baht in 1980 to 19.5 billion baht in 1986. Diversification was also underway: the share of ICs in electronics exports fell to 50 per cent in 1987, whilst that of ballbearings, hard disks, computer parts and components rose (Table 4.5). Between 1986 and 1991, an even larger number of new foreign investment projects were undertaken in Thailand12 as a result of currency appreciation and rising labour costs in the Asian NICs, a competitive exchange rate, sound macroeconomic adjustment policies and a decade of political stability in Thailand. Most of these companies manufactured electronic components, computer peripherals and consumer electronics for export. An increase in the domestic demand for communication services and the partial privatization of the communications industry in the late 1980s also led to a larger number of new firms producing communications equipment. The investment boom of the late 1980s boosted electronics exports almost sevenfold between 1986 and 1991. In 1991, the total value of electronics exports amounted to 138 billion baht (Table 4.5), with the four top export earners being computer and peripherals, parts and components, telecommunications products and consumer electronics. Television exports rose dramatically once television assemblers from the Asian NICs and Japan moved their plants to Thailand. Since many of the large exporting firms are United States subsidiaries, that country has been the largest export market for Thai electronics products since 1975. It is, for example, the biggest importer of ICs and television sets and the second largest importer of computer peripherals after Singapore. The second largest market for electronics exports is Singapore, because it is the major Asian production base of final electronic products assembled by United States and Japanese MNCs. Major products exported to Singapore include computer peripherals, such as hard disks and ICs. Japan is Thailand’s third largest market

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for electronics exports, even though the Japanese are the largest group of foreign investors. IV BUILDING TECHNOLOGICAL CAPABILITIES Since the 1960s, firms in the textile and clothing and the electronics industries have gradually built up their technological capabilities. The following paragraphs examine this process in a group of 21 firms.13 Basic data for each of these firms are summarized in Tables 4.6 and 4.7. The textile industry Since its early development in the 1950s when most textile firms were using simple Chinese-made machinery and employing low-cost labour, Thai entrepreneurs in the textile and clothing industries have gradually built up their technological capabilities and become successful exporters—as can be seen from the cases of the four textile and six clothing firms discussed (Table 4.6). Investment and production capabilities The two oldest textile firms in the survey, AST and CDT, were set up by immigrants from China, more than a decade before the introduction of importsubstitution policies. Both benefited from their links with China which became the natural source of investment and production capabilities. Both also began by weaving simple grey fabric for the mass market of low-income consumers and, in both companies, sons of the founders are currently in charge. BNT, Thailand’s second largest textile conglomerate, was also founded by a Chinese immigrant who came to Thailand from the textile trade in Hong Kong and Japan and SYG was established by a Chinese-Thai family originally from Hong Kong. At MLG, the current President’s family has been in the clothing business for 20 years, while the founder and current Managing Director of CTG is from a family with deep roots in the silk and cotton business. The importance of the China connection and of family ties in the development of the Thai textile and clothing industry cannot be over-emphasized.14 The first textile factories often used second-hand machinery from Japanese and Taiwanese factories whose owners wanted to modernize at home. Mainly interested in complementing their simple technology with low-wage labour, these factories drew upon an abundant supply of young women from the rural areas, a process which continued throughout the 1980s.

Source: Authors’ survey (1992) Note:a Companies listed on the Bangkok Stock Exchange

Table 4.6 Basic data on textile and clothing firms surveyed

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Table 4.7 Selected data on sample electronics firms

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Source: Authors’ survey (1992) Note: EP=export promotion; IS=import substitution

Table 4.7 (Continued)

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During the 1960s and 1970s, the BOI’s role in encouraging joint ventures between local and foreign entrepreneurs was an important catalyst in pulling in the capital and know-how needed to expand production. VRT, incorporated in 1970, for example, was initially a Thai-Taiwanese joint venture set up with BOI promotion to produce nylon yarn and fabrics for the domestic market. HMG, incorporated in 1972, was originally a BOI-promoted, Thai-Hong Kong joint venture for the manufacture of clothing for export. In the mid-1960s, the domestic surplus production or simple grey cloth forced AST to look towards export markets. A few years later, it took on a Japanese trading company as a partner to provide the cash required for further expansion into the export market. Access to financial resources is essential for technological capability-building and some firms started out in a very small way. For example, CDT began with one set of hand-looms and expanded slowly because of the difficulty of borrowing large sums from the formal credit market where substantial collateral is required. BNT’s growth into the second largest textile conglomerate in Thailand owed much to the owner’s alliance with the largest commercial bank in Thailand, whose president became a partner in several of his ventures. During the 1960s and 1970s, pre-investment studies and production plans were in most cases drawn up by foreign equity or technology partners with some local participation. But Thai managers were keen to master production and investment technology. The current manager of AST, who earned an M.Sc. in textile engineering from Manchester University, is a case in point. At the time of his graduation, AST had just expanded from weaving into spinning by the purchase of 200 machines from Japan. As a young man, he spent several months with the firm’s Japanese machinery supplier in order to learn more about those new machines. The QCCs, already popular in Japan, made a strong impression on him and upon his return he encouraged their introduction at AST. Similarly at VRT, Taiwanese partners provided the necessary technology know-how, machinery and technical personnel. The company’s president was Taiwanese and the founder’s son, a business studies graduate of Michigan University, became its vice-president. The technical aspects of production were initially under the responsibility of 38 Taiwanese technicians, who were gradually phased out. Thai workers were trained in the production of man-made fibres, a process which was then new to Thailand, and they proved to be fast learners. The presence of Taiwanese technicians soon became a constraint to VRT’s continued growth due to their lack of incentive to keep up with the latest technological developments. Their contracts were allowed to expire and by 1988, there were no foreign employees at VRT. Although Taiwanese technicians were also a factor in the development of production capabilities at NKG, a Thai clothing company founded in 1981, the managing director’s own experience and training were the key elements in the company’s investment and production decision-making. As a commerce graduate working with a foreign trading company in Thailand, in 1969 he joined one of the first Thai-Japanese clothing firms as a personal assistant and translator

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for the Japanese managing director. At that time, the Japanese firm had nothing but land. He thus had the opportunity to observe how a clothing factory is planned and constructed and how machinery is selected and installed. When the Japanese managing director left seven years later, he was made responsible for marketing and general affairs. In 1980, he joined the BNT group, whose major shareholder is his brother-in-law, where he was put in charge of the spinning plant and nine months later set up NKG, on the understanding that he would use BNT fabrics in his production. NKG started out on a small scale, with just 200 Japanese-made sewing machines, which made it ineligible for BOI promotion. During its earliest years, the firm employed three Taiwanese—one as factory manager and the other two as deputy factory managers—whose main task was to train the workers, which took six years. Two of the technicians then returned to Taiwan Province of China and one chose to start his own company in Thailand with NKG’s help. The present factory manager is a Thai with a management degree from a United States university. From the outset, market forces and the managing director’s own experience in clothing exports strongly influenced production decisions at NKG. Recognizing that the sharp downturn in exports during the early 1980s was part of a normal cycle, he seized the opportunity to secure as much of the unused Thai quota as possible. Thus NKG was in the unusual position of starting up with a variety of products and markets instead of just one or two, like most other firms. This gave the firm flexibility which has become its main strength in the current market situation. In 1992, when the export market was again on a downturn, the same strategy was repeated with the opening of another clothing company to produce solely for the United States market. In all these cases, the development of export marketing capabilities followed the building of production capabilities. At MLG, however, production capabilities were acquired after marketing capabilities through close ties to its client firm. MLG’s president holds a marketing degree from Wharton School at the University of Pennsylvania. After noting that Thailand had only one producer of ski-wear, he carried out an analysis of potential buyers from the list available at the Department of Export Promotion, which led him to conclude that the growth potential in high-end products was greater in the European than in the United States market. He first targeted Germany where many companies were closing down and technicians were being laid off. But he quickly learned that buyers had little interest in taking risks with newcomers, as ski-wear is a highquality, high-value item. Finally, a chance meeting with a German buying agent helped him conclude a deal with a ski-wear firm that wanted to close down its plant and supply its know-how to a low-wage producer with a view to importing finished products. The first order was for 5,000 pieces, which is relatively large for the ski-wear business. The buyer sent a German technician to MLG for oneand-a-half years, in three month periods, to teach ski-wear sewing techniques to MLG workers. Although almost all (95 per cent) of the raw materials had to be

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imported, MLG has since been able to expand into the Japanese market by producing very complex, very high value added items. Like MLG, PPG also has a German customer who has been buying from the firm for about four years and who has also provided technical assistance, sending technicians and making recommendations, for example concerning new techniques in knitting for particular types of clothing. Firms that have dealt with Japanese buyers agreed that their profit margins might not be as high as in other markets because of the stricter quality control and higher cost of raw materials required by Japanese customs, but they have acquired production capabilities in the process. To check out potential manufacturers, the Japanese first send a team of technicians who carefully verify factory capacity, cleanliness and other factors. A favourable report will result in a second team to discuss the possibility of an order, followed by further teams bringing samples to be made up and providing feedback on the quality of the garments. These processes can take up to one year before an order is confirmed. However, once the Japanese firm places an order, a long and close relationship normally follows. After investing so much effort in investigating a particular manufacturer, Japanese buyers are reluctant to change suppliers. To cement their relationship, MLG’s Japanese buyers sometimes even send small presents to everyone working on their order, a practice which has a favourable effect on the care and attention paid by the workers to those particular garments. In contrast to MLG and PPG, which have both learned from their buyers, HMG acquired both production and investment expertise through links with its machinery supplier. Initially set up with BOI promotion as a joint venture with a Hong Kong company to produce men’s shirts for export, HMG soon diversified into women’s wear. When the present owner succeeded her father, the firm was in financial difficulties due to corrupt practices on the part of the firm’s sales manager.15 The firm is now 100 per cent Thai-owned. Towards the end of the 1980s, HMG decided to diversify further into women’s outerwear and rainwear and to build a new factory for this purpose. After two years of research, during which the present owner went to several machinery fairs in Europe and visited a number of potential suppliers, she chose the German firm Pfaff over her earlier Japanese machinery supplier. In planning its new factory, HMG asked for full cooperation from PfafT, which sent a team of 15 to work out the exact details, down to the height of workers, with work tables being designed accordingly. Minor change capabilities Minor change capabilities, particularly those related to the production of more complex and varied items, were acquired along with the development of production capabilities in most Thai textile and clothing firms. VRT, for example, quickly expanded into other product lines based on synthetic fibres because the machines acquired were capable of producing a variety of items and required only minor adjustments. CTG, in contrast, found a specialized niche in

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the cottage look which uses local craft traditions in the northern Thai city of Chiang Mai, with appliqué work being incorporated into high-fashion ski and sportswear. For other firms, pressures on profits in the domestic market encouraged the development of the capabilities required for diversification and the upgrading of existing products. AST, for example, moved into canvas to escape domestic competition which was reducing its profit from grey coarse fabrics, and soon became the largest canvas producer in South-East Asia. Recognizing that it could not compete in export markets by cutting costs alone, NKG went into a joint venture with a manufacturer of men’s suits in Japan to upgrade and diversify its production. Under the terms of a three-year agreement, NKG pays royalties to the Japanese company for its technology and all 200 of the workers in the joint venture company have been trained in Japan at the rate of 15 per month. Marketing capabilities During the late 1960s, an oversupply of textiles on the domestic market led some of the larger textile firms to develop their marketing capabilities. AST, for example, began by exporting to customers in the United States who were attracted by Thailand’s low prices. Once Thai products were accepted overseas, a Japanese trading company approached these firms. In the case of AST, exports of grey cloth to Japan grew so fast that the Japanese trading company joined forces with AST to facilitate its expansion, providing the necessary cash and production know-how. As AST’s output expanded, encouraged by subsidies from the newly formed Textile Producers’ Association to search out its own export orders, the use of a Japanese agent proved a limiting factor in developing its distribution network in the European market. The managing director thus began to build up his own marketing capabilities, travelling extensively and dealing directly with customers abroad. Marketing in the United States was facilitated by the fact that Thailand was then considered a developing country and a supporter of the United States in the Viet Nam war. In other cases, however, the existence of a protected domestic market delayed the entrance of many textile firms into the more competitive export market. VRT, for example, at first repeatedly turned down enquiries from overseas buyers and became more receptive to approaches from trading companies only when local competition increased. Even so, VRT only exports 20 per cent of its output and although it has engaged in some marketing on its own, this was less due to any conscious strategy than a result of contacts by interested buyers through the intermediary of Thai embassies abroad. Like VRT, CDT is a reluctant exporter. Although its managing director has a long history of involvement with the textile industry and the firm has successfully built up its production capabilities, it has chosen to keep its focus on yarn dyeing and spinning for the highly protected domestic market (Box 1).

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Unlike textile firms, which were geared to the domestic market, most clothing firms started up by producing for the export market under OEM arrangements. One exception is MLG, which had been in the clothing business for more than twenty years as a producer of ladies’ knitwear for the domestic market and a distributor of imported socks. When the current president took over from his mother in the early 1980s, the domestic market was on a downturn. With a degree in marketing, he thought immediately about exporting. Knitwear, however, had attracted many Thai manufacturers and it was almost impossible to secure a quota for exports. His costs were also higher than many of his local competitors, who were able to use yarn from their own spinning factories. Costs and quotas thus led him to enter the export market as a producer of woven garments. His first major order was for 10,000 cotton suits. Production technology was not a problem, but being new to the export business, he had little knowledge of the intricacies behind the quota allocation system. Ultimately he was obliged to buy quotas even for woven goods on the ‘black market’, which cost him about 30 per cent of the sales value. Further losses were sustained due to delays in delivery and inexperience in packing the garments. Learning from this, MLG moved its factory away from the downtown area where loading facilities were a problem and abandoned quota items for more sophisticated non-quota ski-wear. SYG similarly reduced the value of its sales under quota from 97 to 15 per cent by gradually diversifying its production into high value non-quota items, and through its strong Hong Kong connection it hired a Hong Kong company to handle marketing, sales-order follow-up and material sourcing. In addition, in line with the firm’s policy of close contact with its customers, it employs an Italian firm to act as its sole agent for the Italian market.

BOX 1 CDT: a reluctant exporter The current manager of CDT owes his knowledge of textiles to the traditional Chinese practice of involving children in the family business at an early age. From the age of six he helped out in the weaving shed and became thoroughly familiar with the working, repairing and maintenance of all types of machines used in the factory. While he was studying for an MBA in the United States, the family firm encountered serious financial difficulties which he set out to resolve on his return by negotiating with the firm’s creditors, all of whom had known him since childhood. The firm quickly recovered. Two years later, however, CDT began a major shift into yarn dyeing, and in 1977, a spinning plant for acrylic high-bulky yarn was set up with 2,000 second-hand spindle machines. A number of factors explain the decision to change CDT’s product-mix. Since the owner’s savings were initially used to revitalize the company, an attempt was made to identify those textile branches most likely to generate the quickest return for the smallest amount of investment. Dyeing and spinning appeared to be the most interesting. Market analysis, including a thorough examination of the Customs

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Department’s list of imported textile items, also pointed to the yarn dyeing business because of the high import protection given to yarn production. The most protected items became his natural choice. But profit margin was also a concern and when he realized that yarn dyeing yielded only a small margin, spinning became the logical next step. However, as this required a major investment for which he would have to borrow, he finally went to Japan to look at the second-hand machinery available there. Setting up the spinning factory marked the first time that CDT had to use foreign technicians. The machinery supplier suggested a retired 68 year old Japanese technician as the firm’s consultant on spinning techniques. Even before his arrival, however, the firm was conducting a number of technical experiments with the machines and only five months’ service was required from the Japanese consultant. CDT’s involvement with foreign markets began in 1975 when it exported some 200 tons of dyed jute yarn per month. An attempt was made to contact potential buyers for the firm’s other products but the long delays in receiving orders, considerable variability in the size of orders and limited staff at CDT at the time ultimately led to the export market being put on hold for about a decade. Then came the golden years of textile exports for Thailand. Around 1987, a Japanese trading firm approached CDT to supply yarn to Sri Lanka and Bangladesh. Two years later, as the yarn quality at CDT improved, the quantity exported was increased. An unfavourable domestic market situation for acrylic yarn in that year led the owner to look towards export markets as an outlet for the firm’s surplus production by contacting a Taiwanese firm selling to Hong Kong and quoting a particularly low price in order to divest itself of its surplus acrylic yarn. However, ‘to enter the export market’, the owner said, ‘is like boxing with bare hands. It is a lot easier to get seriously hurt’. Thus, while CDT still maintains these trade contacts, the owner repeatedly emphasized that, as long as the domestic market remains reasonably protected, profit margins in the export market are far too small to offset the greater risks.

Government endorsements have been another factor in helping firms break into new markets. HMG was one of the first Thai clothing firms to supply the Japanese market after its participation in the first trade mission to Japan organized by the Department of Export Promotion. At that time, very few clothing firms recognized the potential of the Japanese market, The electronics industry In contrast to the textile industry, Thailand’s first electrical and electronics firms were established in the 1960s by foreign investors attracted by the country’s import-substitution policies. The second wave of foreign investors began to arrive in the 1970s in response to the government’s new export promotion policies. During the 1980s, Thailand became an even more attractive production base because of its cheap labour costs and abundant supply of engineers and technicians.

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Foreign investors have thus always been the major source of investment and production technology in the Thai electronics industry and it was not until the 1980s that Thai firms developed some technological capabilities. The pace of technological capability-building, however, has been extremely slow and despite government support, foreign-owned electronics companies have established few linkages to the local economy. Investment and production capabilities Both the import-substitution consumer electrical and electronics firms of the 1960s and the export-oriented IC firms of the 1970s obtained their technology on a turnkey basis from foreign investors. For example, the first Thai producer of television sets relied on German technology. Preinvestment studies and the setting up of production processes at TVTOS, a Japanese joint venture established in 1969 to produce televisions for the domestic market, National Semiconductor (NS), the first IC producer, and COMDT, initially the wholly owned subsidiary of a United States data processing company, were also carried out by foreign partners with little local participation except for site selection, building construction and contact with government offices. Since it was too costly to recruit large numbers of expatriates to run these companies, even the joint venture enterprise that produced television sets for the domestic market, however, trained Thai engineers and supervisors to carry out routine work on the production line. The experience gained by these engineers in television and IC-assembly later enabled new firms, such as ICAM, a wholly owned United States subsidiary established in 1990, PCBGS, an assembler of PCBs and head gimbals founded in 1983, and TVTEC, initially a Thai-Hong Kong joint venture created in 1989 and now a wholly Thai-owned television manufacturer, to conduct their own preinvestment studies and set up production processes without having to rely entirely upon foreign partners. The managing director of ICAM, for example, was formerly the manager of Thailand’s first IC firm, National Semiconductor. When he left NS, he brought with him a group of experienced engineers who already had extensive knowledge on the sourcing of machinery and equipment for IC plants. One of the Thai partners in PCBGS was an engineer with long experience at Sanyo producing consumer appliances who had already played an instrumental role in helping a friend, with no electronics background, to set up a company assembling PCBs. In all the firms of the first group of electronics and electrical appliance companies, foreign partners brought in engineers to give their Thai employees intensive training. Nevertheless, a number of key positions in the production and finance departments of these subsidiaries and joint venture companies are still held by expatriates. Most foreign subsidiaries and joint venture companies now send engineers, technicians and supervisors to be trained abroad. Employees at DISKSEA, DISKMIC, COMMIN and PCBGS are usually trained in Singapore and the

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United States. Once COMDT was chosen by its parent to be a prime plant for the manufacture of display terminals, its engineers were sent to its United States factories for 6 to 12 months of training, which consisted of two phases: design debugging and verification and design maturity tests for the further development of the design prior to production. During the 1960s and 1970s when there was an abundant supply of highquality engineers, the cost of training was very low and most of these engineers remained with the company because the labour market for engineers was not very active.16 This was of particular importance as chief engineers and supervisors were responsible for the training of other employ ees. Although onthe-job training and QCC are widely practised in Thai electronics firms, the degree and intensity of training are particularly high in the IC, PCB and diskdrive factories. The incentive to train arises from the competition that pressures firms in these product lines to cut down production costs as rapidly as product prices fall. Some firms successfully reduced the defect rates to a level of 3 to 5 per cent and increased yields up to 95 to 97 per cent within a few years of operation by setting up training programmes and performing strict quality control. PCBGS, PCBSC, COMMIN and DISKSEA are all cases in point. Reducing the defect rate is also of great importance to television manufacturers because their profit margin is very small and still shrinking.17 Many companies started out with simple products and gradually moved on through trial and error to more sophisticated ones. PCBGS, for example, began with the production of small sized, through-the-hole PCB assemblies, a very labour-intensive product. PCBSC initially produced a watch-module PCB which is very simple and where the circuit design is widely available in the market. COMTV started by importing CKD kits for black and white television set assembly before it began to produce personal computers. Both machinery suppliers and overseas clients are important sources of technology for Thai electronics firms. Foreign suppliers of machinery and equipment, for example, either send technicians and engineers to Thailand to train workers there or bring Thai employees for training to their own plants. This is common practice in firms that use automated or computer controlled machines, as in the assembly of disk drives and PCBs and in the production of miniature ball-bearings. Clients also provide new opportunities for learning. When PCBGS is contracted to produce new products for which it does not have the necessary technology, it is the client who provides the required know-how and machines. Clients also train the engineers and technicians at PCBGS on condition that the firm signs a non-disclosure agreement. PCBSC is slowly moving into the production of more sophisticated electronics equipment by becoming an original equipment manufacturer, since OEM firms are generally provided with product designs and specifications.18 Most OEM firms are permitted to source material and components on their own and the search for low-cost suppliers has contributed to the development of

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production capabilities in many cases. In some foreign subsidiaries, such as COMMIN, DISKSEA and DISKMIC, local staff are also allowed to source their own parts after they have shown that they meet the quality standards set by parent firms. Component sourcing has thus become a critical means of building technological capabilities in the electronics industry, which not only strengthens production capabilities, but leads to the introduction of minor technological changes in production processes. However, companies that produce colour television sets from imported CKD kits as OEM suppliers cannot take advantage of such learning opportunities because Thai customs regulations require them to register the exact formula for imported CKD parts to be eligible for lower duty rates. These subsidiaries and joint venture companies are therefore implicitly forced to depend solely on CKD parts from their Japanese foreign partners. Some joint venture companies in import-substitution industries, such as TVTOS, have not been keen to develop the technological capabilities of their Thai staff. Others, such as National Thai and Philips, both of which are leading television set producers, used to provide extensive training including courses in design, although the companies were managed by foreign engineers, and a number of employees from these two firms joined several of the newer electronics companies as key management and technical staff. The type of management system imposed by parent firms or joint venture partners was also found to affect the building of technological capabilities. In TVTEC, an export-oriented joint venture company, the Thai management staff was able to build its own technological capabilities (Box 2). In contrast to the lack of centralized control in TVTEC, United States subsidiaries tend to organize their management in hierarchical fashion, with each level of management assuming certain responsibilities and employees, being intensively trained to carry out their tasks in the most efficient way possible (including through ‘problem-solving’ courses at National Semiconductor, ICAM and COMDT). Minor change capabilities There are five ways that Thai firms have used to develop minor change capabilities: component sourcing (which, as noted above, was important in two firms), training and the use of QCC, the development of R&D capabilities, networking and reverse engineering. Training and the use of QCC enabled DISKSEA, PCBGS and COMMIN, for example, to learn about potential improvements from their workers and supervisors. Employees at COMMIN invented a cooling method that reduces pollution, while those at DISKSEA developed a CFC-reduced cleaning process that was subsequently transferred to other units of the parent company. Both COMMIN and DISKSEA reward employees who suggest ways of reducing production costs or improving the production process. At PCBGS, engineers

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have helped to design a circuit for a hearing device for the Ministry of Public Health. R&D is a third means used by Thai firms to develop minor innovations in products or processes. TVTEC established an R&D section after experiencing serious quality problems and its foreign partner, faced with financial difficulties, had been taken over and could no longer be relied upon for technical assistance (see Box 2). A leader in the local colour television

BOX 2 TVTEC: a case of learning-by-doing TVTEC is a BOI-promoted, export-oriented joint venture firm established in 1989. A year later it was listed on the Bangkok stock exchange. TVTEC’s partner, a Hong Kong television company, provided designs and production management during the firm’s early years. Since then, Thai engineers, with help from a Hong Kong manager, have been responsible for strengthening production capabilities and most decision-making, with the exception of marketing, which is in the hands of professional Thai managers recruited from other companies in the early 1990s. Even before the Hong Kong partner was the object of a takeover, it did not impose its management and control systems on TVTEC. This led to a number of production problems, the most important of which was the high defect rate of 20 per cent, a problem which TVTEC technicians and engineers had to resolve. Through trial and error and improved testing, TVTEC began to increase productivity and reduce the defect rate. Between 1991 and 1992, for example, the workforce was reduced by 10 per cent, but total production remained unchanged. In addition to assembling television sets for export, the company has a small production plant that uses automated machines to insert small electronic components into printed circuit boards which, along with picture tubes, are the core components of television sets. After its partner was taken over, TVTEC was forced to purchase all the equipment and machinery used in the production and R&D units in Hong Kong. It was at this point that TVTEC decided to set up an R&D unit both to solve its production problems and to design and innovate new products. However, the firm’s senior management is still not clear about what kinds of products the company should produce, in part because marketing strategy has, until now, been more defensive than offensive and in part because the firm still lacks a qualified staff of designers.

market, National Thai, a Japanese-Thai joint venture company, also set up its own R&D division which developed at least ten minor changes in its television sets between 1989 and 1990, including an AV outlet for video users and an FMradio signal receiver. Two factors motivated this aggressive research activity: first, National Thai needed to modify its televisions so that they could produce a clear picture in remote rural areas; second, the company had suffered a decline in its market share when its main rival, Sony, introduced new models. Since

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production at National Thai is near the point of economies of scale, it was profitable for the firm to invest in R&D,19 which has enabled it to maintain its status as the market leader. But these firms are the exceptions. For the most part, however, the continuation of Thailand’s importsubstitution policies, despite the introduction of export promotion in 1972, has been a major disincentive to technological capability building in consumer electronics firms. In the dualistic structure which characterizes this segment of the industry, ThaiJapanese joint venture television manufacturers exploit the protected domestic market and produce only a few thousand sets per year. They do not therefore achieve the economies of scale which would make R&D investment profitable. Exporting is not an option, because the Japanese partners who hold only 49 per cent of the shares have invested in similar import-substitution projects in other countries. For their part, the Thai partners do not appear to appreciate the importance of technological capability building20 and do not develop the marketing capabilities needed to sell their products at home or abroad. This is a particularly negative feature in the development of the consumer electronics industry where the link between minor change capabilities and marketing capabilities appears to be strong. Export-oriented television producers differ significantly from their import-substituting counterparts in this respect. In these firms, although the foreign partner owns more than 50 per cent of the shares, Thai managers frequently participate in marketing. The BOI’s policy of allowing these joint venture companies to sell a portion of their production in the local market has also enabled Thai managers to learn more about Thai consumer demand and, in the case of TVTEC noted earlier, stimulated the creation of an R&D unit geared towards the development of new products and improvements in product quality. In other sectors, the creation of small R&D facilities is now slowly beginning. COMDT, formerly a wholly owned United States subsidiary and now a wholly owned Thai company, has a small group of four R&D engineers who will form the nucleus for new product development in the coming years. COMMIN, a wholly owned Japanese subsidiary, also recently established an R&D centre to support its expanding production activities in Thailand (Box 3). Government policies have indirectly stimulated these moves. Networking and reverse engineering have also been key factors in the development of minor change capabilities in several Thai electronics companies. Here, too, government technology policies in the late 1980s, and in particular the establishment of the National Electronics and Computer

BOX 3 Developing R&D capabilities in an electronics firm COMMIN is a subsidiary of the world’s leading producer of miniature ballbearings used in electronic products. A conglomerate, it consists of eight

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companies producing a wide range of electronic components and peripherals including precision motors, floppy disk drives, measuring instruments and mechanical assemblies. Ballbearings account for 32 per cent of total sales. COMMIN was established in 1980 when its parent firm moved some of its operations from Singapore to Thailand. COMMIN received the maximum privileges available under the Investment Code, including a lifetime import tax exemption on raw materials and machinery. Once COMMIN received these concessions, it grew rapidly into one of the top firms in Japan. Today it has a worldwide market share in ball-bearings of about 80 per cent—most of which comes from its factories in Thailand. Although proven manufacturing technology is transferred to Thailand, Japanese and Thai staff members collaborate in the development and construction of mass-production lines and Thai maintenance trainees are provided with the knowledge necessary to operate and maintain the machines. The Thai subsidiary has thus successfully reduced its defect rate and solved production problems rapidly. The substantial revenues accruing to COMMIN as a result of tax concessions received from the Thai Government have been a major factor in stimulating the firm to reinvest its unpaid dividends in the expansion of its product range. COMMIN recently set up an R&D unit and a number of Thai engineers have been sent to the parent company’s research centre in Japan for four years of training. Fringe benefits at COMMIN are more generous than average and will undoubtedly ensure that these newly-trained engineers remain with the company.

Centre of the Ministry of Science, Technology and Energy (NECTEC), played an important role. NECTEC was established in September 1986 to fund marketable R&D and industrial product development in universities and in the enterprise sector. Its mandate includes the promotion of collaborative research between private firms and university staff, which is not an easy task because Thai firms have traditionally been active in the import sector and there have been very few industrial entrepreneurs (interview: NECTEC, March 1992). In 1989, NECTEC began to transfer technology developed at universities with NECTEC funds to private firms. Interphonic, then an injection moulding company, was the beneficiary of university work on a prototype telephone set carried out with NECTEC funding. It now markets this telephone and has since gone on to work with Kasetsart University’s engineering school to develop a 300-line PABX. NECTEC also played a catalytic role in stimulating innovation (Box 4). V NEW CHALLENGES TO SUSTAINED EXPORT SUCCESS Over the 1980s, the textile and clothing and the electronics industries have performed remarkably well, with a steady increase in the export of clothing and a

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sharp rise in that of electronics. Much of this success was due to low labour costs, the availability of skilled engineers and a favourable exchange rate. At the beginning of the 1990s, Thailand’s competitiveness in exporting labour-intensive products, however, began to decline in response to changes in both the internal and external environments. The main internal factors were a sharp increase in real wages, from a 1 per cent annual rise between 1978 and 1986 to 5.4 per cent between 1987 and 1991 (Poapongsakorn and Suzuki: 1992, 39), a shortage of skilled workers and engineers, and an infrastructure bottleneck. But the most serious threat came from Thailand’s foreign competitors whose export growth rates were rising more rapidly than those of Thailand. Thailand’s ranking among world textile exporters fell from 19 in 1989 to 21 in 1990 and among clothing exporters from 8 to 10 over the same period. In response to these new challenges, Thai entrepreneurs introduced various forms of adjustment which are examined in the following two sections. Adjustments by textile and clothing firms As Thai firms began to lose their low-wage comparative advantage, they turned their attention to the development of new production management and marketing capabilities in an attempt to improve productivity and product quality and facilitate a move up-market into more sophisticated, less easily imitated products. For SYG, this meant investing heavily in expensive new machinery to produce higher value added items such as women’s suits, Gortex waterproof ski-wear and sports-jackets for men. At MLG a new line of clothing—surgical suits—was introduced in 1993. While cutting and sewing surgical suits is relatively simple, the strict requirement for cleanliness in the factory is a reasonably effective barrier against newer

BOX 4 Assembler to innovator COMTV, the smallest local company in the sample, was founded by a university drop-out who, as a child, worked at his father’s television assembly plant until it was shut down as a result of changes in government regulations that were detrimental to small assemblers. Founded in 1982, COMTV’s first product was a computer monitor. Since the owner had no technological know-how, he simply imported CKD kits from Taiwan Province of China and hired two technicians to operate the equipment. In his first year he sold only 50 units. Later, he expanded into the production of power supply and main boards. In 1990, a director at NECTEC invited him to join a research project on computer design. The research budget was 2 million baht, with which he took an engineering professor to tour factories in Taiwan Province of China and study the design of PCBs. Within six months the project was completed and COMTV began to produce the first Thai personal computers. Competition in the PC

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export market, however, was fierce and, despite BOI privileges, COMTV was not competitive. Domestically, the company also had difficulty expanding its PC production once the import duty on PCs was reduced to 5 per cent, but imported components were taxed at 4 per cent. Profits were thus squeezed and COMTV decided to move into new product lines with higher profit margins and less competition. The first of these was the development of a data dictionary in Thai for which it received research funding from NECTEC. The second was a cellular telephone for which there was growing domestic demand and no local producer. NECTEC was again the source of design and development funds, committing 8 million baht to the project. This time, COMTV used a reverse engineering method and within eight months was able to produce a cellular telephone model of its own that included some radio frequency modifications. Because of its continuous involvement in research, this small company has developed a strong R&D unit which employs one Ph.D., three M.Sc. and four B.Sc. graduates in engineering. Over the past few years, the team has also introduced new products on its own, including a computer maintenance teaching software package called Micro-copy. Although most of COMTV’s output is sold in the domestic market, 1 per cent of its products are indirect exports, i.e. parts sold to local exporting firms.

entrants. In the late 1980s, managers at AST, which produces simple cotton grey cloth and canvas, did not anticipate that wages would rise as rapidly as they did and expansion was thus based on less automated spinning machinery. To offset its lower productivity, AST is moving into higher value added products through major new investment in a dyeing and finishing plant undertaken jointly with a German partner. None of the firms in the survey has, as yet, experienced a shortage of general production workers, but all are aware of the need to improve worker skills and increase productivity to remain competitive in these higher value added products. AST and CDT, for example, are attempting to increase workers’ productivity by improving their basic education, including through evening classes approved by the Ministry of Education. Although HMG’s manager complained that her workers often leave for firms offering slightly higher wages soon after they have been trained, she recently hired three consultants from the United Kingdom to launch a training programme for new recruits. Similarly, VRT has not let the problem of staff turnover limit its efforts toward building a high-quality workforce. Despite an increasing shortage of scientists and engineers in Thailand, VRT has managed to recruit six chemists and thirteen engineers. The firm also actively encourages its technicians to study for university degrees, and each year two or three technicians are selected for financial support. VRT and CDT have also been pioneers among Thai textile and clothing firms in building linkages to the scientific and technological community. VRT, for example, has established links with local universities and uses university

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lecturers to strengthen its in-house staff development programme. University lecturers in psychology offer special seminars at the company’s annual recreational trip for workers and, throughout the year, lecturers from the Engineering Department of Chulalongkorn University conduct in-house training courses for workers at the supervisory level and above. CTD has worked with the Textile Industry Division (TID) of the Ministry of Industry, which is the main government agency responsible for training and other services to the textile and clothing industries. Although its activities are seriously limited both by its small budget and its reduced staff levels,21 a special one-week training course for CDT’s chemists was recently organized. However, a recent survey of small and medium-sized textile and clothing firms conducted by TID revealed that more than half of the textile and clothing firms had never heard of the TID and among those that had, less than 20 per cent had made use of its services. Building management capabilities is essential if firms are to adapt to smaller lot sizes and higher quality demands by reorganizing traditional production processes. CTG, for example, replaced the older bundle system, under which workers specialized in only one or two tasks, with the newer modular system, where workers are trained in multiple skills. While this facilitates the achievement of economies of scope, the company is also aware that multiskilling provides workers with the broad range of skills needed to start their own business. Nevertheless, it is convinced that this is the only way for the firm to survive. PPG and SYG have also moved to the modular system and just-in-time training programmes have been introduced. Competitive pressure to improve product quality has also induced firms to change the method by which workers are paid. At PPG, the former piecerate has been replaced by a monthly salary. HMG, which took a similar step, argues that this encourages workers to focus more on improving quality than on simply increasing quantity. CDT hopes to achieve the same objective through its new system of monetary incentives. Instead of adding 15–20 cents to the legal minimum wage, as many other firms do, a much larger amount is put into a pool to be divided according to a worker’s weekly or monthly performance. The need to upgrade products and product quality has also been a prime motivating factor at NKG. The company entered the clothing export market by collecting unused quota, and has never specialized in any particular clothing item or market, preferring to shift its product mix in response to changing market conditions. Thus, flexibility has, to a large extent, been its source of strength. But as competition from low-wage countries undermined its ability to compete in simple garments such as trousers, NKG entered into a joint venture with a Japanese maker of men’s suits and will pay royalties for production technology over the next three years. On the positive side, this arrangement has meant that all 200 of the workers in the new factory have been sent to Japan at the rate of 15 per month for training, thus improving product quality and productivity. On the negative side, however, because buyers are now mainly looking for a full

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collection in which jackets and trousers match in quality and delivery times, NKG can no longer rely on fabrics supplied from within its own group. The proportion of imported fabrics has thus risen significantly as the company tries to accommodate customer demands by producing a greater variety of clothing. To reduce costs and respond quickly to changing conditions in the export market, domestic subcontracting has also become a more interesting proposition for NKG which now sends out some of its middle-range garments for sewing to small firms in the Bangkok area with 50 to 60 sewing machines. High-value items, however, are done entirely in-house. It is rare to find a Thai firm working in the middle to higher-price garment range that subcontracts out to the rural areas. CTG is the exception, but increasing reliance on sales to middle and up-market customers abroad might undermine this strategy in the future and further reduce the incentive for CTG to develop its own collection (Box 5). Moving up-market will require a stronger domestic fabric sector as well as the development of design capabilities and the establishment of brand

BOX 5 From designer to marketer CTG is the only firm in the survey to subcontract work out to village women in Thailand’s rural areas and more recently in Laos. This practice originated with CTG’s founder, whose family’s hand-woven silk business had a long tradition of village subcontracting. But it also reflected CTG’s choice of market niches, one of which was the ‘cottage look’, based on its own designs with hand-embroidery and appliqué work. This type of garment has the advantage of being able to combine low-cost labour in the village with distinctive local handicrafts. At the bottom end of the clothing export market, reliance on village women can be a tremendous cost saving. At the medium to high end, where CTG must now compete, it makes control over product quality and delivery times very difficult. Nonetheless, CTG has decided to go into modern production management with the assistance of a world-renowned consulting firm while retaining its traditional practice of village subcontracting. How far it will be able to combine these two approaches depends upon its ability to upgrade the skills of workers who have only limited formal education. It is, however, a promising initiative and creates new hope for Thai women villagers, as well as for rural development and the strengthening of domestic linkages. However, as competition in the export market changes, CTG is finding it more difficult to cover the factory’s fixed costs and ensure that workers have jobs all year round by marketing its own designs. In part, this results from the difficulty for Thai designers trained in Europe to keep up with colour and fashion trends abroad. CTG has attempted to solve this problem by recruiting European designers for a couple of months each year to design the firm’s annual collection, but it is increasingly finding it simpler to work as a subcontractor to foreign buyers, making up items in accordance with clients’ designs. In addition, it is developing

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new production capabilities in specialities such as down-filled garments that require high technical skill and specialized knowledge. Because marketing capabilities have also become critical in determining a firm’s competitiveness, CTG, which used to employ local agents in various countries, is now developing its own sales force and goes directly to buyers, especially small retailers. Cutting out the middleman not only reduces costs but it allows the firm to select appropriate customers for its products and helps to build customer loyalty over the longer term. While CTG has thus invested heavily in improving its production, management and marketing capabilities, competition in the changing export market has led to adjustments which lessen the firm’s distinctiveness and ‘roll back’ its design capabilities.

names. However, all the firms in the survey acknowledged that it is especially difficult to establish brand names in the Thai context. Original designs for the production of clothing for export markets are at present limited and firms have little hope of developing them soon. Although NKG, for example, would like to move towards higher value added products, recruiting inhouse designers is not among its immediate plans. For its part, NKG believes that Thai designs are inappropriate for European customers. MLG also believes that Thai designers are unable to cater for foreign customers, particularly the Japanese who have a distinctive taste. However, the firm does have some employees with a background in design who work with the buyers’ own designers. They can quickly understand very rough sketches and are able to offer suggestions that reduce costs or improve manufacturability. Other firms that used to employ a parttime designer, such as PPG, have discontinued the practice because the result was not considered to be worth the expense. Thus PPG is content to produce for major sportswear companies, such as Nike and Puma, in accordance with their specifications. Meeting new challenges in the electronics industry As in the textile and clothing industries, changing competitive conditions are motivating electronics firms to move towards higher value added products. But since labour costs are not such an important determinant of competitiveness in this industry, electronics firms must achieve economies of scale and lower defect rates if they want to reduce production costs. Economies of scale can be achieved by mass production and by using automated machines which have faster production speeds and greater precision and almost all electronics firms are now employing fewer semi-skilled workers and more skilled operators. PCBGS is heading away from labour-intensive techniques towards volume production following its improved access to the United States market and COMMIN has enjoyed low average costs and rapidly expanded to become the largest factory of its kind in the world. But some firms,

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such as PCBGS and PCBSC still maintain some manual production lines with lower capital costs. Most firms in the survey realize that demand for electronics products is highly volatile and that markets are heterogeneous. To be competitive, therefore, they have to be able to serve many market segments at the same time. In most factories, changes in production lines are also frequent, which means that firms must have good inventory and production management and strict quality control if a high defect rate is to be avoided. Reduction in defect rates can significantly lower production costs in electronics firms because of the savings in raw materials and components which are the largest cost items. The research team at TVTEC, for example, has been working to improve production on its newly automated production lines and is developing product-testing procedures to reduce its current defect rate of 20 per cent to 5 per cent. COMMIN, which has always used precision machines, had a high defect rate in the production of stepping motors, but within one year, it successfully reduced the rate by improving production and engineering processes. Stricter testing also allowed COMMIN, PCBGS and PCBSC to identify the sources of errors and thus solve problems more quickly. Capable operators and careful maintenance are required if automated machinery is to be run efficiently. Defect rates can also be more easily reduced if skills are upgraded so that workers can more easily identify problems. Electronics firms therefore tend to invest heavily in both formal and informal training. Line workers in many of the companies surveyed receive a full month of intensive training by supervisors and team leaders prior to a further period of on-the-job training over several weeks. When a new product or model is introduced, selected operators, supervisors and engineers are generally sent abroad for training at the parent or client firm and are responsible for training other workers on their return. This is the case with COMMIN, DISKSEA and PCBGS, although at TVTOS and TVTAT, where pay is relatively low and labour turnover is high, workers’ skill levels have not been upgraded. Moreover, at TVTOS, the volume of production for the local market is relatively small because new models are constantly being introduced and thus yields and productivity are low. High turnover of engineers is a problem in the electronics industry which ICAM, COMMIN and DISKMIC have dealt with through a dual strategy of increasing the salaries of their Thai engineers, offset by the recruitment of cheaper foreign engineers from China, the Philippines and South Asian countries. Bonding contracts are used when engineers from COMMIN, DISKSEA and PCBGS are trained abroad for more than one year. In an attempt to reduce staff turnover, COMMIN also now pays health-care benefits for the parents of its workers, while other firms offer shift allowances, bonuses and performance rewards. A small number of electronics firms have begun to source raw materials, components and peripherals locally because it is both cheaper and faster than

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using foreign sources. In response to the government’s policy of industrial linkage development, COMMIN, for example, contracted four plastic manufacturers to supply 18 million plastic components. It is also purchasing other high precision parts and components in Thailand (mainly from its traditional Japanese supplier),22 although other firms complain about the poor quality of these components, the limited choice of suppliers and the high costs in time and money incurred from having to claim import tax rebates on their imported inputs.23 Currently, less than 20 per cent of total components are sourced locally. But as the industry expands and opportunities arise to increase economies of scope, local sourcing may become more attractive. BOI policy has recently been modified to encourage domestic linkages by allowing investment privileges to be granted to component and peripheral producers and permitting joint venture companies to sell up to 50 per cent of their output in the domestic market. The procedures for issuing customs clearance documents to component suppliers selling in the re-export market have also been rationalized. These policy measures should encourage more intra-industry linkages, but they might be too late for a firm like PCBGS, which has significantly improved its cost advantage by using a satellite-based coordinated global sourcing system. As domestic sourcing increases, labour disputes have had a greater impact on the industry’s performance. In 1992, a one-day strike at COMMIN resulted in a revenue loss of several million baht.24 DISKSEA, which buys components from COMMIN, was also affected and had to shift its workers to other products, which resulted in overstocking at a time when inventories were being reduced and a just-in-time system was being implemented in rival firms. Since electronics firms are often located on the same industrial estate, disputes in one plant may easily spread to others, as at the Nava Nakorn Industrial Estate in early 1992. In response to the intensified competition in low-end products, many of the firms in the survey have attempted to integrate backwards, diversify into new product lines and look aggressively for new markets. DISKMIC is a case in point which, having successfully weathered a recession in hard-disk drives by introducing the newer 3.5 inch disk-drive and a faster data storage system, is now attempting to upgrade from peripherals-producer to product-assembler and, in the process, to manufacture more of its own components. This, however, poses a direct threat to its sister plant in Singapore. To remain competitive, COMMIN found it necessary to integrate different technologies so that it could check key aspects of the entire process and incorporate new functions and features into its high-performance products. By 1991, only 30 per cent of its sales still came from its original product (ball-bearings) and the firm now produces key-boards as well as various parts for hard-disk and floppy-disk drives. PCBGS has not only started high-volume, fine-pitch, surface-mount production lines but has enlarged its capabilities from complete product assembly to surface-mount and PTH-PCB assembly, plastic injection-moulding in circuit and functional testing, as well as some engineering services. Other firms have diversified and entered markets

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with fewer competitors and higher potential profits. PCBSC, for example, is trying to become an OEM of consumer electronics products such as safety boxes and starter motors, which have a higher profit margin and COMTV, as noted earlier, has also diversified by developing its R&D capabilities (Box 4). Most Thai electronics firms have very weak marketing skills because this sphere is usually handled by the parent company or foreign partner. One consumer electronics firm (TVTOS) is not only prohibited from exporting its television sets, but has to sell them in the local market through the sales arm of its foreign partner. Thai-owned firms are now tending to be more active in marketing. After COMDT was taken over by a Thai entrepreneur, the firm had to develop its marketing staff and skills from scratch, which it did by signing a major contract with IBM. Similarly, PCBSC, which was acquired by a Thai bank from its United Kingdom owner, built up its marketing skills by sending employees abroad, although it has not yet found any new major customers. PCBGS adopted a different approach: its acquisition of a firm in California which produces its high-end products and does local marketing has improved its access to the United States market and made volume production possible. As a result, PCBGS increased its sales from 304 million baht in 1989 to more than 4, 000 million baht in 1991, although its local staff has not yet been exposed to marketing. In an effort to boost domestic sales, television set producers have focused on market niches. Thus all three producers in the survey (TVTOS, TVTEC and TVTAT) are now offering a wide range of products to satisfy the requirements of today’s discerning customers. The establishment of the ASEAN Free Trade Area (AFTA) in January 1993 exposed Thailand’s consumer electronics firms to new competitive pressures from cheaper Malaysian imports and the largest local producer of colour television sets proposed to use its strength in research to cope with this challenge, with the design of story boards that meet customers’ preference being one of its marketing tactics. After its Hong Kong partner was taken over, TVTEC also had to carry out its own marketing. The firm recently launched an after-sales service for the domestic market, but it has yet to develop a clear marketing strategy in its export markets. Some domestically oriented joint ventures in audio-visual equipment plan to increase the share of their Japanese partners in order to expand the production base in Thailand to serve the ASEAN market. VI CONCLUSIONS From 1957 to 1971, Thailand pursued the classic policies of importsubstitution, which proved attractive to local entrepreneurs in the textile industry and to foreign investors in simple consumer electronics products. During the 1970s, export promotion policies were adopted and strengthened, but protection of the domestic market was maintained, which created a disincentive to export for

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established firms25 in these two industries. However, along with legislation to stimulate foreign investment, low labour costs, good infrastructure and political and macroeconomic stability, the shift towards export promotion successfully lured new entrants into both industries. The 1970s and 1980s saw a significant increase in export-oriented foreign investment, notably in the semiconductor and computer-related sectors of the electronics industry and the rapid growth of an export-oriented clothing industry. By the mid-1980s, Thailand had clearly established itself as a major exporter of manufactured products, joining the ranks of the second tier NICs. In explaining the growth of manufactured exports, this study has emphasized the historic practices of firms in the textile and clothing industries, particularly with regard to the building of investment, production, management, minor changes and marketing capabilities, the pivotal role of foreign investors in creating production facilities, providing markets and training a future generation of entrepreneurs in the components and peripherals sectors and the dynamic interaction with clients and suppliers which provides feedback and new learning opportunities for export-oriented firms. Individually, however, specific policy changes appear to have played a less decisive role in stimulating the building of technological capabilities or the growth of exports than the combined set of positive and negative incentives resulting from these policies and the policy dynamics emerging from the interaction of these policies and the historic practices of the firms with regard to innovation and competition. The complexity of this process is reflected in the rather slow growth of manufactured exports following the adoption of export promotion policies, the accelerated pace of export growth later in that decade and the dramatic burst of exports during the years 1985–1992. Once basic production, investment and management capabilities were established, policy dynamics, opportunities and constraints in the international system and the underlying stability in wages, prices and exchange rates that prevailed for much of this period were all critical elements in Thailand’s emergence as a major exporter of manufactured goods. Over the ensuing decade, the development of engineering capabilities and a skilled, but low-wage labour force, along with the adoption of additional measures to attract foreign investment, currency appreciations in Japan and the NICs and a sharp depreciation of the baht in the late 1980s, further stimulated exports in these two industries. To assess the sustainability of this process, a brief look at the strengths and weaknesses that have emerged in the Thai productive and technological system over the past quarter century is necessary. The shift to export promotion came at a particularly opportune moment for the Thai textile industry. Over the previous two decades, Thai textile firms had gradually strengthened their production and management capabilities, initially, through an infusion of know-how by Chinese immigrants from the mainland, Taiwan Province of China and Hong Kong. Subsequently, these Thai-Chinese entrepreneurs, most of whom had little formal education, sent their sons and daughters abroad to study textile engineering in the

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United Kingdom, business management in the United States and clothing production and fashion design in France. The second generation of entrepreneurs of the early 1960s was thus able to participate in all aspects of investment and production decision-making. Learning through close contracts with clients and suppliers, particularly Japanese trading companies, in the 1960s and later with firms from the NICs enabled this generation to move into garment manufacturing. Opportunities for doing so emerged during the 1970s and early 1980s as MFA quotas on textile and clothing exports from Hong Kong, South Korea and Taiwan Province of China became more restrictive. Quality improvements in the labour force and low wages gave Thai firms a clear advantage for penetrating both quota and non-quota export markets. Despite relatively little help from the government and few supporting industries, Thai manufacturers managed to expand production and exports, mostly serving as subcontractors to firms from the East Asian NICs which supplied them with fabrics, patterns, designs and markets. No local capability for designs or marketing was thus necessary. But the more entrepreneurial Thai firms soon developed their own marketing capabilities and tailored their production to newer, up-scale clients. They also identified market niches where barriers to entry were based more on the mastery of technical and production skills and the management of delivery times and product quality than on low wages. A number of Thai firms successfully made this transition. Textile firms, however, have been subject to a much greater extent than clothing manufacturers to a variety of arbitrary and frequently contradictory policy pressures that, over the 1980s, slowed the development of technological change capabilities needed for their own competitiveness and reduced their ability to play a positive role in sustaining the export success of the Thai clothing industry. Intermittent investment promotion policies, for example, gave larger textile firms, which were able to obtain prior warning of impending policy changes, an advantage in securing funds for capacity expansion at the expense of smaller firms or newcomers. At the same time, wage and macroeconomic stability provided them with little incentive to invest in more productive machinery and equipment or to develop the minor change capabilities needed to adjust as the quality and design frontier advanced. In addition, periodic restrictions on capacity expansion seriously hampered the development of the dyeing and finishing sector, thus compromising the move towards higher value added textile products and encouraging the import of fabrics by clothing exporters. To stimulate the modernization of the weaving and dyeing sectors, the Federation of the Thai Textile and Garment Industry has urged the government to create a Textile Institute and a Textile Adjustment Fund. The Institute’s main function would be to help upgrade the industry by funding research projects, collecting information on production, technology and marketing and providing training. The government is now looking for the resources to set up the Textile

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Adjustment Fund which will be used to help finance companies wanting to upgrade their production. For the most part, however, linkages to the science and technology infrastructure are particularly weak and most firms share the view that Thai designers, for structural reasons related to national tastes, climate and distance from major markets, will be unable to penetrate northern markets. As Thai wages rise, this may be a limiting factor for the further expansion of exports by clothing firms. In the absence of a rapidly growing domestic market for clothing, pressures to internationalize production will rise and a number of Thai firms have already begun to explore the possibility of investing in the emerging markets of Viet Nam, Laos and Cambodia. In one important respect, the electronics industry stands in marked contrast to the textile and clothing industries. This is the role of foreign direct investment as a source of technological capacity, a critical element in explaining the boom in electronics exports in the 1980s. As in the textile industry, however, export promotion policies were grafted on to existing import-substitution policies and practices, resulting in a dualistic industrial structure in the consumer electronics industry where domestically oriented firms, whether Thai-owned or joint ventures, have developed fewer technological capabilities and are less efficient than export-oriented companies. Continued protection of the domestic market and limited government support for R&D activities in this sector have also slowed its contribution to exports. However, in the largely foreign-owned semiconductor, components and peripherals sectors, technological capabilities have steadily built up and exports are booming. In the 1970s, pre-investment tasks, for example, were carried out exclusively by parent firms or foreign partners. During the following decade, Thai engineers began to play an active role in procuring machinery and equipment, installing production lines and carrying out the necessary test-runs prior to start-up. Rising labour costs and competitive downward pressure on product prices pushed some firms into strengthening their production capabilities, particularly in the areas of process operation and control, quality control of both inputs and outputs, development of in-house training programmes, new management processes, including employee participation, maintenance and calibration procedures relating to machinery and equipment and inventory controls. Defect rates and hence production costs were thus drastically reduced. Productivity was also enhanced by the mass production made possible by the introduction of automated machinery, and despite rising wages late in the decade and a rapid decline in the price of electronics products, Thai exports have remained competitive. By the late 1980s, the range of electronics products manufactured in Thailand had widened, with the addition of a large number of manufacturers of peripherals and a gradual shift from assembly towards the production of components and higher profit-margin final products following the relocation of plants from the East Asian countries. The degree of local sourcing remains, however, very

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limited. Firms in the semiconductor industry believe that design capability cannot be developed unless Thailand introduces wafer fabrication. This, however, will require huge investments and the private sector believes that the project will be implemented only if there is government coordination and support. Adaptive capabilities also developed towards the end of the 1980s and were found in seven of the eleven sample firms26—two Thai firms, two joint venture companies and three foreign subsidiaries. However, only three of these have a separate R&D division. Most of the changes observed in the sample firms involved modifications and improvements to existing plants and processes undertaken to correct weaknesses in imported machinery and equipment or to meet environmental standards such as new international regulations concerning CFCs. Minor product-design changes were observed only in joint venture companies and in Thai firms which are OEM producers. These changes are made in an attempt to meet changing consumer preferences. R&D activities tend to be carried out only by large companies because of the high fixed costs involved. Recently, however, a few small Thai firms and medium-sized joint venture companies have set up R&D units and in some instances these small innovative Thai companies have developed linkages to the science and technology community, particularly universities and the public sector research-funding body, NECTEC. In conclusion, Thailand’s textile, clothing and electronics industries have travelled far from the days when low-cost labour was their major advantage. There have been a number of obstacles along the way, but Thai producers have learned how to acquire the various technological capabilities. They are now able to select investment sites, choose machinery, improve production processes and testing procedures, source raw materials and components, search for technicians and personnel, both at home and abroad, and train employees at all levels. Textile and clothing firms have also successfully developed their marketing capabilities and a few electronics firms are now following suit. In order to sustain their growth and remain competitive in a fast changing world, exporters acknowledge that they must further strengthen their technological capabilities. The principal effort must now be concentrated on the area of training; most firms send their employees to training courses in management, technology and quality control, and some have organized inhouse training. Industry associations are also beginning to play a role. The Thai Garment Association, for example, recruited a Hong Kong consultant to provide intensive training courses for managers of its member companies in the critical fields of marketing, production and designing. The second most common approach in both electronics and textiles is to introduce incentive pay systems to reward workers for productivity gains and quality improvements. Bonuses and other rewards reduce labour turnover and firms do not lose their investment in training.

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To stimulate further the development of technological capabilities and hence the ability of Thai firms to maintain their export success, policies that retard industrial development will have to be eliminated or modified. For example, Thailand’s tariff on imported raw materials, parts and components for local production is the highest among the ASEAN countries, resulting in a lower domestic production than would be expected given the high level of nominal protection afforded to finished products. Policy biases not only affect those producing for the domestic market but have a negative impact on exports. Import tax rebate and exemption procedures are examples of time-consuming measures that create extra costs for exporters. Attention will also have to be paid to the problem of land speculation. During the period 1986–1991, many companies found that the return on reinvesting profits from their manufacturing activities into real estate development and land speculation was much higher than in manufacturing. Whether or not further land speculation will yield higher rates of return is not certain, as land and real estate markets have stagnated since 1992. NOTES 1 However, when the dollar depreciated in the 1970s, Thai exports were penalized by the overvalued baht. 2 Firms that can enjoy protection in the domestic market feel little pressure to export unless forced to do so by competition and local overproduction. Even then they tend to retain a foothold in the domestic market to fall back upon in hard times. 3 In the late 1980s, the exemption from import duties on machinery and equipment, which had long been a feature of the investment promotion policy, was lifted. 4 In 1992, NS was acquired by Chinteik Electronics Industries, a Thai-owned firm. 5 Each firm exports at least 0.3–1.0 million sets per year. The joint ventures and the Thai firm also sell a small portion in the domestic market. 6 The leading Thai firms are DiStar and Synco. 7 In addition to the firms in these four sectors, there were over 60 software firms in 1991 (TDRI: 1992c, p. 29). Apart from local firms, many foreign companies also set up operations in Thailand, either as joint venture partners or foreign subsidiaries, to provide services to local clients of parent companies such as IBM and Datamat, and/or develop custom software to suit clients’ individual needs (TDRI: 1992c, p. 30). Of the 40 producers in the communication equipment market, 30 were foreign subsidiaries or joint ventures which had received BOI promotion by 1993. The remainder are small Thai producers catering for the local market. The most important group of local firms consists of four PABX producers (Faculty of Economics: 1992). 8 Completely built-up and completely knocked-down kits. 9 The BOI monitors their accounts. Nevertheless, the large television set manufacturers complain that some export firms illegally sell their products in the local market. 10 These include the picture tube, fly-back transformer, yoke and capacitors.

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11 Prompt delivery is extremely important in the electronics industry where competition is fierce and some products have to be shipped by air. Transportation is the third largest cost for electronics firms. 12 A total of 584 projects was recorded. 13 These data were gathered between March and October 1992 through personal interviews with senior executives. In the case of textiles and clothing they were also major shareholders who had been involved in the company from the beginning, while in the electronics industry, these were mainly managing directors, factory managers and personnel managers. Information was also gathered from a number of informal meetings with managers from other electronics and electrical firms. 14 Almost all of the case studies involved entrepreneurs with ethnic Chinese backgrounds—a fact which simply reflects the dominance of Thai-Chinese in all commercial and industrial activities in Thailand. The kinship network was particularly important in these firms, although family members must also prove their merit like everybody else. One advantage of employing relatives is the resulting social pressure to work harder and to be honest, so that they do not cause their family to ‘lose face’. 15 The sales manager had all contracts concluded in Hong Kong, enabling him to share half of the profit with the firm’s Hong Kong partner. 16 At the time, engineers worked mainly in the public sector. 17 Since the training provides firm-specific skills, firms have an incentive to train. The same, however, is not true in the textile and clothing industries where firms are reluctant to develop in-house training programmes and to finance the training of their workers in state-sponsored programmes for fear of losing them. 18 It should be noted, however, that the type of products produced by original equipment manufacturers is usually based on mature technologies, and designs do not require much adaptation. 19 Similarly, the rapidly expanding domestic market for air-conditioners meant that firms which had developed behind high tariff walls were now able to enjoy economies of scale. This motivated these firms to integrate backwards and to develop some minor change capabilities. One leading joint venture company which previously had problems buying compressors from the local monopolist established its own compressor plant after the five-year ban on new compressor plants expired. The company acquired know-how in die-casting and mouldmaking at a very low price from a Japanese company which was facing high labour costs, in exchange for agreeing to supply compressors to the Japanese firm. 20 The exception, as noted above, was National Thai, the largest television set manufacturer producing 300,000 units per year. A few joint venture companies in the electrical appliance industry are also actively building technological capabilities. 21 The division also has difficulties retaining its own experts because of the large differential between salaries in the government and private sectors. 22 Because COMMIN is vertically integrated, the parent firm continues to monitor product quality and control sourcing. Twelve years after start-up, 27 out of the 37 managers are Japanese, although Thai assistants play an active role in day-to-day operations in almost every department. 23 BOI-promoted firms, which supply parts and components to exporters who use them as inputs, have to obtain valid customs documents for entitlement to

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duty exemption. Non-promoted suppliers of parts to producers of electronics exports have to file a claim for import tax rebates. The process takes several months. 24 The strike was quickly settled when managers agreed to increase fringe benefits. 25 Import protection encouraged many textile firms to hold on to their stake in the domestic market, with the list of protected items serving as an accurate guideline to which products would be the most lucrative. 26 This is consistent with a TDRI study (1989a) which found that 50 per cent of its sample firms had adaptive capability and that the large Thai firms and joint ventures have higher capabilities than other firms.

BIBLIOGRAPHY In English Akrasanee, Narongchai (1973) ‘The manufacturing sector in Thailand: a study of growth, import substitution and effective protection 1960–69’, Ph.D. dissertation, Johns Hopkins University, Baltimore, MD. Boonyubol, C.et al. (1988) ‘The policy review of the tariff structure in the electrical and electronics industry’, prepared for the Board of Investment and the Federation of Thai Industries. Chenery, Hollis and Srinivasan, T.N. (1988) Handbook of Development Economics,Vol. 1, Elsevier Science Publishers, BV, Amsterdam. Christensen, Scott R., Ammar Siamwalla and Pakorn Vichyanond (1992) ‘Institutional and political bases of growth-inducing policies in Thailand’, paper prepared for the World Bank Project on the East Asian Development Experience: Legacies and Lessons (September). Dahlman, C.J. and Brimble, P. (1990) ‘Technology strategy and policy for industrial competitiveness: a case study of Thailand’, Industry and Energy Department, Working Paper No. 24, World Bank, Washington, DC (April). Elliott, Brian (1986) ‘Technology, innovation and change’, selected papers from a seminar organized by the University of Edinburgh, Centre of Canadian Studies, Edinburgh. Herderschee, Han (1995) Incentives for Exports: A Case Study of Taiwan Provinceof China and Thailand 1952–1987,Aldershot, UK, Ashgate, Avebury, pp. xxiii and 235. Krongkaew, Medhi (ed.) (1995) Thailand’s Industrialization and its Consequences,St Martin’s Press, Macmillan, London. Maarten de Vet, Jan (1993) ‘Striving for international competitiveness’, Lessonsfrom Electronics for Developing Countries,OECD, Paris (30 October). Mytelka, Lynn Krieger (1991) ‘Technological change and the global relocation of production in textiles and clothing’, Studies in Political Economy, No. 36, Fall, pp. 109–143. Ohno, Akihiko (1995) ‘Modernizing agents and organizational adaptation of factory workers in Thailand: a case study of a Japanese joint venture in Chiang Mai’, Journal of Developing Economies,Vol. 33, No. 3, pp. 310–329. Santikarn, Mingsarn (1977) ‘Technology transfer: a case study of the textile industry in Thailand’, unpublished Ph.D. dissertation, Australian National University, Canberra.

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Shiowattana, Prayoon (1991) ‘Technology transfer in Thailand’s electronics industry’, in S.Yamashita (ed.) Transfer of Japanese Technology and Management tothe ASEAN Countries,University of Tokyo Press, Tokyo, pp. 169–197. Suphachalasai, Suphat (1992) ‘The structure of the textile industry and government policy in Thailand’, paper presented at the 1992 TDRI Year-End Conference on Thailand’s Economic Structure: Towards Balanced Development? Ambassador City Jomtien, Chon Buri (12–13 December). TDRI (1989a) The Development of Thailand’s Technological Capability in Industry,Vol. 5. ‘Capability development for electronics and information technology-based industries’ (March). ——(1992a) Private Sector R&D: Lessons from the Success,report submitted to the International Development Research Centre (June). ——(1992b) Case Studies of RD&E Performance in Electronics,report submitted to the National Science and Technology Development Agency (July). ——(1992c) Future Potential of Electronics in Thailand, report submitted to the National Science and Technology Development Agency (July). Tiralap, Anupap (1990) ‘The economics of the process of technical change of the firm’, Ph.D. dissertation, Science Policy Research Unit, University of Sussex, (February). UNCTAD (1996) Trade and Development Report 1996,Geneva. Wongkanlayanut, Amornthip (1986) ‘Sources of the sectoral overall and non-proportional output and employment growth in 1961–1975 and 1975–1983’, MA thesis, Thammasat University. World Bank (1989) Thailand: Country Economic Memorandum Building on theRecent Success—A Policy Framework, report No. 7445–TH, Washington, DC (February). Yamashita, Shoichi (1992) ‘Japan’s role as a regional technological integrator and the black box phenomena in the process of technology transfer’, mimeo, Hiroshima University, Japan. In Thai Chulalongkorn University and King Mongkut Institute of Technology (Lard Krabang) (1988) ‘A survey and study of the technological situation in the electronics and computer industries—IC’, Vol. 4, R2/2531, December. Faculty of Economics, Thammasat University (1992) ‘GATT: trade-related investment measures’, Industry Profile, No. 1, September. Poapongsakorn, N. and Suzuki, Pathamawadi (1992) ‘Towards labour shortage market’, paper presented at the 1992 TDRI Year-End Conference on Thailand’s Economic Structure: Towards Balanced Development? Ambassador City Jomtien, Chon Buri (12– 13 December). Seepaiphan, Chatreeet al. (1988) ‘Electronics and the electrical component industry’, Industrial Finance Corporation of Thailand, Bangkok. TDRI (1989b) S & T Manpower Situation: An Update (June). ——(1991a) ‘The identification of key technologies for industrial development’, report submitted to the National Economic and Social Development Board, prepared by the Sciences and Technology Development Programme (January). ——(1991b) ‘Barriers to and strategies for technology acquisition’, report submitted to the National Economic and Social Development Board, prepared by the Science and Technology Development Programme (April).

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Thinnakorn, Pranee (1988) ‘Industrial development path in Thailand’, R.Thanaporaphun and N.Poapongsakorn (eds) Thai Economy: A Path Peace,Thammasat University Press, Bangkok.

in to

5 Technological capabilities and Indonesia’s manufactured exports Thee Kian Wie and Mari Pangestu

I INTRODUCTION Textiles/garments and electronics are illustrative of the fact that Indonesia’s manufacturing is still in a nascent stage of development as regards its ability to compete in overseas markets. The experience of manufacturing firms considered in this chapter shows the first efforts that are being made to go beyond the mere exploitation of cost advantages in an attempt to give attention to other factors such as technology acquisition. An important influence in this process has been exercised by the incentive system. The creation of an improved foreign investment climate and the introduction of export promotion measures by the government in the mid-1980s coincided with locational considerations in the strategies of domestic and foreign investors, inducing them to set up exportoriented plants. However, Indonesia enjoys a continental-size economy which makes it difficult for many established firms to look beyond serving a lucrative home market whose attractiveness is ensured by prolonged government reliance on import substitution policies designed to shelter that market from foreign competition, at the same time that it implements measures aimed at promoting exports. Although firms in both industries face competitive challenges, their situations differ. In the more traditional textiles and garment industry, the acquisition of technological capabilities aimed at raising productivity is essential to the maintenance of export competitiveness in the face of emerging producers in countries such as China and Viet Nam. Electronics is a sector in which Indonesian firms have only just entered the fray. Technology accumulation by these firms reflects the imperative of investing in learning and in maintaining foreign technology linkages in order to keep up with the rapid pace of product and process innovations taking place internationally. Indonesia’s general economic policy framework has passed through several distinct phases since independence, which sets the context for interpreting the behaviour of firms in the textile/garment and electronics industries. As depicted in Table 5.1, a hallmark for the entire period since the New Order Government of President Suharto came to power in 1967 has been

Source: Table 3 in Bhattacharya and Pangestu (1993)

Table 5.1 Changes in policy direction and external conditions

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the achievement and maintenance of relative macroeconomic stability, except for some inflation during the boom in oil and non-oil commodity prices in the latter half of the 1970s. The resulting high rates of savings helped ensure the mobilization of resources required to implement the import substitution strategy of industrial development that Indonesia followed up to the early 1980s, leading to rapid industrial growth and structural transformation of the economy with a near doubling of the relative share of manufactures in GDP between 1969 and 1980. Unlike other East Asian economies, Indonesia was a late starter in adopting an outward-oriented development strategy. The resources generated by the oil windfall and the scale economies permitted by the large domestic market allowed it to follow import substitution longer than most other countries in the region. The import substitution industrialization strategy included state participation, especially in basic industries, and the erection of a complex system of incentives that imparted an anti-export bias and created restrictions on foreign and domestic investments. It was only in response to the end of the oil boom and other major external shocks during the 1982–1986 period that the Indonesian government embarked on a series of adjustment and reform measures culminating in an outright shift to an outward-oriented policy regime in 1986. As a result of the reforms, the most substantial of which were only introduced from 1986, the economy recovered and real GDP growth which had fallen to an average of 4.6 per cent in 1982–1987 from 7.5 per cent in 1975–1981 achieved an average rate of 7 per cent between 1988 and 1992, while non-oil exports, especially manufacturers, rose rapidly. The rise in exports led to a continued strong growth of the manufacturing sector which averaged 10.5 per cent per annum between 1988 and 1992 and now contributes more than 20 per cent of GDP, making Indonesia a semiindustrialized economy.1 The dramatic expansion of manufactured exports and the role of textiles/garments and electronics in this expansion is shown in Table 5.2. Section II of this chapter describes in more detail how the incentive system, reflected in the dynamic interaction between policies and market forces, shaped the development of textile/garments and electronics at the sectoral level. On the basis of information gathered from firm interviews, we go on to discuss how firms in these two sectors have been building up their technological capabilities in section III. In section IV, we present an account of the competitive challenges which textile and garment and electronics firms face and how they have been responding to these challenges as they seek to sustain their export performance, concluding with policy implications for the Indonesian government.

Source: Central Bureau of Statistics, Exports, various issues Note:a Parts and accessories (other than cases, carrying cases and the like) suitable for use solely or principally with machines falling within groups 751 and 752

Table 5.2 Manufactured exports by resource intensity (US$ thousands)

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II THE IMPACT OF THE INCENTIVE SYSTEM ON THE TEXTILE, GARMENT AND ELECTRONICS INDUSTRIES The textile and garment industries Industry structure It is useful to distinguish between the three distinct subsectors which comprise the Indonesian textile industry, namely the upstream, highly capital-intensive, large-scale, synthetic fibre industry, the midstream, capital intensive, large-scale spinning industry, and the moderately labour-intensive weaving and fabricproducing industry (which also manufactures products, such as carpets), and the downstream, highly labour-intensive garment industry. The synthetic fibre, spinning and garment industries are relatively new and began to grow rapidly only from the early 1970s. The weaving industry, on the other hand, is the oldest industry, dating back to the late-colonial period of the 1920s, and is also the largest, both in terms of output and employment (Hill: 1992b, p. 2). The ownership structure of the textile and garment industries, depicted in Table 5.3, has several interesting features. Whereas domestically owned private firms accounted for 61 per cent of value added in the textile industry in 1985, they represented nearly 98 per cent of value added in garments. The small (1 per cent) share of SOEs in the same year reflects a sharp decline from 16 per cent in 1975, due to the emergence of more efficient, private, local and foreign firms over that period. Joint ventures accounted for 39 per cent of value added in textiles in 1988 if projects with state participation are included. The concentration of foreign capital is particularly high in synthetic fibres. The data do not yet reveal the entry of a significant number of Korean and Taiwanese garment firms since the later 1980s. Development of the textile and garment industries The data in Table 5.4 show that the textile industry, particularly the modernspinning and weaving sectors, has expanded rapidly since the early 1970s following the sharp increase in investment by domestic and particularly foreign investors who were encouraged by the buoyant domestic demand and favourable investment incentives, including high effective protection against imports. The rapid growth of the modern, large-scale, power loom weaving subsector in the early 1970s came at the cost of displacement of the unprotected small-scale, hand-loom subsector (World Bank: 1978a, p. 89). Like the modern weaving

Source: For 1975 data: Balasubramanyan (1984, p. 74). For 1985 data: Hill (1990)

Table 5.3 Ownership pattern in Indonesia’s textile and garment industries, 1975–1985 (% of value added generated by major ownership group)

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Table 5.4 Textile production, 1970–1991 (thousand tons)

Source: For 1970–1989: Saastromihardjo (1991), based on data from Directorate of Textiles, Ministry of Industry. For 1990–1991: Directorate of Textiles, Ministry of Industry, October 1992

industry, spinning also grew quite rapidly during the 1970s and 1980s (World Bank: 1978a, p. 91), although it is a new industry in Indonesia which has not been saddled with a large, traditional, small-scale subsector. Due to high domestic demand, the spinning industry has been largely oriented towards the domestic market (Wymenga: 1988, p. 3). The new synthetic fibre industry began to grown rapidly only at the end of the 1970s following the government’s efforts to promote the downstream utilization of energy resources, particularly petroleum (Hill: 1992b, p. 8). By 1981, locally made synthetic fibres accounted for 62 per cent of the total volume of synthetic fibres available to the spinning industry, rising to 83 per cent in 1985, which indicated that import substitution of synthetic fibres had been relatively successful (Wymenga: 1988, p. 15). As a result of the strong growth of the midstream and the downstream industries in recent years, new foreign (Japanese and Korean) investments are now underway in the synthetic fibre industry. The garment industry began to develop rapidly in the late 1970s in response to rising demands in the domestic market associated with rapid economic growth

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and opportunities in the export market. Even as late as the mid-1970s, it was estimated that 85 per cent of the domestic clothing consumption was bought in the form of cloth which was then given out to local tailors to be sewn into clothing. Only 3 per cent of this consumption was supplied by the real garment industry, while 7 per cent was supplied by small-scale establishments (World Bank: 1978a, p. 95). The export-orientation of the garment industry began in the early 1980s, in reaction to sluggish domestic demand associated with slower economic growth at the end of the oil boom era. It was favoured by a comparative advantage arising from low labour costs and by unutilized quotas and attractive incentives, such as the export certificate scheme, subsidized interest rates for export credits and a realistic exchange rate policy (Wymenga: 1988, p. 5). The growth of garment exports can be seen in Table 5.2. It was only after the major external shocks of 1982–1986 that the Indonesian government made a major step, as part of its programme of stabilization and reform measures, to improve the country’s trade regime. The trade policy reform package of 6 May 1986 permitted export-oriented textile and garment firms to purchase inputs at international prices (whether actually imported or locally made). A duty exemption and drawback facility applicable to non-oil exports proved to be an effective mechanism for promoting exports of textiles and garments. Additional trade policy reform measures introduced in June and October 1993 have been of further benefit to these industries. Despite the outward orientation of these trade reforms, as in Thailand during the 1970s and early 1980s (chapter 4) they are incomplete, with the result that they have not given a great incentive to domestic market-oriented garment producers to shift to less profitable export markets. Textile and garment industries, in company with other industries, have continued to be subject to tariff protection including a battery of restrictive measures such as import licensing procedures, import surcharges, splitting of basic tariff items and selective tariff exemptions. Although they have been falling over time, nominal and effective rates of tariff protection have remained higher on import competing than on export competing goods, thereby imparting a persistent bias in favour of firms selling in the domestic market rather than abroad. Exporters of textiles and garments could obtain their tradable inputs at international prices (whether imported or locally made). However, their non-tradable intermediate inputs still had to be purchased at ‘above-free-trade’ prices, with the result that their export sale received negative effective protection, whereas sellers in the domestic market continued to enjoy a high effective level of protection on their value added. Other types of regulations have also penalized exporters. These include the imposition of a compulsory levy on exports of textiles and garments to countries which apply quota restrictions on Indonesian goods, the grant to a single designated firm the sole right to import cotton and synthetic fibres required by the spinning industry (rescinded after industry complaints), and the operation of a non-transparent system for the allocation of export quotas.

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Given the remaining ‘anti-export bias’ of the trade regime in the late 1980s, and other formidable restrictive measures, the question arises as to why textile and in particular garment exports were nevertheless able to increase so rapidly. The most important factor appears to be the dutyexemption and drawbackfacility scheme which enabled these firms to procure their intermediate inputs at international prices with few bureaucratic hurdles, and thus operate as though in an export-processing zone (EPZ) (Hill: 1992b, p. 67). Another crucial factor in the surge of Indonesia’s manufactured exports since 1987, including textile and garment exports, has been the maintenance of a competitive real effective exchange rate. Other factors may also have contributed to the rapid increase in Indonesia’s textile and garment exports. First, Indonesia may have benefited from the MultiFibre Arrangement (MFA) during the early export phase, when its textile and garment firms were not strong enough to compete effectively with established exporting countries, such as the Asian newly-industrializing economies (NIEs), whose exports were by then constrained by the MFA. Second, the policy reforms introduced from 1985 also included other elements which improved the competitiveness of export-oriented firms, such as speedier customs clearance, more efficient and flexible financial services and simpler licensing procedures for export-oriented investments. Third, the shift from the domestic market to export-orientation may have been hastened by sluggish domestic demand during the economic slowdown of the mid-1980s when textile and garment firms ventured into the export markets to maintain capacity utilization (Hill: 1992b, pp. 68–69). The prospects for the continued strong growth of the textile and garment exports, although at a slower rate, appear good, at least for the next few years. Three factors have been advanced for this optimistic forecast. First, textile machinery imports have risen very rapidly, from around US$4 billion in 1989 to almost US$8 billion in 1991 (Hill: 1992a, p. 10). The increase clearly reflects new investments and expansion in the textile and garment industries in response to the excellent export opportunities emerging with the shift to more exportoriented policies in the late 1980s. Second, as a result of the agreement reached with the United States government in May 1992, Indonesia agreed to liberalize the import of United States films in exchange for a major increase in the United States import quotas for Indonesian textile and garment exports (about 35 per cent). The agreement also contained a provision that unused quotas from (South) Korea and Taiwan Province of China could be transferred to Indonesian firms, a provision which may lead to even more Korean and Taiwanese investment in the textile and particularly garment industry. A third factor is the improved operation of the export quota allocation system which was previously hampered by fierce disputes between rival textile producer associations (Hill: 1992b, pp. 31–33). As further export growth may be constrained by import quotas in major export markets, serious efforts will however have to be made to penetrate non-quota markets. The data in Table 5.5 show that, in recent years, Indonesia’s textile

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Table 5.5 Relative shares of major export markets for Indonesia’s textile industry, 1989– 1991

Source: Directorate of Textiles, Ministry of Industry, October 1992 Note:a n=negligible (less than 0.1%)

industry has been relatively successful in redirecting its exports away from quotaconstrained markets to non-quota countries (Bank Dagang Negara: 1991, p. 8). Textile exports to non-quota countries rose from 41 per cent of total textile exports in 1989 to 49 per cent in 1991, mainly due to a rapid increase in exports to Singapore, which are mainly destined for third markets, while exports to the

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large and lucrative, but demanding, Japanese market rose only slightly, from 4.8 per cent of total textile exports in 1989 to 5.5 per cent in 1991. The data in Table 5.5 also show that over the past three years Indonesia has been losing its market share in the relatively small but affluent Australian market which could, with a more determined effort, be recovered or even increased. Table 5.5 also indicates that textile exports to the affluent markets in the Middle East, particularly Saudi Arabia and the United Arab Emirates, have been increasing. With the economic and political recovery of Kuwait, textile exports to the promising Middle Eastern markets could be increased even further. As the Asian NIEs are becoming relatively prosperous and gradually losing their comparative advantage in the production of labour-intensive products, there should also be good opportunities for the Indonesian textile and garment industries to increase their exports to these countries. The electronics industry Industrial structure and competition The electronics industry is normally defined to include three major subsectors: consumer electronics (video, audio and entertainment), industrial electronics (telecommunications, data processing and office equipment) and components. The sector consists mainly of private firms. In 1974 the structure of ownership was 59 per cent foreign owned enterprises, 1 per cent state owned and 40 per cent domestic privately owned (Balasubramanyan: 1984). By 1985, ownership in the electrical equipment sector was 45 per cent domestic private, 40 per cent foreign and 15 per cent state. State-owned enterprises have operated mainly in the telecommunications sector where they enjoy a monopoly (P.T. Inti) over the supply of equipment. Around 70 per cent of firms are located in the greater Jakarta area, and most of the remainder in Java. More recently, there has also been a rapid growth of electronics firms in Batam, as reflected in the significant amount of exports originating from this island. The electronics industry in Indonesia is still small, whether measured in terms of output or the number of firms operating in the sector as a whole. It is estimated that, by 1990, there were 120 firms in this sector, with 40 in consumer electronics (all private), 63 in business and industrial electronics (one stateowned enterprise in telecommunications), and 18 in component manufacturing (one state-owned enterprise).2 Consumer electronics are dominated by the larger joint ventures3 and a number of domestic producers were set up in the early 1970s. The consumer electronics subsector consists of nine large companies (with more than 800 workers) and 31 small and medium-sized firms. Since 1990 a number of relocation type export-oriented joint ventures from Japan and South Korea have

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been established which are mostly majority foreign-owned. The industrial electronics subsector consists of 29 firms in telecommunications and 24 in data processing. Only one is a large state-owned company, whereas the rest are small or medium-sized companies. There are 17 component producers, of which six are large and 11 small or medium-sized firms. At present, there are only two firms producing ICs. The components industry is still underdeveloped and dualistic in structure. On the one hand, there are several producers of basic components, such as plastic and mechanical parts, printed circuit boards, capacitors and resistors, supplying producers who sell on the domestic market, with very little subcontract linkage with domestic industry for the manufacture of components. On the other hand, some segments of the components industry are 100 per cent export-oriented (such as the assembly and packaging of ICs). The subsector consists of two joint ventures with majority Indonesian ownership, whereas in other countries the sector is dominated by multinationals. Other export-oriented investments in components, such as speakers and parts, flyback transformers and television tuners, were also motivated by relocation considerations and are majority foreignowned. Impact of the incentive system on electronics The impact of the incentive system on the electronics industry can be divided into three different phases corresponding to the major changes in the incentive regime and specific sectoral policies. In the Old Order period (1950–1966), the electronics industry was very underdeveloped, and consisted mainly of a small group of importers, repair and service centres and a few simple assembly operations. In the 1950s, some of these small operations began to produce radios under their own brand name. Subsequently, when black and white television sets were introduced in 1962, a number of larger local companies began assembly operations. The period 1971 to 1985 can be seen as the import-substitution phase, when the industry was protected by both quantitative restrictions and tariffs. Initially the government introduced a ban on the import of completely built up (CBU) television sets and radios and imposed tariffs on final consumer electronic goods (2–50 per cent) and professional electronic equipment (5–50 per cent). Protection from imports and the incentives granted to foreign investment attracted a number of foreign-controlled, joint venture firms and local private firms under licence to assemble consumer electronic products in Indonesia from the early 1970s. Many foreign firms were Japanese, such as National, Sanyo and Sharp, although there were also a few European companies, such as Grundig, Philips and ITT. At first, the import duties on CKD kits were lower than those on separate parts and components, with the purported justification of protecting domestic component producers and preventing importers from becoming pseudoassemblers. This policy favoured companies linked to principals, but created a

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disadvantage to other domestic producers since, at the time, CKD kits could be imported only through principals. Recognition of this disadvantage led to the elimination of the differential treatment in the late 1970s. Two other types of quantitative restrictions affected the electronics industry in the late 1970s and early 1980s. The first concerned the introduction of a ‘negative list’ whereby the import of prescribed items was banned.4 This policy was part of the domestic content programme introduced by the government towards the end of the 1970s and which continued up to the mid-1980s.5 Under the second type of quantitative restriction, some electronic products could be imported only by approved importers. The sole agency system for electronic goods and domestic electrical appliances was also introduced in 1982 for domestic assemblers linked to a foreign principal. The government also restricted the import of second-hand machinery. The rationale of the policy was to prevent the import of obsolete machinery through joint ventures, although it also discouraged the relocation type of investments since it made investment costs higher. The result of such an incentive system is predictably a high effective rate of protection (ERP) and an unfavourable environment for export-oriented firms. In 1987, the ERP for electric machinery was 152 per cent and 92 per cent for communication electronics (including consumer electronics). The structure of protection was biased towards the manufacture of final consumer durable goods, to the detriment of capital and intermediate goods as well as exports.6 Such a protection system, as well as other disincentives, led to weak backward linkages in the assembly of final consumer electronics goods for the domestic market. Protection and barriers to entry (new licences for new investments and expansions were difficult to obtain prior to the deregulation period) also limited competition in the domestic market, creating lucrative price differences and encouraging smuggling. At the same time as the import substitution policy was being implemented, the government also promoted the export-oriented electronics component industries. In the early 1970s, firms could apply for bonded-warehouse status and two major United States semiconductor companies—Fairchild in 1973 and National Semiconductor (NSC) in 1974—were granted such status. Both firms were 100 per cent foreign-owned (fully owned subsidiaries were allowed prior to 1974), and all their semiconductor output was exported. However, in 1986, both plants closed down as a result of the worldwide slump in the semiconductor business7 and the unfavourable incentive system, which discouraged automation in semiconductor factories.8 NSC operations in Indonesia were subsequently taken over by an Indonesian-Singaporean joint venture. The rise and fall of semiconductor exports (specifically diodes and transistors) between 1975 and 1985 can be seen in Figure 5.1. After a peak of US$135 million in 1984, exports rapidly declined after the closure of the two plants in 1986. Table 5.6 shows selected output and export figures in dollar values for the period 1985 to 1992. By the end of the import substitution period (1985), total

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Figure 5.1 Exports of semiconductor devices and ICs Source: Central Bureau of Statistics, Exports, various issues

electronics output had reached rupiah 463 billion (US$417 million), of which 54 per cent consisted of consumer electronics, 21 per cent industrial electronics and 25 per cent components. In 1985, the industry was clearly not export-oriented, with exports reaching only US$118 million, or 28 per cent of production. In 1985, only the IC subsector was export-oriented, with 74 per cent of production being exported. By 1985, most of domestic demand for consumer electronics was met by domestic production, while that for industrial electronics and components by and large still had to be met through imports. Weakening domestic demand in the early 1980s and the introduction of several deregulation measures to encourage export orientation, particularly since the mid-1980s, led to the third and current phase in the development of the electronics industry, when joint ventures and some domestic firms began to export consumer electronics products. As with many other manufacturing firms which started to export at this time, this was a response to the improved export promotion incentives, especially as regards customs procedures in 1985, the administration and implementation of dutyexemption facilities for exporters, the establishment of export-processing zones in the industrial estates from 1989 and the approval of majority foreign ownership of export-oriented foreign firms. Lifelong investment licences were now granted by the Department of Industry, while extensions of production capacity up to 30 per cent no longer required approval. The maintenance of the real effective exchange rate since the 1986 devaluation was also conducive for exports.

Source: a Calculations based on Central Bureau of Statistics data Note: Mainly portable radios, tape recorders, radio combination players and car radios

Table 5.6 Electronics output (O) and export (E), 1985–1992 (US$ millions)

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Another possible reason why domestic companies moved towards exports was to increase their production scale in anticipation of sharper competition in the domestic market after export-oriented companies were allowed to sell a certain percentage of their production in the domestic market.9 Export-oriented investments of the relocation type from Japan and the East Asian economies only came to Indonesia in 1991–1992, despite the fact that the outflow of such investments more generally began 5 years earlier. There are several reasons for the late start in Indonesia. First, the electronics industry in Indonesia is relatively underdeveloped and its image has not been helped by the closing down of two semiconductor firms. Most relocation investments from Japan and the Asian NIEs were initially directed to other countries with a more developed electronics industrial base, such as Thailand and Malaysia. A second reason relates to the length of time required to complete the necessary procedures and set-up operations. For instance, some of the firms which began operations in 1991–1992 had announced their investment plans as early as 1988. A third reason for the late start is that the electronics sector was deregulated only in May 1990, after which all electronics goods and their main components could be imported under the non-restrictive general importer licence rather than only through approved importers. This essentially meant that CBU electronics products could be imported subject to a tariff. Import tariffs for final electronics goods were also reduced from 20–60 per cent to 20–40 per cent and all surcharges removed. There was also an evident change in government policy towards the electronics industry, when import tariffs for components were lowered from 20–30 per cent to 0–5 per cent to reduce the cost of inputs to downstream users and encourage multi-sourcing.10 The resulting growth in production and exports was dramatic, especially in 1992. Output grew three and one-half-fold between 1990 and 1992 (see Table 5.6). This rapid growth can be attributed to increased exports in the sector as a whole, up from US$59 million in 1987 to US$865 million in 1992. A significant percentage of component exports come from Batam, amounting in 1991 to US$78 million, or more than half of total exports in electronics from Indonesia. Output of total electronics reached US$1.6 billion in 1992. The share of output by subsectors in 1992 showed that consumer electronics still account for half the output, with industrial electronics (28 per cent) enjoying a greater share than components (21 per cent), as compared with 1985. Electronics exports are made up of consumer electronics, 44 per cent, components, 34 per cent, and industrial electronics, 23 per cent. The major consumer electronics products exported are colour television sets, VCRs, radio/ tape recorders and radio combination and car radios. The VCR and radio/tape recorder and radio player combination industries export over 70 per cent of their production, mainly in the form of ICs, speakers and specific electronics parts. The main industrial electronics products exported are telephone sets, microcomputers (mainly calculators) and disk drives. The high percentage of industrial

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electronics production exported needs careful interpretation. The reduction of duties on components and parts has led to a proliferation of small assembly operations producing microcomputers which are sold domestically or exported. Some disk drive and telephone set exports originate from companies in Batam which carry out basic assembly operations. For instance, in 1991, exports of cordless telephone sets from Batam amounted to US$61.6 million. As shown in Table 5.7, the main destinations of consumer electronics are the United States and the European Union, reflecting the exportorientation relocation motive of investments. The main destination for colour television sets and VCRs is the United States, for radios and car radios the European Union, and for radio combination players the European Union and the United States. Industrial electronics, such as telephone sets, are mostly exported to the United States, while microcomputers (calculators) are sent to Singapore. IC exports were mainly destined for the United States in 1990, with Singapore and Taiwan Province of China also accounting for a significant share. However, it is interesting to note that in 1991 the main destinations for components became Singapore, Thailand and Taiwan Province of China. Other components, such as speakers and microphones, are exported to Singapore, Malaysia, the United States and the European Union. Given the entrepot role of Singapore, a large percentage ends up in third markets, with or without further processing in Singapore. The general pattern suggests that the export of final electronics goods to the United States and the European Union is due to the relocation type of investments. The fact that industrial electronics and components are also exported to countries within the East-Asian region indicates the division of labour and process of production approach that is part of the globalization strategy of the electronics industry. III TECHNOLOGICAL CAPABILITY FORMATION AND ITS RELATIONSHIP TO EXPORTS OVER TIME This section discusses the dynamics of technological capability formation and its relationship to exports over time, with specific reference to the experience of the textile, garment and electronics firms. After a brief outline of the basic features of the firms and their respective technological capabilitybuilding experiences, an attempt is made to identify which elements of the incentive system, as defined above, affected firms’ decisions to build up their technological capabilities, the choices made and the methods used. The final part discusses what the various firms perceive to be their major technological strengths and weaknesses. Table 5.8 provides basic data on the 13 textile and garment firms and the 11 electronics firms interviewed, although firms are identified only by code numbers in order to protect the confidential nature of the interviews.

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Table 5.7 Exports of main electronics goods (major destinations)

Table 5.7 Continued

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Source: Central Bureau of Statistics Note:a The subtotal refers to categories appearing the table

Table 5.8 Basic data on firms interviewed

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Table 5 8 Continued

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Table 5 8 Continued

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Source: This study

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The textile and garment industries Basic features of the firms interviewed A total of 13 export-oriented textile and garment firms were interviewed: one upstream synthetic fibre firm (A.1), five midstream integrated textile firms (combining both spinning and weaving operations, as well as bleaching, dyeing and finishing operations) (A.2, A.3, A.8, A.9, A.13), and seven downstream garment firms (A.4, A.5, A.6, A.7, A.10, A.11, A.12). From the point of view of ownership, the upstream synthetic fibre firm (A.1) was a Japanese-Indonesian joint venture (JV) in which the Japanese partner held a majority ownership. Of the five textile firms interviewed, two were domestic private firms (A.2, A.9), one a fully state-owned enterprise (A.8), while the remaining two (A.3, A. 13) were Japanese-Indonesian JVs with a majority ownership by Japanese partners. As with many Japanese overseas investments in the textile industry, there were two Japanese partners, namely a textile firm responsible for technical operations and a general trading firm (Sogo Shosha) in charge of marketing. The synthetic fibre firm and all the textile firms were large-scale operations employing thousands of workers. Of the seven garment firms interviewed, six were domestic private firms, and the seventh a Korean-Indonesian JV with a majority holding by the Korean partner. Four of the domestic private firms and the Korean-Indonesian JV were large firms, employing thousands of workers, mostly female sewing operators. The two remaining national private firms were relatively small, employing only 125 and 75 mostly female workers respectively. The synthetic fibre firm and all the textile firms were established in the late 1960s or early 1970s. The seven garment firms were relatively new, having been set up in the late 1970s and early 1980s, and the Korean-Indonesian JV in the late 1980s. Building technological capabilities: the historical experience of the firms interviewed Textile firms In the case of two large, established domestic private textile firms (A.2 and A.9), active involvement of the Indonesian employees in the pre-investment phase and project execution was much greater than in the textile JVs. In one instance (A.9) the Indonesian senior managers and technical experts played an active role from the outset up to the execution of the project. In the pre-investment phase, they studied and assessed the findings of a feasibility study conducted by a Japanese textile firm at their request. The owner of the firm trusted the judgement of this Japanese textile firm and the associated Japanese general trading firm with which he had enjoyed a long-standing relationship since the days when he was an importer of textiles from this firm. After the pre-investment phase, he also requested technical assistance in project execution from this Japanese textile firm, specifically with respect to the layout and construction of the plant, purchase of the best available capital equipment and production start up.

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The pattern of technological capability-building in the other large established domestic private textile firms was largely similar to that of firm A.2. The establishment of this firm was made possible by a package agreement concluded by the Sino-Indonesian founder/owner with a well-known Japanese general trading firm and a Japanese textile firm before he embarked on this project. Under the terms of this package, the Japanese textile firm carried out the feasibility study, designed plant layout, supplied the textile machines, constructed the plant and also set up production lines. The Japanese firm also provided supplier’s credit to enable the firm to purchase the most up-to-date capital equipment. The Japanese general trading firm and textile firm also provided eight Japanese senior managers and technical experts to assist the Indonesian senior managers in operating the plant. Indonesian managers and technicians are now able to run the plant by themselves, although the firm still relies on Japanese experts for quality control since the bulk of its exports is handled by the Japanese general trading firm. Through its long-standing relationship with the Japanese general trading firm and textile firm, A.2 enjoys access to new albeit not quite state of the art technology. This may in part be due to the fact that the Japanese technical experts currently employed by this firm are mostly retired people over 50 years old, who may not be fully conversant with the latest developments in textile technology. Firm A.2 values its long-standing relations with the Japanese general trading firm and textile firm which have provided it with continued access to new technologies, new capital equipment and experienced technical experts, in exchange for relatively low-priced, good-quality textiles which can be sold profitably in the export markets. In turn, the good reputation acquired by the textiles made by this firm has also enabled it to strengthen its bargaining power over the years with its Japanese partners. While firm A.2 has found it profitable to continue to rely on its Japanese partners, firm A.9 was fortunate to have recruited as its production director an experienced Indonesian textile engineer who had studied textile engineering in Japan and had worked in a Japanese textile firm for 8 years. This has enabled the firm to acquire greater technological capabilities, including minor process modification capabilities. When the firm recently installed new capital equipment in all its units (spinning, yarn dyeing, weaving, dyeing, finishing and printing), the production director was actively involved in discussions with the overseas equipment suppliers on the exact designs and technical specifications of the capital equipment. These two well established textile firms employ a large number of universitytrained engineers, mostly chemical engineers, some of whom have been sent abroad to study dyeing technology with the Swiss chemical firm Ciba-Geigy and the German chemical firm Hoechst. Their close relations with Japanese general trading firms have enabled enterprises to rely on their Japanese partners for the marketing of their products

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overseas. However, this reliance has compromised acquisition of their own marketing capabilities, although in recent years they have made some progress in identifying and penetrating new, non-quota markets, such as Australia and the Middle East. Their dependence on Japanese partners has also meant that these two firms have not yet felt a need to build up major change capabilities. They do not have a fully fledged R&D department, although they have set up technical departments which conduct research on new materials and on dyeing, printing and finishing. Like most foreign-controlled JVs, the two Japanese-Indonesian textilefirms carried out the various pre-investment activities themselves, including the feasibility study and its evaluation and implementation. Although the results of the feasibility study were discussed with the Indonesian partners, their employees were otherwise little involved in the pre-investment activities. In the subsequent project execution phase, however, the senior staff of one firm actively involved the managers and technical experts of its Indonesian partner in discussions on plant layout and construction and the purchase of capital equipment. The actual construction of the plants of both JVs, however, was carried out by Japanese firms. In the course of their long-standing operations in Indonesia, the Japanese managers and technical experts of both JVs transferred basic productioncapabilities (production management and engineering, repair and maintenance of capital equipment and quality control) in spinning and weaving operations to their Indonesian counterparts. Local managers and technical experts are all actively involved in the various phases of the production process, including production planning, material and component sourcing, production management and engineering, quality control and maintenance and repair. However, the fact that even after a period of 20 years both JVs still employ 10 or more Japanese expatriates indicates that the transfer has been less than complete. While several Indonesian employees have been promoted to senior positions in both JVs, Japanese managers and technical experts continue to provide back up and advice. Their number may decrease once the Japanese experts are fully satisfied that their local counterparts have mastered all required production capabilities. Garment firms As in the case of textile firms, a distinction is made between domestic private garment firms and foreign-controlled joint ventures (JVs) and also between large- and small-scale firms. In the case of four large domestic private garment firms (A.4, A.6, A. 10 and A.11) interviewed for this study, one striking similarity was that all have been able to acquire greater investment capabilities than is usually the case with JVs. As regards pre-investment activities, the firms had either conducted the feasibility studies themselves, or, in the case of one firm, assigned a consulting firm to

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undertake the task, the findings of which were subsequently verified by another consultant. All the firms were actively involved in the project execution, in as far as it was generally the employees of these firms themselves who designed the layout of the plant (in consultation with the construction firm selected), purchased the most appropriate capital equipment, consulted and advised the construction firm assigned to build the plant, and started up the production process. One firm (A.4) assigned a group of Hong Kong technical experts to implement the project and another (A.11) sought the advice of its sewing machine supplier (a subsidiary of the Pfaff firm in Singapore) in the design and construction of the plant. The two other firms sought the advice of friends of trusted technical experts before buying the capital equipment required for their operations. As regards production capabilities, one firm (A.4) hired the services of technical experts from Hong Kong to train its own technicians in production management and engineering, machine repair and maintenance and quality control. Since most of these firms exported their garments under job orders from foreign buyers, who specify the designs, patterns and colours of the garments they want, they have learned to adhere to very strict quality standards. Another firm (A.6) used the services of management consultants from Kurt Salmon Associates, a well-known United States consulting firm for the textile industry, to give advice on how to improve the efficiency of its operations. The above examples show that large export-oriented garment firms have been able to develop some linkage capabilities in the sense that they are seeking technical or management advice from foreign consulting firms or other firms on ways to improve their production or other capabilities. Another instance of this type of linkage capability is the technical and marketing assistance agreement which one firm (A.6) signed with Sunkyong, a Korean garment firm, under which the latter would provide technical experts for the manufacture and marketing of better-designed, high-quality jackets. Similarly, another firm sought an agreement with a garment firm in Belgium (specializing in the production of up-market men’s sports shirts costing US$150-US$300 at the retail level) to produce slightly less expensive men’s shirts for it. Such an arrangement would be mutually profitable to both firms, giving the Indonesian company access to Belgian designs and enabling the Belgian firm to tap a market niche for slightly less expensive items which could be produced at a much lower cost by the Indonesian firm. With a view to developing its design capability, one large firm (A.4) recently installed a CAD system and computerized pattern-grading system from Taiwan Province of China as well as a computerized cutting system. Similarly, another firm recruited local designers to enable it eventually to make its own brand products, in particular ladies’ wear. To increase local skills, the firm has sent some of its designers abroad for further training. There were some distinct differences in the two smaller garment firms11 (A.5 and A.7) in the pattern of building technological capabilities as compared with

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large firms. Unlike the latter, these two small firms did not acquire investment capabilities and did not carry out any thorough economic feasibility study. Before starting their business, the two owners relied mainly on the advice and information obtained from relatives and friends concerning the capital equipment they required and the best suppliers. Being relatively small operations, their factories do not have a long production or assembly line, but operate more like craft workshops. The plants are therefore relatively easy to manage. The firm specializing in expensive embroidered clothing for ladies is more reminiscent of an artist’s workshop rather than a garment factory, with a large majority of women workers engaged in intricate embroidery work. Exports from both firms are handled by foreign trading firms with which the two firms have established a good working relationship. The exports of firm A. 5 are handled by Pier One, a United States trading and retailing firm, with about 500 marketing outlets in the United States alone. Over time, the firm has been able to build up its marketing capabilities after contacts with trading agents in other countries, such as Australia, at trade fairs such as the National Exhibition of Export Products (Pameran ProdukEkspor (PPE)), organized annually by the Ministry of Trade, and which is often attended by representatives of several foreign trading firms. In addition, with the assistance of the National Agency for Export Development (Badan Pengembangan Ekspor Nasional (BPEN)), Ministry of Trade, the products of this firm have been displayed at overseas exhibitions and trade fairs. The lesson from this firm’s experience is that, given adequate support by governmental and non-governmental organizations, small exporting firms can also achieve considerable success in marketing their products overseas, provided they take advantage of the available opportunities by exporting well-designed garments of consistently high quality. Contacts with foreign buyers can enable them to widen their export markets and linkage capabilities with foreign buyers can help them to build up their marketing capabilities. The experience of the other small firm is in several ways similar. It established a good working relationship with the Japanese department chain store, Daimaru, which evaluated trial designs sent by the firm and provided assistance in qualitycontrol methods and meeting strict delivery schedules. Like other joint ventures, where the foreign partner, by virtue of its large majority shareholding, exerts firm management control, the Korean — Indonesian garment JV (A. 12) was in almost every way a Korean operation (Korean majority holding with 95 per cent of shares), in which the senior executives and technical experts were all Koreans. In fact, the feasibility study for this JV was conducted and evaluated by the Korean partner, who also carried out all phases of the project execution, including plant layout and construction and purchase of capital equipment. The local partner was informed on the progress of these investment activities, but did not actively participate. Similarly, production management and engineering, repair and maintenance of capital

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equipment and quality control are the responsibility of the Korean managers and technical experts, with Indonesian staff occupying only subordinate positions. However, this may be due to the relatively young age of the firm which has been in operation for only three and a half years. At present, there are two Indonesian managers (in charge of accounting and personnel), but no local production manager. As an export-oriented firm, this JV produces all its output for the export market under original equipment manufacturing (OEM) arrangements, whereby the patterns, designs and colours of the overcoats and jackets it produces are supplied by the firm’s overseas buyers in Western Europe (mainly in the United Kingdom and Germany). As regards the acquisition of marketing capabilities, this Korean-controlled, export-oriented firm has the advantage of having longestablished contacts with its overseas buyers. As a result, its Indonesian employees have had little opportunity to acquire any overseas marketing capability. Impact of the incentive system on the pattern of technological capability (TC)formation The above discussion of the incentive system and the dynamics of technological capability formation indicates that macroeconomic policies, in particular the trade regime, exchange rate policy and investment policy, have been the major factors determining the behaviour and priorities of firms in building up their technological capabilities. For instance, the highly protectionist trade regime pursued by the Indonesian government in the 1970s and early 1980s had fostered the acquisition of rudimentary production, management and engineering capabilities in a wide range of manufacturing industries, including textiles, which largely catered to the domestic market. In this ‘easy’ environment, building up TC to improve a firm’s competitiveness was not given any high priority by firms. The shift to export-oriented policies since the mid-1980s has fostered a more efficient manufacturing sector, in which labour-intensive industries, such as textiles and garments, in which Indonesia with its abundant, relatively cheap labour has a strong comparative advantage, have been able to increase their exports very rapidly. With impeded access to the quotaconstrained markets of the United States and Western Europe and strong competition from other, low-wage developing countries, such as China, VietNam and India, Indonesia’s textile and garment producers face the challenge of increasing their competitiveness by improving their TC. In the case of domestic private textile firms (A.2 and A.9), maintaining and improving export performance have meant that yarns and fabrics must be of a high quality. To achieve this goal, both private firms relied a great deal on their good working relationship with Japanese textile and general trading firms which provided them with technical assistance in qualitycontrol procedures, improving

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management access to newer technologies and export markets. Efforts to increase exports have also meant that new markets had to be identified and penetrated. Here too both firms relied on their Japanese partners for valuable information and assistance in developing their distribution channels. Once again, however, the benefits derived from their long association with Japanese firms deprived them of any real incentive to develop the necessary major change and marketing capabilities to become highly competitive independent firms. Like the domestic private textile firms, the Japanese-Indonesian textile JVs (A. 3 and A.13) have, since they started exporting, accorded a higher priority to raising the productivity of their operations and the quality of their products than was the case when they were still oriented towards the domestic market. In the first instance, they concentrated on raising production capabilities with a view to improving the efficiency of their operations. To this end, the Japanese experts of these JVs have in the past few years given greater priority to transferring production capabilities to their Indonesian counterparts. However, as overseas marketing is still handled by the Japanese general trading firms, the Indonesian employees have in general not been able to acquire the major marketing capabilities so essential to exporting firms. Like the textile firms, the domestic private garment firms (A.4, A.5, A.6, A.7, A.10 and A.11) also had to pay greater attention to TC building, when the Indonesian government shifted to export-oriented policies in the mid-1980s. In view of the severe competition in the export markets, most garment firms saw a steady rise in productivity and improvements in the quality of their garments as essential for their survival. In the same way, raising labour productivity became important to offset the expected rise in labour costs following the mandatory rise in the daily minimum wage from rupiah 2,600 (US$1.25) to rupiah 3,800 (US$1. 90) on 1 January 1994 in the Jakarta metropolitan area, where a majority of the large and medium-sized textile and garment firms are located, and mandatory contribution to a social security fund by 1 July 1993. Among the firms specializing in the production of up-market garments, the acquisition of minor change capabilities was also important, and in particular the ability to change the range of garments to be made, as fashions of up-market garments change very rapidly. Furthermore, improved efficiency of operations, for instance, through the introduction of higher speed sewing machines, also implies the improvement of production capabilities, as production management and engineering as well as repair and maintenance capabilities have to be adjusted accordingly. To increase the productivity of their operations, some firms have made use of their linkage capabilities and turned to consulting firms or foreign managers and technical experts. Improving production capabilities, particularly production management and engineering, also become crucial, as changes in demand patterns in the export markets in the developed countries have meant that garment firms must be able to supply a wide range of relatively small lots (categories) of garments, consisting of various different styles of men’s shorts, instead of producing only

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four to five big lots, as was the case only a few years ago. Clearly, the shift to the production of a large number of small lots has put a much greater burden on production management and engineering and required greater production capability in these garment firms. Although most garment firms, producing under OEM arrangements, make their garments according to designs specified by their buyers, some large firms are taking steps to develop their own design capability. For example, one large firm (A.11) is setting up its own design house to collect and study various overseas designs, while another large firm has sent its designers overseas for further training. The National Agency for Export Development (BPEN), Ministry of Trade, has also helped garment firms to establish their own contacts with foreign buyers, which will broaden their experience in export markets and hopefully develop their own marketing capability. While export-oriented policies have, since the mid-1980s, been the major factor prodding export-oriented firms into improving their competitiveness by building up their TC, the present incentive system still contains a number of shortcomings which reduce the competitiveness of these firms, and sometimes distract them from focusing more on TC building. For example, there are the high interest rates which the domestic private firms, as well as JVs, have faced since 1991 as a result of the tight money policy introduced in early 1991 to contain inflationary pressures brought about by booming economic conditions. Although deposit rates have recently come down, lending rates have remained high, partly because the commercial banks in Indonesia want to cover the high risk of bad debts. Firms can seek offshore loans, but these entail a high premium for swap facilities which are considered necessary as a hedge against the risk of devaluation. Second, textile and garment firms alike have considerable difficulty in meeting their strict delivery schedules due to the lengthy administrative procedures of the duty-exemption and drawback scheme and the clearing of goods through customs. Although there has been some improvement in customs since 1985, the length of time required is still much longer than in other countries in the region, such as Singapore and Malaysia. Third, JVs have in recent years experienced problems when their senior staff have moved to domestic private firms, although this process has contributed to the domestic diffusion of more advanced technologies. Another problem which textile JVs, like most other JVs, have experienced concerns the issuing of the necessary work permits or extensions for their expatriate personnel.

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Current strengths and weaknesses Textile firms After more than twenty years of operation, the domestic private textile firms (A.2 and A.9) viewed their production capabilities, particularly production management and engineering, and their capability to repair and maintain capital equipment, as their main technological strengths. However, both firms, which have close relations with Japanese textile and general trading firms for the overseas marketing of their products, still rely for quality control on expertise from their Japanese partners. On the other hand, unlike many foreign-controlled JVs, where the Indonesian partners often are rarely involved in investment activities, the Indonesian managers and technicians of these domestic private firms have played a more active role in this respect, discussing with the Japanese experts the implications of various alternatives before any major decisions were taken. A major weakness of these export-oriented textile firms is their great dependence on Japanese general trading firms for the handling of their exports. For example, 70 per cent of the exports of firm A.2 are handled by a Japanese general trading firm. However, in the face of quota limitations in their established export markets, these firms have had to make attempts on their own to identify and penetrate new export markets in non-quota countries. One firm (A. 2) has also been building up its own design capability for printing by employing 25 printing designers, all of whom were trained at the Indonesian Academy for Fine Arts (ASRI) in Yogyakarta. The three Japanese-Indonesian textile JVs, one an upstream synthetic fibre firm (A.1), and two integrated textile firms, are Japanese-controlled operations in which major decisions on strategies and operations are taken by the Japanese, albeit after consultations with their Indonesian partners. The key executive positions in all three firms are still held by the Japanese staff, and even though Indonesian staff occupy important positions (excluding public relations and personnel), they continue to be assisted by Japanese ‘advisers’. The production, minor change and marketing capabilities are relatively high, because of the large presence of Japanese expatriates. However, the synthetic firm (A.1) is having increased difficulties in recruiting suitably qualified Japanese technical experts, which has prevented the transfer to this JV of the so-called Shingosen (new top quality synthetic fibre) technology and, hence, the increasing need to train qualified Indonesian staff. As a result of the strong emphasis placed on such production capabilities as onthe-job training, labour productivity in these two JVs has risen steadily over the years, although it has not yet matched the levels achieved in the principal plants in Japan. For instance, compared with a labour productivity index at the parent firm of 100 in 1972, the index for one of these JVs (A.13) during the same year was 50. At present, however, this index is between 70 and 80, compared with

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100 for the plant in Japan. These two textile JVs have also focused on improving the quality of their yarns and fabrics which now are rated almost as good as those being produced in Japan. Garment firms The six domestic private garment firms interviewed were all managed and run by Indonesian nationals. Only one firm (A.11) has ever employed foreign technical experts from Hong Kong, and still employs three Hong Kong technical experts to provide advice on mechanical matters, sewing techniques and finishing. Apart from these specific technical tasks, for which foreign expertise was still considered necessary, all the other managerial and technical functions were carried out by Indonesian personnel. None of the other five garment firms employed any foreign technical experts. As domestic private firms, these export-oriented garment firms had acquired adequate investment, production and, to a lesser extent, marketing capabilities. In the pre-investment phase, the large firms had either conducted the feasibility studies themselves, or had them prepared by Indonesian consultants whose reports were then reviewed by the owners and senior executives of the firms. Project execution was carried out by themselves or assigned to foreign technical experts under their direct supervision. In general, these firms considered their production capabilities one of their strengths, as reflected in improved quality of their products in the export markets. In the case of one large firm (A.11), its reject ratio has fallen from 3 per cent a few years ago to less than 2 per cent at present. Financial incentives have been offered to staff to help the firm achieve a zero reject rate over the next few years. This same firm rates its capability to produce a wide range of men’s shorts in various styles in small lots (quantities) within a relatively short time as a special advantage over its local competitors. Another large firm (A.10) has been even more successful in meeting the quality standards of its overseas buyers, with no rejects of its products over the years. It has also managed to shift from the production of relatively cheap men’s shirts to expensive up-market ladies’ blouses. Making garments, mostly under job orders from overseas buyers with strict specifications regarding designs, patterns, colours and fabrics, or having their exports handled by foreign trading firms, have meant that the design and marketing capabilities of these firms are generally limited. However, through their contacts with other foreign garment firms or foreign fashion houses or the establishment of their own design houses, these firms are making efforts to develop their own design capability. Unlike that of domestic private firms, the strength of the Korean-Indonesian garment JV (A.12) lies in its proven investment, minor change and marketing capabilities, which have all been supplied by the Korean partner. Although it is now training its Indonesian staff to occupy more senior managerial and technical

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positions, it remains to be seen whether they will have any real say in running the company. The electronics industry Basic characteristics of the firms interviewed A total of 11 electronic firms were interviewed, of which six manufacture consumer electronics products (B.1, B.2, B.3, B.7, B.8 and B.9), four produce components (subsidiary 5 and 6 of B.5, B.6 and B.11), and two manufacture industrial electronics equipment (B.4 and B.10). Two types of firms were interviewed, with quite different patterns of technological capability-building: first, national private firms and JVs set up in the 1970s, which originally catered for the domestic market and then began to export in the mid-1980s (national private firm B.1 and joint venture B.2); second, export-oriented firms established in 1989–1991 following the improvement in the investment climate and relocation from East Asia. There were four large majority foreign-owned JVs (firms B.3, B.6 and B.7 are Japanese and B.9 is Korean) which were 100 per cent export-oriented, two joint ventures with significant Indonesian ownership under firm B.5 (subsidiary 5 with Korea and subsidiary 6 with Singapore and Taiwan Province of China) and two national private firms (B.8 and B.10) in this category. Another export-oriented type of firm (B.11), started producing and exporting much earlier than the former group after it was taken over from the former National Semiconductor (NSC) plant in 1986. B.11 is an IndonesianSingapore JV, with majority Indonesian ownership. In employment terms, the consumer electronics JV (B.2) was by far the largest, with 2,748 employees. The size of the domestic private firms ranged from medium (B.8 and B.6), with 158 and 250 employees, to intermediate, with 400–700 employees (B.4 and B.1). The majority foreign-owned, export-oriented firms were large, employing between 800 and 1,425 workers. As for the value of exports, not all the firms interviewed were willing to provide figures. However, the value of exports of the consumer electronics JV (B.2) and the majorityowned, export-oriented firm (B.3) were around US$80–100 million, while the exports of firm B.11, which exports packaged ICs, amounted to US$45 million in 1992. The main export destinations of consumer electronics appear to be the United States and the European Union, in line with the relocation motive of the export-oriented firms. Some components are sent to other East-Asian countries.

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Building technological capabilities—the historical experience of the firms interviewed Consumer electronics Domestic-owned firms, such as B.1 and B.8, and well-established JVs, such as B. 2, were more involved in the pre-investment and project execution phase than the majority-owned, foreign JVs interviewed. The experience of B.1 was unique. When the firm was set up in 1976, the feasibility study was undertaken by the owner, although four newly recruited directors participated in the project execution stage. The owner allowed for two years of trial and error in product selection and specification, selection of suppliers of parts and components, especially CKD kits, and plant construction. Of particular interest was its difficulty in obtaining CKD kits, since at the time it was not linked to any principal. After several unsuccessful attempts to obtain such kits, it decided to set up its own R&D section to modify imported parts. This experience became an important source of technological capability in the later development of the firm. As for B.2, the local partner was involved in the pre-investment phase, in particular with regard to production and site selection, processing of licences and labour issues. However, product specifications, production technology, design and plant layout are determined by the Japanese partners. In the case of B.8, the feasibility study, site selection and project execution were carried out by the owner. However, since production was under subcontract from a foreign principal, the choice of technology, plant layout, construction, products and specifications, production set up and suppliers was made by the principal. In contrast, the experience of majority foreign-owned JVs indicates that the Indonesian partner was less involved in the pre-investment process (B.3, B.7 and B.9). The small share of the local partner and lack of experience with exporting precluded much participation beyond the processing of land, investment licences and worker-related issues. Firm B.1 developed production management and engineering capabilities over time and on-the-job. It also obtained technical assistance for production and testing from its suppliers. Firm B.8 secured training to develop its production and engineering capability from the foreign contractor, including sending its own engineers to the contractor’s plant in Malaysia. Quality control and increased productivity were achieved by several approaches. Domestic private firms such as B.1 recruited Japanese consultants to provide training in systems such as just-in-time production. In contrast, firm B.8 adopted the quality control system of its European principal, involving daily briefings between supervisors and labour, checking quality at the end of every production process and rewards granted on a personal rather than a group basis, as with the Japanese system. Considerable quality improvements were achieved, with a reduction in the on-line rejection ratio from 3 to 0.5 per cent and in the sales rejection ratios from 2 to 0.5 per cent in 1992–1993.

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Not surprisingly, there is very little indigenous production and engineering capability in the more recently established, majority foreign-owned JVs. The basic and latest technology comes from head office, but outer design and specifications are provided by contractors, as most production is under subcontract rather than under the parent firm’s brand-name. Most firms said that it was difficult to recruit experienced engineers and managers, which meant that top positions are still held by expatriates, while the middle-level and lower positions are filled mainly by recent graduates from local universities and institutions, who are trained in-house, at the head office or in subsidiaries in Malaysia and Singapore. The domestic firms B.1 and B.2 use a combination of automatic and manual insertion of components in their production process, while firm B.8 uses only manual methods. All the new majority-owned JVs (B.3, B.7 and B.9) have invested in the automatic insertion of components, although some processes which are automated at headquarters are carried out manually in Indonesia. Only B.7, the acknowledged market leader in quality products, has invested in surfacemount technology. Since both B.1 and B.2 are established domestic firms, they have considerable maintenance and repair capability arising from their after-sales service and distribution network. This capability also supports their export production. Firm B.8 has developed some maintenance and repair capabilities, but major problems require assistance from the principal’s plant in Malaysia. Almost all the consumer electronics firms interviewed have some minor change capability. For instance, firms B.8 and B.5 are able to make minor modifications to the production line to adjust to local conditions, and B.3 can make minor modifications to adjust to parts sourced locally. While B.1 has been successful in marketing its products domestically under its own brand-name, its export marketing capability is weak. It has adopted a marketing strategy of direct sales by attending trade fairs and setting up representative offices. It does not produce under subcontracting arrangements, but exports its own design of colour television sets which are then sold under the customer’s brand. Given its lack of experience and smaller network, its export growth is understandably much slower than that of firms with a foreign link. Firms with a foreign link, such as joint venture B.2 and the export-oriented domestic firm B.8, have not yet built up any indigenous export marketing capability. Overseas marketing is through the contractor or foreign partner, either at the headquarters in the country of origin or regional headquarters in Singapore. All the firms interviewed reported few linkages with outside institutions. Most of the training and production development, engineering and design capabilities are on an in-house basis, sometimes with the involvement of the foreign principal and contractor. Linkages with local universities are limited to the recruitment of engineers and language training. However, there are some linkages within the firm and group and among different firms. In the case of B.1,

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the marketing division provides information on consumer preferences to the design division (within the R&D division) and the design division then comes up with a prototype. The firm has invested in CAD/ CAM to speed up the process from design to the production stage. Firm B.2 has also established important linkages among divisions within the firm and its own group, in particular by developing in-house components production and setting up related JVs. It has adopted a CAD/CAM design system and developed a network of 250 outside suppliers. Two of the firms also illustrate the importance of links with the group of which they are a part. For instance, a manager from firm B.1 was entrusted with the task of setting up a new venture in garments (A.11) as part of the group’s diversification efforts. Similarly, in the case of firm B.8, past success in the export of garments and shoes provided the owner with the experience and knowledge to start up export-oriented operations in the electronics industry. Backward linkages with component and parts suppliers are, in general, still weak. Core and other components used in export production are mostly imported through the duty-exemption facility since local components do not meet export standards and quality requirements. Components are sourced through the principal or the International Purchasing Offices (IPOs) located in Singapore. Ontime acquisition of the cheapest components is considered an important source of competition advantage. The only parts sourced domestically are plastic parts, die casting, some mechanical parts and packaging materials. Firms such as the domestic privately owned B.8, and especially the majority foreign-owned B.3, B. 7 and B.9, are all attempting to build up the capabilities of their suppliers through constant quality control, checking and training. The development of design and major change capabilities has been limited, except in B.1 and, to some extent, B.2. Firm B.1 is able to design outer product appearance as well as its functional operations by modifications to the printed circuit board (PCB). However, it is not yet capable of designing its own components, except for standard products for the domestic market. Firm B.2 has limited design and major change capabilities for its other products. The majority foreign-owned JVs and firm B.8 do not yet have any major change capabilities. The main foreign linkages of B.1 are through its suppliers who provide training in production and testing. In the case of B.2, the foreign partner provides it with the technology and design whereas in the case of B.8 there is total reliance on the foreign contractor for technology, design, core components and materials, software, management advice and quality control. Firm B.8 also has a Singapore consultant with experience in the electronics sector to help it set up the firm’s management system. Components and industrial electronics Pre-investment and project execution were undertaken by a domestic private firm (B.10) and the Indonesian partner of the majority Indonesian-owned JVs

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producing ICs (B.11 and subsidiary 6 of B.5 or B.6). In the case of B.10, the feasibility study, plant construction and design were carried out by the national private firm, although the technology came from the Taiwanese licenser, whereas firm B.5 carried out all the pre-investment and project execution itself, with its foreign partners providing only capital. Firm B.11 had been taken over although it did invest in new equipment and used foreign consultants to assist with planning. As for the Japanese majority joint venture B.6, the Indonesian’s partner’s participation in the pre-investment phase was limited to the processing of licences. The building up of production and management capabilities in firm B.10 followed the usual pattern of obtaining technology and design from the Taiwanese licenser and training for its engineers and workers in Taiwan Province of China. At present, two Taiwanese are responsible for quality control in the plant. Reliance on the Japanese partner to develop production and engineering capabilities is also evident in the Japanese majority-owned firm B.6, where training of Indonesian engineers and workers was provided at the firm’s headquarters in Japan. Maintenance and repair capability has been developed, although still under the supervision of the Japanese partner, as is quality control. Productivity increased by 20 per cent in between 1989–1992 to a level higher than that of similar plants of the firm located in Mexico and China. Firm B.11 initially obtained production process and assembly technology from National Semiconductor. However, it had to build up its own production and engineering capability to source inputs, including machinery and equipment, learn to use new equipment, and keep up with the rapid changes in technology in the IC field. Similarly, the other IC manufacturer, B.5.5, was able to draw on the production capabilities of former Fairchild workers—which, however, it had to upgrade—and develop the technology, engineering and management know-how for IC assembly and packaging. In building up their production, engineering and management capability, both IC producers, not being linked to a multinational principal, had to recruit experienced expatriate managers, engineers and consultants. Although costly, this was the only feasible way to acquire production capability. The reliance on foreign workers is much higher in the case of the newly established firm B.5.6, with 60 foreign workers at the managerial and supervisory levels and 400 Indonesian workers, compared with 10 foreign workers at the managerial level and 1,300 workers (including engineering and technical level staff) in firm B.11. Productivity and quality have been upgraded in firm B.11 by investing in automation. Quality levels are comparable with others in the region, with reject ratios falling within an acceptable 1 per cent. Productivity, however, is lower than in other countries. Although there has been a reduction in cycle time (i.e. from order to delivery) from 20 to 14 days, it is still higher (i.e. productivity is lower) than in Malaysia and Singapore (10–12 days). Similarly the firm’s plant

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requires 10 workers to operate 1–2 machines, whereas in Hong Kong, the same number can operate 5–6 machines. There is limited minor change capability and no major change capability at all in the four firms. For example, firm B.10 is able to undertake minor changes with licence assistance. The IC manufacturers also have limited minor change capability, since they carry out mostly subcontracting work and rely on the customers to provide them with designs and specifications. Firm B.10 relies on its Taiwanese licenser for market access, although it has also begun to make its own marketing efforts by opening up a marketing office in Singapore. Firms B.5.6 and B.11 are not linked to any multinational principal and therefore have to market their own products. Firm B.5.6 has done so by opening up representative offices in the major markets—Germany, Japan, Singapore and the United States—run by staff with established marketing networks. Firm B.11 has done its own marketing since 1989, after back orders from NSC were completed, by establishing marketing offices in Singapore and the United States. The development of local linkages is even more limited compared with the consumer electronics firms. There is hardly any local backward linkage by the IC manufacturers and almost all the components are imported. Only in B.10 has there been some linkage with domestic component manufacturers in the production of plastic cabinets. Subsidiary B.5.6 has important links with its holding company for training and as regards corporate policy. It is majority Indonesian-owned because it is the philosophy of the holding firm, based on its experience from its core business as a licensee to a major Japanese automotive firm, not to enter into an OEM-principal relationship but to strive towards majority ownership and control. Foreign linkages are important in all three firms, where production and engineering capabilities were obtained from foreign sources. The recognition of the advantages of linkages with Singapore led B.5.6 to locate in that country, with a view to acquiring an international reputation, drawing on the availability of skilled labour and speeding up orders and keeping abreast of latest technological developments by being close to the source. The impact of the incentive system on the pattern of technol ogical capacity formation All the firms interviewed, whether well established enterprises exporting part of their production, or more recent domestic private firms and JVs set up for export, began to export following the deregulation measures and improvement in the investment climate from the mid-1980s. Potentially increased competition from export-oriented companies in export-processing zones selling part of their output in the domestic market also led domestic firms, such as B.1, to increase their scale of production by exporting.12 As for the foreign majority-owned, exportoriented companies from Japan and Asian NIEs, the decision to relocate to

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Indonesia was motivated by the availability rather than the low cost of labour, the abundance of raw materials, such as wood, for the manufacture of speakers, and the potential size of the domestic market, given the more favourable government policy environment since the mid-1980s. The reasons for relocation by firms from Japan and the NIEs are well known: the steep appreciation of their currencies, rising labour costs, graduation from GSP status by the East-Asian NIEs, and the desire to defuse trade friction with Europe and the United States. A number of JVs interviewed also mentioned their increased ‘regionalization strategy’ to source components from the region and sell final products to the rapidly growing regional market. Despite substantial improvements in the incentive system, several enterprises interviewed mentioned aspects which they believed hindered their ability to export, including infrastructure constraints, especially electricity and telecommunications infrastructure, and the shortage of skilled workers, engineers and managers. Enterprises have resolved the former by locating in industrial estates or investing in their own generator sets, while the recruitment of expatriates and investment in training young graduates from local universities are ways of dealing with the latter difficulties. Another aspect of the incentive structure, which was thought by many enterprises to add to operational costs, was the high interest rate resulting from the tight money policy of 1991–1992. Firm B.9 pointed out that the lack of an efficient forwarding system caused delays in the delivery of its goods to ports for shipment. Another negative factor relates to the administrative procedures regulating the movement of goods in and out of Indonesia. In the competitive electronics market, timely delivery is crucial and delays create a serious disadvantage for exporters. Firms such as B.7, B.3, B.9 and B.11 emphasized the longer lead times in sourcing inputs in Indonesia compared with similar operations in the region, which also add to overhead costs since they result in longer storage costs and the need to stock higher levels of inventories. Three specific bottleneck areas were mentioned. First, was the processing time of the duty-exemption scheme, which has apparently increased because of the greater amount of documentation needed. In the case of electronics, the number of components are numerous and the administrative documentation very complex. Second, was the movement of goods in and out through the SGS and customs. While it was acknowledged that the situation is now much better than before the customs reorganization in 1985, the number of days required for checking and processing the import of goods is seen as too long compared with other countries. Third, was the procedure relating to the duty-exemption scheme for indirect exporters, i.e. producers of components and parts for exporters, and the complex process of transferring goods in and out of export-processing zones or bonded warehouses. The problem is essentially one of administrative procedures and the management of export-processing zones, which has discouraged the domestic sourcing of inputs. Two companies reported that they imported components produced in Indonesia through Singapore by using the

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duty-exemption scheme, rather than buying directly from the componentproducer in Jakarta through the indirect exporters’ scheme, since the administrative procedure was much easier. Strengths and weaknesses In-house design capability and R&D are important sources of strength in exports. The lack of any foreign links has forced firm B.1, for example, to build up its own production and management capability as well as major change and design capability, enabling it to modify standard television sets for different markets. Costs can also be kept low because the technology is not imported. In contrast, JVs, such as B.2, and those producing under subcontracting arrangements in the consumer electronics subsector have not developed much indigenous technological capability and remain dependent on the foreign principal for the production and engineering capability needed to make them competitive in exports. However, even though productivity levels still need to be improved, these firms have been able to develop some basic production and engineering capability, make minor changes, carry out repair and maintenance and meet quality requirements. A major weakness in technological capability leading to a lack of export success is the absence of foreign linkages, especially as regards marketing and technology acquisition. Domestic companies, such as B.1 and majority-owned Indonesian JVs such as B.5.6 and B.11 do not have any foreign link and thus have to market their own products overseas. Since the establishment of an international reputation is time consuming and costly, these firms have not been able to increase their exports rapidly. B.5.6 and B.11 have attempted to break into the highly competitive marketing network dominated by multinationals by setting up marketing offices in the major markets and recruiting expatriates with marketing networks. Such a strategy could work in the short term, but much depends on the ability of the staff recruited to maintain the marketing network. In all three cases the lack of linkage to a foreign principal also limits the ability of the companies to keep abreast of the latest development and process technology. Firm B.1 mentioned this problem specifically, but pointed out that it was not very important in the case of standard products. The problem was more serious in the case of the two IC companies, since technology is changing rapidly. The strategy of B.5.6 and B.11 has been to recruit experienced expatriate engineers and managers and keep them up-to-date with the latest developments. Another major weakness is the lack of any backward linkages to domestic suppliers of components and parts. This is partly due to the fact that Indonesia was a late starter in the export sphere and the natural emergence of component suppliers in the wake of large demand from exports has not yet occurred. In part, as noted earlier, administrative bottlenecks have also made it difficult to provide an appropriate incentive system for the development of the component sector.

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IV NEW COMPETITIVE CHALLENGES AND STRATEGIC OPTIONS This section examines the new competitive challenges to sustained export performance by the various textile and electronic firms interviewed and possible ways of meeting them. Views of the textile and garment firms Textile firms In this discussion of the new competitive challenges and strategic options facing Indonesia’s textile industry, a distinction will be made between the upstream, synthetic fibre industry and the mid-stream spinning and weaving industries. The Japanese-Indonesian synthetic fibre JV (A.1) expects to face stronger competition in the domestic market over the next few years as another Japanese and a Korean firm are planning to set up similar modern synthetic fibre plants. However, despite this greater competition, A.1, which is mainly a domestic market-oriented firm, does not foresee any great difficulties if the mid-stream (spinning and weaving) and the downstream (garment) industries are able to sustain their rapid growth through expanded sales in the domestic and export markets. In view of its close relations with a majority of mid-stream spinning firms in Indonesia, it is fairly confident that it will be able to continue to sell its products to the mid-stream spinning industry, whether export-oriented or not, as long as it maintains the high quality of its products. As a result of the sharper competition in the synthetic fibre industry, this firm is experiencing difficulties in recruiting qualified Japanese technical experts to introduce the new Shingosen (top quality synthetic fibre) technology developed by the Japanese parent company. Indonesia must therefore train its own experts, particularly textile engineers in the field of synthetic fibre technology. However, the prospects for the synthetic fibre industry are now better following an improvement, from the late 1980s, in the outlook for yarn, and the abolition of the earlier CBTI import monopoly in 1988. Both the two domestic private textile firms (A.2 and A.9), and the two Japanese-Indonesian textile JVs (A.3 and A.13) said that competition in the export markets was becoming increasingly fierce, not only in the traditional markets of the United States and Western Europe but in other non-quota areas, and one textile JV (A.12) said it was experiencing sharp export competition in the Middle East, particularly from Indian competitors. Moreover, because of quota ceilings in the large export markets of the United States and Western Europe, firms now have to produce a broader product mix, with more expensive up-market textiles, such as the ‘heavy’ fabrics which one JV (A.13) is producing (which are waterproof, of higher density and softer than the older fabrics), thanks to its

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access to new product technologies developed by Toray, its parent company in Japan. Other potential threats facing Indonesian textile firms include problems with market access due to increased protectionism in developed countries and the possibility of closed regional trade blocs, particularly the single European market and the North American Free Trade Area (NAFTA). One way for these firms to circumvent NAFTA might be to establish a plant in Mexico from where the large North American market could continue to be supplied. However, such an important step is still beyond the investment and production capabilities of domestic private textile firms which themselves remain dependent on Japanese textile and general trading firms. In addition to possible restrictions to developed country markets, textile firms will also face increased competition in the domestic and regional markets following the establishment of the ASEAN Free Trade Area (AFTA) on 1 January 1994. The aim of AFTA is to reduce tariffs on intraASEAN trade, excluding agricultural products, down to 0–5 per cent in 15 years, with the reduction for textiles and garments taking place within 8 years under the so-called ‘fast track’ agreement. In the face of the sharper competition in export markets, textile firms are committed to upgrading the quality of their products and increasing labour productivity. This goal, however, is not so easy to achieve since the problem lies not so much with the machines which can be imported, but with workers who need to be motivated to work harder and more meticulously. One large textile firm (A.13) has introduced a total quality control (TQC) system, in which the managers and technical supervisors meet after office hours to discuss various ways of raising and maintaining product quality. One Japanese-Indonesian textile JV (A.3) has focused its efforts on the steady and continuous upgrading of its fancy high-quality fabrics in small amounts, but with different designs, and with continuous on-the-job training programmes being provided for its workers. In order to monitor closely the trends in the tastes of foreign buyers, the domestic private firms (A.2 and A.9) see closer links with their prospective customers as a means of avoiding the accumulation of unwanted stocks. To ensure their continued production of textiles for which there is a large export demand and access to new product technologies, these firms will continue to rely on their traditional, close relations with the Japanese textile and general trading firms. However, in their attempts to penetrate non-quota countries, these firms have had more success in Australia and New Zealand and the Middle East than in the much larger but much more demanding Japanese market. Indonesian textile firms, whether domestic or JV, are very much aware of the challenges ahead and are taking several steps to deal with them, including the search for new non-quota export markets, the shift to more expensive up-market textiles, the upgrading of product quality and increased labour productivity to offset the steady rise in minimum wages. Another important step to sustain export earnings could involve the diversification of product mix into household

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textiles (e.g. draperies, curtains, linen), industrial textiles (e.g. for parachutes), geo-textiles (e.g. for dams and roads) and non-woven textiles (e.g. felt, carpets). The question arises as to whether or not the present incentive system is sufficient to encourage new investments by textile firms in more demanding technological capabilities (TC), in particular design, new product development, strategic marketing and linkage capabilities, and the related organizational restructuring. As it stands, the incentive system does not yet provide an adequate incentive for domestic private firms to develop more demanding TC beyond their relative strong production and minor change capabilities or to relinquish their continuing reliance on Japanese assistance for design and major product and process changes and overseas marketing. In the case of the synthetic fibre (A.11) and textile JVs (A.3 and A.13), new investments in TC are naturally dependent on continuous technology transfers from the foreign principal. Although transfers have taken place, the technologies have been mostly limited to production capabilities and, at most, minor change capabilities. Even when the majority shares are eventually transferred to the Indonesian partner under the present foreign investment regulations, available evidence suggests that management control is likely to remain with the minority partner by virtue of management contracts. In other words, the present incentive system does not encourage the local partner(s) to acquire the necessary TC to be able to run the firm alone. Garment firms Several of the garment firms interviewed, including both domestic private enterprises (A.4, A.5, A.6, A.7, A.10 and A.11) and the KoreanIndonesian garment JV (A.12) said that price competition in the export markets was becoming sharper from lower-wage countries, such as Viet Nam and China, where working hours are longer (48 hours compared with 40 in Indonesia) and labour productivity higher. Nominal wage rates in Indonesia are higher than in China and Viet Nam, and expected to rise even further in the coming years. One important way of offsetting the adverse effects of rising wages on unit labour costs would be to raise labour productivity. If the experience of the Korean-Indonesian JV (A.12) is any indication, there is still plenty of room for improvement in this regard. For instance, during its almost four years of operation in Indonesia, this JV (which specializes in making ‘heavy’ garments, such as overcoats and jackets) has been able to increase its labour productivity slightly from 1.5 coats per worker per day to 1.7 at present. However, this is still much lower (by 50 per cent) than that of its parent firm in Korea (3.5 coats per worker per day). Raising labour productivity has therefore been a major priority of this JV, which is making considerable efforts to improve worker training and attitudes. In an attempt to increase the efficiency of its operations, one large domestic private garment firm (A.4) has replaced the ‘bundle’ system originally adopted

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from Hong Kong with an ‘in-line’ system advocated by Sunkyong, a Korean garment firm with which it has concluded a technical and marketing assistance agreement. New higher speed sewing machines have also been introduced by several of these garment firms. One of the large domestic private firms (A.4) has also bought a computerized cutting system from Taiwan Province of China. However, these firms have not introduced automated sewing systems, as one of the strengths of Indonesia’s garment industry lies in the individual craftsmanship and adaptability of its largely female workforce. While the garment firms interviewed appear to have correctly identified the major competitive challenges of the coming years, and are taking appropriate steps to meet these challenges, there are still a number of domestic bureaucratic hurdles which adversely affect their competitiveness. Although the Indonesian government has introduced several deregulation measures since the mid-1980s, comparisons with other South-East Asian countries, particularly Singapore and Malaysia, suggest that much more still needs to be done before Indonesia is on a par with these countries. In contrast with the textile firms, the current incentive system appears to be an adequate means of encouraging export-oriented garment firms to acquire more demanding TC, particularly design and marketing capability. The most likely reason for this difference is that process technologies in the garment industry are relatively simpler and more labour-intensive than in the synthetic fibre and textile industries. Although most garment firms still export their products under OEM arrangements with their overseas buyers or principals, they seem to have a greater chance of developing their own designed products because they can either rely on designs inspired by their native products (e.g. batik) or on those developed by their own designers after training at overseas fashion houses. The need to penetrate new non-quota export markets has also forced several firms to explore and develop their own marketing channels. However, in view of the continuing anti-export bias, the present incentive system is not yet effective enough to encourage domestic marketoriented garment firms to export and improve their international competitiveness by building up their own TC. Unlike the domestic private garment firms, the foreign majority-owned JV (A. 12) is not being encouraged under the current incentive system to transfer the design, marketing, linkage and major change capabilities to its Indonesian employees. In this respect, the situation is not any different from that of the synthetic fibre and textile JVs. Views of the electronics firms Consumer electronic firms The firms established in the domestic market, such as B.1 and B.2, are facing, and will continue to face, increased domestic competition due to several factors.

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First, even though imported CBU products are subject to a tariff, the unequal treatment of producers and traders with regard to sales and luxury taxes, and the growth of ‘informal’ trade (i.e. smuggling) have led to a situation where the price differential between goods produced in Indonesia and imported goods is estimated at much less than the present tariff of 40 per cent. Another potential source of increased domestic competition will come from large export-oriented firms located in export-processing zones which can sell up to 25 per cent of their output in the domestic market. All the export-oriented JVs (B.3, B.7 and B.9) and the export-oriented national private firm B.8 said that they intended to sell in the domestic market. A third potential source of greater domestic competition will result if the government reduces tariffs on final consumer electronic goods, either under the AFT A agreement or unilaterally. The lower scale of production and less developed nature of the industry in Indonesia compared with other ASEAN countries will mean that domestic producers will face stiff import competition from Malaysia and Thailand over the next few years as, under the AFTA agreement, intra-ASEAN trade in electronic products will also come under the ‘fast track’ agreement. While the main issue addressed in this section is the sustainability of exports in the face of new competitive challenges, there is a natural synergy between the response to increase domestic competition and increasing exports, as shown by the response of firm B.1. The obvious reaction to greater domestic competition is to step up marketing efforts, raise efficiency and improve productivity so that costs can be reduced. The firms selling in the domestic market today obviously still have advantages in comparison with new entrants. B.1 has developed a strong marketing strategy and niche to sell in the domestic market, although if newcomers can sell foreign brands at much lower prices, then even B.1 will face stiff competition. A more important step towards reducing costs, which has already been undertaken by firm B.1, is to increase the volume of production by exporting, which in turn, has been made possible by improved export incentives. A distinction needs to be made here between the challenges faced by national private firms producing under their own brand, such as B.1 and the JVs, and licence holders producing under a foreign brand. In the former case, the main challenge will be for the firm to establish its brand-name internationally and improve its market access. While B.1 has the major change and design capability to enable it to carve out a niche in colour television sets and possibly audio products, the competition is stiff and it may not be able to achieve a sufficiently competitive volume of production. At present, its plan appears to be to continue its strategy of exporting television sets under ODM arrangements and eventually to export products under its own brandname. Whether the strategy is realistic or will work will be very much dependent on the success of the firm’s marketing strategy. An alternative policy would be to continue its present strategy in conjunction with a second option of producing under subcontracting arrangements to achieve the necessary volume. The

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introduction of high definition television (HDTV) will also pose a serious challenge for B. 1 since it has no foreign link. A possible solution would be for it to specialize in market segments that are not serviced by the dominant players. As for JVs and firms producing under subcontracting arrangements, the ability to increase and sustain exports is very much dependent on the overall strategy of the foreign principal, with headquarters establishing a rationalization and restructuring plan for its subsidiaries in the region, in particular in ASEAN if AFTA is taken seriously, and among its subsidiaries or licensees in the domestic market. This rationalization strategy would involve dividing the location of production centres according to product type (e.g. 14 inch vs. 21 inch colour television sets) and kind (e.g. television sets vs. VCR, components vs. final products). The local decision would be determined by the incentive system, size of the domestic market and efficiency and productivity of plants already in the location. In this regard, Indonesia faces stiff competition from China, as a number of firms interviewed pointed out. An interesting question is what would happen to national private firms producing a foreign brand under licence for the domestic market if majorityowned export-oriented firms, such as B.7, with the same brand decided to sell the same product in the domestic market. Much will once again depend on the production capability and efficiency of the plant concerned. The question of whether electronics exports from Indonesia will continue to increase and remain sustainable depends on whether the right strategic decisions are taken. An important factor which will ultimately influence the location decision and which was emphasized by all the firms interviewed is the capability to source components domestically. At present, most components for export production are still imported due to the low quality and standard of available domestic components, the incentive system which discourages sourcing domestically and the small scale of demand due to the late start of Indonesia in the field of exports. Thus the second wave of relocation by component producers following that of their clients (as in China) has not taken place in Indonesia, where only plastic parts, mechanical parts and packaging materials are sourced domestically. All the firms interviewed said that, without the development of a domestic components industry, especially for core components, they would not become competitive in exports. Labour costs comprise only a small proportion of total cost (2–10 per cent), with materials comprising the bulk of the latter. For instance, CRT tubes make up 60 per cent of the material costs. Having to source from abroad is expensive in terms of lead-time, transportation and stock maintenance. A further advantage of increased local content is that exports would be eligible for GSP treatment in the United States and Europe, which requires 40–60 per cent local or ASEAN content. At present, because of the high import content, there is little utilization of the GSP facility by electronic exporters. All the firms interviewed pointed out that component producers have not relocated to Indonesia and local component suppliers have not developed

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because of the lack of a supporting incentive system. Demand from existing producers was expected to create sufficient scale of production, especially in the coming few years as more export-oriented assembly operations are carried out and domestic demand continues to increase. The particular aspects of the incentive environment mentioned as problematic included the difficulties of moving goods in and out of the country, the movement of goods among exportprocessing zones, administrative procedures for obtaining duty and tax exemptions for indirect exporters, and bureaucratic procedures regulating investment licences and site location. The JVs interviewed contrasted the situation in Indonesia with that of other locations, in particular China, Malaysia and Singapore. All said that headquarters were carefully evaluating their relocation decision to Indonesia and parts and components suppliers were also adopting a wait-and-see attitude, despite insistent requests from JVs already in Indonesia to follow them. It is therefore essential for the Indonesian government to do its part to improve the present incentive system, or the momentum for sustaining electronics exports will be lost. A final competitive challenge is to increase TC beyond production, minor change and repair and maintenance capability, i.e. how to develop major change and design capability so that costs can be reduced and the important transition from OEM to ODM manufacturing achieved. This will involve the development of a capability to design modifications so that component utilization is efficient, an ability to design new components to increase efficiency and the capability to undertake product differentiation and establish a market niche. Except for firm B. 1, none of the firms interviewed has responded to this competitive challenge, although they all recognize its importance. For instance, firm B.10 has considered taking over the R&D division of its Taiwanese licenser, but recognizes the risk and costs of having to keep abreast of technological developments. The main option still appears to be to establish a foreign link enabling the domestically based firm to keep abreast of latest developments in process technology and design. However, the firm must also develop its in-house capability by investing in human resources and the necessary equipment. Components and industrial electronics The main challenge faced by this subsector—the development of a domestic components industry—has already been addressed above. However, the production of ICs poses its own set of additional competitive challenges. The main difficulty here is that the technology is changing rapidly and, as pointed out by firm B.11, it is difficult to make projections or adapt to strategies of other firms as prices are very volatile. The two firms engaged in IC production are not linked to a foreign principal and keeping abreast with developments, through purchasing technology and recruiting foreign manpower on a continuing basis, has proved costly and risky. Investment in rapidly changing technology is

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a gamble and dramatic price falls can radically alter the cost-effectiveness of any purchase decisions. The managing director of firm B.11 suggested several options that could help overcome these risks. The first would be to reduce the cycle or turnaround time. Other than continuing to increase production efficiency, he believed that further reduction of turn-around time would require some solution to the delays resulting from the administrative bottlenecks noted earlier. The second option would be to increase marketing efforts in order to produce at full capacity. A third option would be to look for a more permanent link to a multinational enterprise. In this respect, Indonesia would have to dispel the negative image of its semiconductor industry following the closure of P.T.NSC and Fairchild in 1986. B.11, as well as other firms interviewed, believed that the government should actively seek to redress this negative image. B.11 plans to diversify its operations to less risky products such as professional and industrial electronics, with part of the production being sold on the domestic market. V CONCLUSIONS The preceding account of the dynamics of TC building in a sample of textile, garment and electronics firms in Indonesia shows that several domestic private firms have, to a greater or lesser extent, acquired the investment, production and minor change capabilities that are an essential component of the early stages of industrialization. Of the firms interviewed, locally owned private firms tended to have greater success than either foreign-owned or state enterprises in mastering the three types of capabilities. However, the more demanding linkage, marketing and major change capabilities, which are so important to maintaining and improving the international competitiveness of Indonesia’s manufacturing firms, are still beyond their reach. In general, these firms have been unable to establish meaningful ties with university faculties and technology institutes. Nor have they learned how to penetrate and service external markets, but have continued to rely heavily on foreign buying agents, trading companies, contractors or, in the case of JVs, on their foreign partners. With neither the facilities nor the skills needed in order to carry out R&D, these firms have hardly been in a position to introduce their own process innovations or design new products suitable for acceptance in foreign markets. To a very large extent, this is explained by their lack of experience in producing for foreign markets. It was only in the mid-1980s that Indonesia’s manufacturing sector was goaded into exporting, much later than in the Asian NIEs—Korea, Hong Kong and Singapore—and even later than its immediate ASEAN neighbours—Malaysia and Thailand. The inward-looking, state-centred ideology of industrialization has a powerful hold on the thinking of industrial policy-makers in Indonesia. While during the latter part of the oil boom era in the late 1970s and early 1980s a wide range of large-scale basic resource-processing industries were being pushed by the

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government, the Minister of State for Research and Technology, with the support of the President, strongly promoted in the early 1990s, the development of a number of state-owned ‘strategic’ industries, in particular high-technology enterprises, such as the stateowned aircraft industry (Industri Pesawat Terbang Nusantara—IPTN). However, of the 10 ‘strategic industries’ only IPTN and the shipbuilding industry, P.T.PAL, have been targeted to achieve international competitiveness in the near future. These ‘strategic’ industries are nurtured by strong protection, government procurement and substantial amounts of implicit and explicit government subsidies. Without taking into account any possible trade-offs between the promotion of these costly ‘strategic’ industries and the promotion of a ‘broadbased’ strategy of outward-looking industrialization, as advocated by a more export-oriented Ministry of Industry, the Indonesian government has emphasized that this ‘dual-track’ industrialization strategy will be pursued in the coming years. However, the Indonesian government has not been unambiguously vigorous in managing its export promotion programmes, as several exemptions and exceptions in its various deregulation packages continue to convey conflicting signals to textile/garment and electronics manufacturers. Despite the government’s efforts in recent years to improve bureaucratic efficiency, these firms continue to encounter a greater number of hurdles than their Malaysian and Thai competitors. It remains to be seen whether the recent deregulation package of October 1993 will be implemented efficiently and be sufficient to remove the remaining ‘anti-export’ bias in Indonesia’s trade regime which has reduced the profitability of exporting for electronics firms. The Indonesian government’s selective interventions, often achieved by direct controls, have hampered the efficient operation of the market and promoted ‘rentseeking’ activities which in turn have led to market distortions and inefficiencies in the allocation of resources. We argue, therefore, that the Indonesian government should refrain from pursuing an explicit industrial policy along the lines of Japan and Korea and limit itself to ‘neutral’ or ‘functional’ interventions, to ensure that macroeconomic stability is maintained, markets function well and competition is preserved, and that the necessary complementary assets and capabilities, which are important to competitive firms, are available and accessible to these firms. These include adequate financial resources to invest in raising firms’ TC, adequate human resources (highly skilled engineers and managers and middle-level technicians as well as skilled and highly motivated workers) and adequate support services, such as those provided by a transparent legal framework (which is still lacking) and by institutions which offer technical consultancy services, testing services, standardization and calibration services and conduct research and development that is of use to manufacturing firms. While most of these complementary assets and capabilities are already available in Indonesia, they are, in general, still far from what is needed to encourage and

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support dynamic, export-oriented textile/garment and electronics firms to improve and expand their TC. NOTES 1 Figures are based on GDP at constant 1983 prices and are calculated from Central Bureau of Statistics, National Accounts and Exports, various issues. 2 As estimated by SRI (1991). The numbers do not include traders and pseudoassemblers who report high production capacity with relatively few workers. 3 About 60 per cent of joint venture and principal licensee relationships are Japanese, with Europe and the United States accounting for the remainder. 4 In 1984, the negative list included the following items from the electronics sector: telephone sets, switchboards, small earth stations up to 200w, loudspeakers, cassette decks (CKD), cassette decks (CBU), cassette boxes (magnetic tape), television antennae, radio antennae, cassette recorders (CKD) and cassette recorders (CBU). 5 The localization policy was introduced to encourage engineering industries, such as the electronics and automotive industries, to use local components. The policy began with the automotive industry in 1977 and was gradually extended to other industries. In 1983, the Ministry for the Utilization of Domestic Components was set up to coordinate the domestic content programmes. 6 Fane and Phillips (1991) and World Bank estimates. 7 NSC, the largest semiconductor plant in Malaysia, closed down its plant in June 1985. Fairchild also reduced its workforce and cut back its operations in the United States (closing down four plants) and in Singapore, South Korea, Hong Kong (two plants) and the Philippines. 8 According to press accounts at the time, Fairchild said that technology restructuring was needed for it to remain efficient. In 1985, it announced plans to introduce new technology which would have involved reducing the workforce. Although permission was eventually obtained to reduce the number of workers, the Ministry of Manpower opposed any retrenching based on automation, and there was considerable negative reaction from society as a whole, as evident from press accounts. 9 The proportion of production from companies located in export processing zones and bonded warehouses that could be sold on the domestic market was initially set at 15 per cent (May 1986). This was increased to 25 per cent in June 1993. Products sold in the domestic market would be subject to import duties and sales tax. 10 Deregulation also created problems in the form of increased domestic competition for assemblers, as importers who assembled electronics products were not subject to the value added (10 per cent) and luxury taxes (10–30 per cent) applicable to producers. Tariffs on some components, such as printed circuit boards, were increased again in June 1991 after protests from the industry. In June 1991, the tariff on packaged software was also reduced from 30 to 10 per cent to encourage efforts to use software for design, development of application software and other uses.

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11 The distinction between large and small firms is not based on the official Central Bureau of Statistics (BPS) criterion, as all the garment firms, except for one, are by BPS standards considered large-scale, having more than 100 paid workers, while the one exception is a medium-scale firm, employing 75 workers. Hence, the distinction is made in a relative sense, as the above two smaller firms employ a much smaller number of workers (125 and 75 respectively) compared with the larger firms which employ thousands of workers, while their exports (US$1.25 million and US$750,000 respectively) are also much smaller than those of the large firms. 12 For instance, if a firm in an export-processing zone produced one million colour TV units, it could now (under the June 1993 modification) sell 250,000 units in the domestic market which, in 1993, accounted for an estimated one-third of the domestic market.

BIBLIOGRAPHY Aswicahyono, H.H., Bird, K. and Hill, H. (1996) ‘What happens to industrial structure when countries liberalise? Indonesia since the mid-1980s’, Journal ofDevelopment StudiesVol. 32, No. 3, pp. 340–363. Bank Dagang Negara (1991) Bulletin Tinjauan Ekonomi Perkembangan Indus triTekstil di Indonesia,Vol. 18, No. 7. Balasubramanyan, V.N. (1984) ‘Factor proportions and productive efficiency of foreignowned firms in the Indonesian manufacturing sector’, Bulletin of Indonesian Economic Studies,Vol. 20, No. 3, pp. 70–94. Bhattacharya, Amar and Pangestu, Mari (1993) ‘Indonesia: development transformation since 1965: role of public and policy’, World Bank, Washington, DC. Ernst, Dieter and O’Connor, David (1992) Competition in the Electronics Industry,OECD, Paris. Fane, George (1996) The World Economy: Global Trade Policy,1996, pp. 101–117. Fane, George and Philips, Chris (1991) ‘Effective protection in Indonesia’, Bulletinof Indonesian Economic Studies,Vol. 27, No. 3, pp. 75–110. Hill, Hal (1990) ‘Indonesia’s industrial transformation, Part II’, Bulletin of Indonesian Economic Studies,Vol. 26, No. 3, pp. 75–110. ——(1992a) ‘Survey of recent developments’, Bulletin of Indonesian Economic Studies,Vol. 28, No. 2, pp. 3–41. ——(1992b) ‘Indonesia’s textile and garment industries’ development in an Asian perspective’, Occasional Paper No. 87, Singapore, Institute of Southeast Asian Studies. (1996) ‘Indonesia’s industrial policy and performance: “orthodoxy” vindicated’, Economic Development and Cultural Change,Vol. 45, No. 1, pp. 147–174. Johnson, Chalmers (1982) MITI and the Japanese Miracle: The Growth of IndustrialPolicy, 1925–1975,Stanford University Press, Palo Alto. Lall, Sanjaya (1992) ‘Technological capabilities and industrialization’, World Development,Vol. 20, No. 2, pp. 165–186. MacIntyre, Andrew (1991) Business and Politics in Indonesia, ASAA Southeast Asia Publications Series, No. 21, Allen & Unwin, Sydney.

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Ostry, Sylvia and Harianto, F. (1995) ‘The changing pattern of Japanese foreign direct investment in the electronics industry in East Asia’, UNCTAD Transnational Corporations,Vol. 4, No. 1, pp. 11–43. Saad, Ilyas (1992) ‘The impact of trade reforms and the multifibre arrangements on Indonesian clothing and textile exports in the 1980s’, unpublished Ph.D. thesis, Canberra, Australian National University. Saastromihardjo, Sanjoto (1991) ‘The Indonesian textile industry’, in Norio Mihira (ed.) Industrialization in Indonesia,Tokyo: Institute of Developing Economies. SRI International (1991) ‘Industrial restructuring of the electronics subsector in Indonesia’, Report prepared by Unecona Agung for the Ministry of Industry. World Bank (1978a) ‘Indonesia: Strategy for growth and structural change’, Industry Surveys, report No. 7758, IND, Washington, DC. ——(1978b) ‘Problems and prospects for industrial development in Indonesia’, Vol. II, Industry Surveys, report No. 1647, IND, Washington, DC. (1993) Role of the Government and East Asian Success,Washington, DC. Wymenga, P.S.J. (1988) ‘The textile industry in Indonesia’, Working Paper No. 9, Industry Planning Project, Ministry of Industry, Jakarta. ——(1991) ‘The structure of protection in Indonesia in 1989’, in Bulletin of Indonesian Economic Studies,Vol. 27, No. 1, pp. 127–249.

6 Technological dynamism and R&D in the export of manufactures from Viet Nam Tran Ngoc Ca and Le Dieu Anh

I AN OVERVIEW OF VIETNAM’S DEVELOPMENT: STAGES OF INDUSTRIALIZATION The earliest industrial activities in Viet Nam date back to the period of French colonialism, which began in the mid-nineteenth century. These activities did not aim at a genuine industrialization of the colony, but rather to produce goods for direct local consumption by the French and Vietnamese elite.1 Although the French made some contributions to education and training in the French language, these activities added little to the general development of the colony and, after sixty years of French rule, 80 per cent of the population was still illiterate (Buttinger: 1982, p. 68). In September 1945 the Democratic Republic of Viet Nam (DRV) was born, and in 1947 an expansion of industries occurred and the first management system for industry was established. Following the creation of the DRV, President Ho Chi Minh declared a nationwide campaign to wipe out illiteracy.2 As a result of this campaign, it was estimated that 93 per cent of the lowland population aged 12–50 years could read and write by 1958 (Marr: 1981, pp. 186–187). In 1954, following a war with France, the country was divided. In the region controlled by the DRV, university-level education was developed and the first science and technology (S&T) research projects were undertaken, as well as some new manufacturing activities (APCTT: 1988, p. 10). Following recognition of the DRV by China and later by the Soviet Union, foreign experts from both of these countries also assisted with the management of Vietnamese industries. With their help, Viet Nam established its first large-scale industrial facilities, and began to export light industrial products and handicrafts to the socialist countries. A new, free and compulsory education system was introduced for children aged 6 to 15 years, and teaching was undertaken in Vietnamese. Informal training for the development of technical skills and industrial competence was also given attention through special schools, training programmes in schools attached to enterprises, and apprenticeship programmes within enterprises under the supervision of older workers.3

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The political division of the country in 1954, however, led to the massive migration of Vietnamese from north to south and to the loss of managerial and industrial production skills from industries in the north. Socialist reform campaigns subsequently introduced in the north led to the elimination of a capitalist class by 1961. During that year further attempts were made to reeducate the workers, by means of movements to turn them into state employees or into members of cooperative organizations (Post: 1989, p. 39). These activities contributed to the destruction of the small industrial and commercial business class, which had begun to display entrepreneurial spirit and technical and managerial skills. In spite of special training campaigns and programmes, the acquisition of technological competence still remained a major problem, due to the old work habits of newly recruited workers (most of them peasants, military personnel or poorer members of the urban population). The slow economic development in the north was further interrupted in 1965 by air strikes carried out in support of the south in its war with the north, and this situation continued until the Paris ceasefire agreement signed in 1973. In 1976 a second five-year plan was introduced that attempted to strengthen the industrial sector in the north. In contrast, the Saigon government set south Viet Nam on a course of capitalist development based on the relatively good industrial infrastructure facilities left behind by the French in 1954. With the coming of the United States troops and foreign aid, there was a further boom in construction to serve the United States forces. As the war accelerated in 1968, many thousands of foreign experts arrived under USAID programmes, together with substantial investments designed to build up manufacturing industries. However, managerial and labour skills were scarce and with most qualified people in the armed forces, industrial productivity was low and industry did not evolve in a competitive and selfsupporting manner. Foreign trade at this time chiefly consisted of imports of consumer goods from the United States and exports of primary products, mainly rice and rubber. In contrast to economic development in the north, the private sector played a significant role in the south. In both the north and the south, this period was marked by a very unstable environment for economic development which was strongly influenced by the effects of a war economy. The war ended in 1975 and a Provisional Revolutionary Government was established with an administration in Saigon. The process of unification began in 1976 with a campaign against the bourgeoisie during which 670 families were arrested, properties were confiscated and a massive outflow of people from the country was provoked. In July 1976 the Socialist Republic of Viet Nam was formally created by the unification of the two regions. Thereafter, measures were introduced to integrate the financial systems, state budgets and the currency and banking systems of the two regions. The state then launched a second battle against the bourgeoisie and, in 1979, with the involvement of Vietnamese troops in Cambodia, the country became extremely isolated, relying chiefly on the former Soviet Union and East European countries for trade and aid. Industrial

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output which had increased from 1976 to 1978, fell during the years 1979 to 1980 due to poor management, rapid socialist transformation, lack of capital, shortage of energy, and insufficiency of raw materials and spare parts for enterprises. Recognizing the seriousness of these problems, the government began a process of reform. The first reform measures, introduced in 1979–1980, included a subcontracting system in agriculture; devaluation of the Vietnamese currency (the dong), greater autonomy of planning for locally managed firms, and the possibility of direct trade between enterprises not covered by the central plan. Another round of reforms came in 1981, when the official price structure was changed and brought closer to free market prices. In industry, a new system of enterprise management was introduced with wages paid according to a piece-rate system. Enterprises were given more freedom in their production, finance and trade activities. But many state-owned enterprises (SOEs) were still subsidized by the state and despite inefficiencies were not allowed to go bankrupt (Beresford: 1989, p. 205). Exports during this period remained tied to the markets of the Council of Mutual Economic Assistance (CMEA). In the early 1980s an inflationary spiral began and the currency reform in 1985 proved to be a major failure.4 In 1986, standing on the edge of a much more serious crisis than that of previous years, the leadership in Viet Nam resorted to more radical reforms. At the national party congress in December 1986 a renovation policy (doi-moi) was officially announced. This included a further extension and deepening of earlier reforms and a number of new measures. First, a structural change in investment priorities took place with a shift from heavy industry to food production, consumer goods and exports. Second, a role for the private sector was officially recognized. Third, economic management in SOEs was decentralized, giving them more autonomy over production, management and other activities.5 Fourth, in the banking and finance sector, new tax provisions were implemented, the interest rate level was adjusted more realistically in 1989 (Dau Hoan Do and Svensson: 1992, p. 53), and the abolition of the multiple exchange rate system in that year, accompanied by a maxi-devaluation, eliminated the differential between the official and parallel rates of exchange. The banking system was commercialized in 1990. Fifth, diversification and liberalization of external economic relations was encouraged. With the dissolution of the CMEA in 1991, Viet Nam ceased to receive aid from the socialist countries of Europe and all trade transactions were subjected to hard currency settlement. Following difficulties in economic relations, the government of Viet Nam reacted by rejuvenating its trade with the markets of former CMEA countries, and by developing new contractual arrangements in trading activities. This orientation of the country’s exports to a convertible currency basis was a major shift, and growing regional integration of the Vietnamese economy with those of other Asia-Pacific countries lessened its

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Table 6.1 Main industrial output (VND billions; fixed price, 1989)

Source: Statistical General Department, Hanoi, 1993

dependence on economic relations with the former CMEA countries. There were also significant changes made in foreign trade management. Many enterprises were now given the right to engage in direct import-export business, provided they satisfied certain conditions. Adjustments to trade policy, such as measures affecting export taxes, import duties and export-import licensing, were introduced in 1987. A new foreign investment law was promulgated in 1987, and various investment options were opened up to foreigners, including the establishment of foreign wholly-owned companies. Various decrees relating to technology transfer from abroad as well as to industrial property rights, patenting, etc. were also promulgated at this time. Sixth, the system of research and development (R&D), education and training was liberalized. During the 1980s changes in economic policy and various reform measures opened up the science and technology (S&T) potential and its impact on economic activities (Vu Cao Dam: 1992, pp. 5–10). The major reforms effected in the sphere of S&T were: to recognize the right of R&D institutions to make direct contracts with industry; to enable R&D institutions to diversify and widen the range of their activities; to diversify the financial sources of R&D institutions to include state budget contributions and industrial contracts and bank credit; and to privatize R&D activities and protect intellectual property rights. With doi-moi, the potential strengths of the south (such as production experience under a market economy and better infrastructure) were given a chance to take root in the north. During 1985–1986, many managers in order to keep their companies alive ceased to follow official regulations on production activities, input supply, sale of products, use of the labour force and deployment of material incentives, etc. and were ready to ‘break the fence’. These fencebreakers were the first group of reformers among managers of SOEs and they pressured the government to undertake further reforms. The growing

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Table 6.2 Foreign direct investment in Viet Nam, 1988–1993 (30 June 1993) (US$ billions)

Source: State Commission for Cooperation and Investment (SCCI), Hanoi 1993 Table 6.3 Foreign direct investment by sector (as at 7 April 1994)

Source: State Commission for Cooperation and Investment (SCCI), Hanoi, 1994

possibilities of opening up the country to the ‘other side’ of the world since 1986, have created more favorable conditions for establishing a good technological base for the economy. Data relating to industrial production and foreign direct investment (FDI) are presented in Tables 6.1–6.3. They show how Vietnamese industry has moved through three distinct phases: a pre-1975 period of dependence on the socialist countries for markets and technology, a first reform period from 1975 to 1986 and the post-1986 period of export-led growth.

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II IMPACT OF THE INCENTIVE SYSTEM ON THE DEVELOPMENT AND EXPORT PERFORMANCE OF TWO SELECTED INDUSTRIES Textiles and clothing During the colonial period, spinning of imported cotton and silk began in the north delta of Viet Nam (Beresford: 1989, p. 19). Following the end of the first Indo-Chinese War, although there were very few textile plants left in good condition, the firms in the textile industry had already acquired valuable industrial experience and technological skills. By 1950, there were some 40 state owned factories in the liberated area of north Viet Nam, four of which were textile mills (Fforde and Paine: 1987, pp. 87–88). Facilities created by the DRV government before 1954 were small-scale and handicraft-oriented. Equipment and other facilities were obtained through aid received from China, the former Soviet Union and other socialist countries. At the same time, in the urban area occupied by French forces, certain industrial facilities (light manufactures, including textile plants) existed to serve the modest needs of the civilian population and the army. Limited trading in textiles also occurred, but mostly between contiguous localities within the country. Between 1954 and 1960, a number of larger scale spinning, weaving and knitting plants emerged around the bigger towns in the DRV. During the Viet Nam War (1965–1973), these facilities were either evacuated to rural areas, or were very severely damaged by air bombardment. In 1975 the production of the textile industry began to recover, but the equipment was still of 1950–1960s vintage, based on machinery imported from China and the former Soviet Union. At this time the enterprises belonged to the Ministry of Light Industry (MOLI) or to local governments, and their administration of these enterprises suffered from a lack of coordination. There were few linkages between R&D activities and the actual needs of the companies. In the south, the textile industry was concentrated in urban areas, and almost all of the manufacturing, commercial and financial activities were in the hands of the private sector, which was dominated by ethnic Chinese who controlled some three-quarters of the southern economy (100 per cent of wholesale trade, 80 per cent of industry and 70 per cent of foreign trade). Some of them were big capitalists in the textile industry. The equipment, embodying the technology of the 1960s, had been mainly imported from Japan, the United States, France and Germany, The textile industries of both regions relied on imported materials and spare parts and produced wholly for their respective domestic markets. During the war with the French, some small garment workshops were set up to serve the needs of the army. In 1956–1958, two factories were established in the north to produce some thousands of pieces of simple clothing for the domestic market and work overalls for export.6 In the south, beginning in 1971, a garment

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industry was developed, initially with six factories producing for the domestic market as well as for export. By 1975, South Viet Nam had accumulated a technological base with a range of industrial, commercial and managerial skills and supporting experience, together with a reasonably good physical infrastructure necessary for industrial development. In this context, the manufacturing industry in general and textiles in particular had thus acquired a favourable foundation from which to develop. Specifically, some observers have also pointed to the birth of a viable entrepreneurial class and the emergence of a corps of technocrats (Hoang Ngoc Nguyen: 1990). Changes in the textile industry came mainly during the years 1982–1986 and involved large investments in new spinning plants. Quite modern plants were purchased on the basis of foreign loans (mostly from France, Germany, Japan and Italy) to produce cotton and polyester yarn. Together with some large spinning and weaving plants left in the south after 1975 and nationalized by the state, these mills came to constitute the modern segment of the Vietnamese textile industry in the post-war era. Southern garment factories which had existed since the beginning of the 1970s also became an integral part of the country’s textile and garment industry. Throughout most of the 1975–1986 period, however, a lack of consistent investment policies, dependence on older technology from the socialist countries and financial constraints kept the industry inefficient. Moreover, the lack of incentives and competitive pressure from the market induced in managers a passivity towards innovative activities. The adherence to principles, such as ‘normative profit as a percentage of production cost’, did not encourage companies to introduce new technologies to reduce these production costs. Officially, until the reforms in 1986, the private sector was not recognized in Vietnamese industry. But, in fact, private activity in textiles and garments existed throughout the period of socialist transformation, mainly in the form of cooperatives, small industries and handicraft production. However, private enterprise was considered a negative force under the old DRV model of socialist construction, and there were repeated campaigns in both north and south to destroy private wealth. In this period the Union of Textile Enterprises and Union of Garment Factories were set up as intermediaries between the firms and the Ministry of Light Industry in order to improve coordination and other aspects of production. Initially, these unions played the role of middle-level managerial bodies. They established the plans, allocated investment funds and applied economic performance criteria as a tool for monitoring the implementation of state planning targets. But the situation remained cumbersome and became confused because the Ministry continued to interfere (sometimes directly without the Unions) in the daily activities of the enterprises. The most significant changes in the textile industry came after 1986. Under a more open economy and more diversified linkages with foreign investment

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sources and markets, many enterprises formed business relationships with overseas partners from non-socialist countries in order to expand their production.7 Private entrepreneurs, who had survived successive socialist transformation campaigns with some of their wealth intact, were now encouraged by the multisectoral economic reforms to use their resources and personal links with foreigners to set up new production plants. The abolition of the old management system and other industrial reforms radically changed the attitudes of companies regarding technological innovation. Cooperatives during this period became more than a network of production units executing orders from state enterprises. The number of employees in the non-state sector rose by two to three times the number employed in the state sector. This workforce was intended to serve large state enterprises in fulfilling their production plans through a domestic subcontracting relationship. Private garment manufacturing companies, including some large ones in the south, proliferated during this third period of the textile industry’s development, mainly as a result of more relaxed policies towards the private sector. The reforms of this period tended to shift the role of the ministry, away from that of micro-management of individual firms and towards activities involving more strategic planning for the entire industrial sector. The unions became more like another company, although they remained ready to assist enterprises in those activities which they could not accomplish alone, such as research, training, trading and securing supplies of strategic materials (cotton for textile plants etc.), while giving enterprises more freedom in their business operations. Although the unions are now called corporations, they act as consultancy bodies for the Ministry and have developed contract-based relationships with enterprises. More recently, the Association of Vietnamese Garment Factories was formed, which includes SOEs and private firms as members. Later it became the Vietnam Garment Manufacturing and Trading Corporation. This is an attempt by firms to concentrate their resources and efforts for improved production and export of garments. Members of the corporation meet several times a year to discuss trends in the industry and strategies for its development, funding for necessary activities and lobbying of government organizations.8 Vietnamese R&D institutes have increased their involvement with the textile/ garment industry in recent years. Within the structure of the MOLI itself there are two main research units: the Institute for Textile Industry and the Research Centre for the Garment Industry. Both are located in Hanoi, with affiliates in Ho Chi Minh City.9 Currently, they are affiliated with the trading companies, Textimex and Confimex, respectively, and financed from various sources.10 MOLI also has an Institute for Light Industry Design which is responsible for the design and execution of projects in this industry. Responsible for the industry’s highly educated, technical personnel is the training given by the textile faculties of the various polytechnic institutes located in Hanoi and Ho Chi Minh City. During the years 1984–1986, the production of fibres and fabrics increased rapidly, while garment production mostly increased in 1980–1981. Following the

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Table 6.4 Number of enterprises in the textile and garment sector

Source: Statistical Yearbook, Hanoi, 1992

reforms after 1986, and again at the beginning of the 1990s, the garment industry experienced a boom in the construction of new plants and workshops by both state and private companies to meet export demand. In 1986 garment production in millions of pieces increased from 73 to 102.3. Another surge occurred between 1988 and 1990 when production rose from 109.9 to 125.3 million pieces. Thus, while the growth in spinning and weaving output rose steadily, there were radical increases in the production of garments. Tables 6.4–6.6 provide data for the textile and clothing industry over the period 1980 to 1990. With regard to export activities, Viet Nam began to export textile and garment products in the 1960s on a trial basis. The products, however, were chiefly designed to serve a lower-income domestic market and the level of quality and restricted assortment of products did not meet export requirements. Real exporting only started in the mid-1970s with most Vietnamese products going to CMEA countries. Tables 6.7 and 6.8 provide figures for the evolution of exports in the 1980s and the structure of textile exports at the time of the study. Contracting work with the former Soviet Union started in 1976 with Soviet partners supplying cotton and Vietnamese companies producing fabrics and garments in return. Export activities thus mainly took the form of passive subcontracting relations with CME A countries. The notion of an international

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Table 6.5 Employment in the textile and clothing industries (thousands of persons)

Source: Statistical Yearbook, Hanoi, 1980–1992

division of labour among socialist countries based on different levels of development is well-known. Thus, in addition to being a supplier of primary agriculture products and tropical natural resources, the Vietnamese also became subcontractors for other socialist countries in simple manufactures. CMEA countries supplied Viet Nam with equipment and production inputs in return for output, but there was no active role for Vietnamese companies in developing their technological expertise, improving their quality and product design, and in enhancing their marketing skills. The passive export mentality of this period which, in turn, was a result of government policies, induced companies to be comfortable with simple types of cooperation, poor quality and limited assortments of products. In textiles and clothing, the former Soviet Union developed extensive production cooperation with the Vietnamese to manufacture shirts, woollen carpets, work overalls and other types of garments. During the years 1980-1985 as much as 2 per cent of cloth consumption in the former Soviet Union was supplied by Viet Nam. After 1986, Viet Nam and the former Soviet Union upgraded their economic relationship in a large, garment subcontracting programme. Soviet buyers supplied designs, patterns, and materials and received clothing in return. Fees for subcontracting were paid in the form of sewing machines, equipment and other goods. This enabled Viet Nam to receive supplies of new Soviet-made sewing machines and the technical expertise of Soviet experts who visited each enterprise to give guidance and technical assistance in the garment business. Exported products included cotton and mixed cotton/polyester yarns, clothing of various kinds (shirts, underwear, knitwear, baby clothes, and other products such as work overalls). When the export surge came at the end of the 1980s and the beginning of the 1990s, more clothing exports (including jackets, coats and higher quality suits) were directed to market economy countries, such as Australia, the European Union, Japan and South Korea. More than 30 per cent of total garment production is now destined for export.

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Table 6.6 Textile and garment production in Viet Nam

Source: Statistical Yearbook, Hanoi, 1992. Beresford, 1988: aggregation from Statistical Yearbooks, Hanoi, 1992

In the years 1986–1990, Vietnamese companies supplied more than 60 million garment pieces to the former Soviet Union, and pursued a similar system of subcontracting with the East European countries. These subcontracting programmes helped Vietnamese companies to upgrade their production capability and technological competence significantly in garment-making activities. However, the difficulties they encountered with this intra-CMEA system (such as uncertain deliveries, lack of suitable products for exchange and lack of hard currency) induced some Vietnamese companies to venture modestly into other markets in Asia and Europe. The penchant for hard currency receipts spread to other firms within the industry. Table 6.9 depicts the dramatic shift in the destination of Vietnamese garment exports from non-convertible to

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Table 6.7 Export of textiles and clothing in millions of roubles and US$ (1991 and 1992, US$ only)

Source: Statistical Yearbook, Hanoi, 1992 Table 6.8 Export structure of textile and garment industry, 1991–1992 (%)

Source: Ministry of Commerce, Hanoi, 1993

convertible currency markets in 1991–1992 compared with the preceding five years. Exports of yarn and garments to Japan, although small, were undertaken in the mid-1980s through Japanese trading companies, following the import of new spinning machinery from Japan. Those Vietnamese companies that became involved in trial trading with Western countries and Japan saw the chance to go further, and demonstrated the way forward to other companies. This required new investment in plant facilities and growing technological competence in production and marketing. After 1990, in order to enter new markets, Vietnamese companies began to integrate downstream from spinning and weaving to the production of knitwear, garments and high fashion products. At the same time, with the improvement of the country’s economic situation, the domestic market became more attractive for producers. This led many textile/garment producers to change the pattern of

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Table 6.9 Destination of garment exports, 1986–1990 and 1991–1992 (%)

Source: Ministry of Commerce, Hanoi, 1993

distribution from reliance on a network of wholesalers towards the opening of their own shops and showrooms. The opening up of opportunities for foreign direct investment in Viet Nam created a rush by companies to seek new forms of cooperation with foreign partners. Some of the more experienced enterprises entered into joint ventures. The new business linkages gave local enterprises access to modern technology, capital and management expertise not previously available. The garment industry today has become one of the most outward-oriented industries in Viet Nam, in terms of technology, inputs and market access. Private companies also took advantage of these new forms of cooperation by devising more efficient planning strategies and streamlining their operations (Bow: 1992, p. 10). Reflecting the post-1986 policy of permitting companies to make their own overseas trading contacts and execute their own import-export transactions, the two trading companies Textimex and Confectimex (formerly related to the Ministry of Foreign Trade and exercising a monopoly of the export-import of textiles and garments) were transferred to the Ministry of Light Industry. However, the government’s overall policy of foreign trade management was still not consistent, changing rather frequently and creating difficulties for companies. Many companies took advantage of this unstable situation to realize benefits without engaging in production. One of the main obstacles was the unpredictability of the ministry’s quota allocation procedures. Many companies sold their quotas, and some companies failed to receive quotas, due to lack of established links with ministry officers. Corruption and lobbying could not be entirely excluded in this context. These difficulties hindered Vietnamese industry in fulfilling successfully its trade agreement with the European Union. In sum, the Vietnamese textile and garment industry has changed dramatically. Before 1975 the industry developed in the context of a purely Soviet model of industrialization. Priority was given to heavy industry, but there was also a requirement to satisfy basic consumption needs of the population (Vu Cao Dam, 1988). Textiles have thus always been considered to some extent a priority. In the period 1976 to 1986, the textile industry was able to upgrade and expand its production facilities on the basis of credits from Western countries to buy new technologies and benefited further from the shift of official policy towards consumer goods and export programmes. After 1986, the industry

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expanded its exports in terms of products and markets and exporting became an important and explicit purpose of the industry’s activities. The liberalization of foreign trade and foreign investment also contributed to a surge of new production facilities in this period. Thus, the move was completed from an inward-oriented import-substitution strategy to an outward-looking and exporttargeted development. However, the existence of a large domestic market demand ensured that the textile/garment industry was not solely export-oriented. Among the strengths of the Vietnamese textile/garment industry are the abundance of relatively cheap labour and a long tradition of Vietnamese artisans in small-scale textile activities. Especially during the period of dominance by state enterprises, the small-scale and family-based production units constituted an important part of the subcontracting network to serve the needs of larger companies. The large domestic market of more than 70 million people and increasing purchasing power over the last four years provide a good basis for the industry’s future development.11 The main weakness of the industry is its technological obsolescence. Much of the textile machinery was more than 20 years old in 1988.12 Although some modern textile equipment was imported in the second half of the 1980s and the 1990s this could only partly reduce the level of technological obsolescence. In the garment industry the situation is better. About 20 per cent of sewing machines in use by centrally managed SOEs are now less than 10 years old, with 10 per cent being older than 15 years. In SOEs under local management only 10 per cent of the machines are less than 10 years old, since more restricted sources of investment are available to local government. In the third period, however, the boom in garment exports facilitated the import of new sewing machines, both ordinary and specialized (such as automatic embroidery machines and stonewashing machines). The SOEs and also private companies were able to improve their equipment and technology at this time.13 The range and volume of domestically produced raw materials are also rather limited. Only small amounts of cotton are produced domestically (10–20 per cent of industry usage), while synthetic fibres are not available. Almost all raw materials have to be imported for the textile industry (cotton yarn, viscose, polyester). Not only raw materials, but other supplies for plant operations have to be imported, such as chemicals and spare parts (UNIDO: 1990, p. 78). Formerly, supplies from abroad came almost entirely from Soviet sources. Now the industry must buy from other sources at higher international prices. Processing equipment for domestically produced raw cotton is also obsolete and results in the low quality of input for textiles, which further explains why the spinning industry has to rely on imported raw materials. Moreover, some high quality fabrics cannot be produced by textile firms and the garment companies, in order to produce top quality finished products, have to import materials (about 90 per cent of the industry’s total input) or have them supplied by foreign partners. Thus the shortage of good locally produced fabrics is another problem for the garment industry.

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Electronics industry Major features of the industry’s development As with textiles and garments, the evolution of the Vietnamese electronics industry can also be divided into three historical phases, reflecting the impact of dramatic changes that have marked the development of Vietnamese industry as a whole. The first period dates to the mid-1950s and the creation of some radio electronics manufacturing in support of the establishment of the country’s radio broadcasting service.14 Small workshops in Hanoi and other cities provided maintenance services and trading activities for large foreign firms such as Philips (The Netherlands) and Thompson (France). By 1956, repair and maintenance workshops were operating in all of the provinces. In the early 1960s, the government set up small factories to assemble amplifiers and transformers and to produce loudspeakers. The main components imported from the Soviet Union, GDR and Hungary were condensers, resistors and vacuum tubes. In 1970, with the first National Conference on Electronics, more attention was paid by the government to production in this industry. An electronics laboratory was established in the Ministry of Mechanical Engineering and Metallurgy. In the south, the assembly of black and white TV sets and radio cassettes from imported parts and components started before 1975. Four plants based on Japanese technology started operation in the early 1970s. Training in radio electronics was provided from 1958 in the Hanoi Polytechnic Institute. In each four-year study programme there were about 30 trainees, and some of the graduates were sent abroad for further training. A technical school, which was established in 1960, offered a two-year academic programme. Many workers in this industry also received short training courses in radio electronics from the early 1950s. Vietnamese expatriates, returning from France after 1954, became actively involved in the subsequent organization of electronics training facilities, of which several became polytechnic institutes. Throughout the war years, radio electronics served military purposes with technologies supplied by the socialist countries. In the south, using United States technology, TV broadcasting was undertaken to serve United States troops and the urban population from the early 1970s. Computers first came into use in Viet Nam in the late 1960s.15 When the first computer system was installed in Hanoi in 1967, Vietnamese technicians and specialists were able to run it on their own. Some efforts in the teaching of computer science were also made at this time (APCTT: 1988, p. 54). In 1966 the first IBM-360 (model 20–50) was installed by the IBM (Viet Nam) Company in Saigon.16 United States experts played a very important role in instructing Vietnamese staff in maintaining computer systems in the south, but research activities were limited. All computers were imported and the Vietnamese efforts were limited to the production of software products, mostly for local use. After

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1975 almost all the technical personnel working in the computer industry of the south had left Viet Nam. After the country’s unification in 1975, the use of radio receivers and TV sets based on transistors was rapidly diffused among the population. Television broadcasting started to use satellite facilities from 1980 with Soviet satellite transmission earth stations built in the cities. Colour television broadcasting started in the north in 1982, but the number of TV sets was limited and they were of Soviet and Polish origin. In 1983, in order to give greater priority to the industry, the government set up a General Department of Electronics and Informatics independently from the Ministry of Mechanical Engineering and Metallurgy to oversee this industry. A Viet Nam Commission for Radio and Television was also established. During 1977 to 1979, the government set up plants for small-scale production and the repair and maintenance of radio electronics parts.17 For example, in Hanoi a plant was created with French assistance to produce transistors and other parts from monocrystal germanium. The technological level was simple; it did not produce IC chips or microprocessors, but some of its low quality products were exported to East European countries.18 Unification of the country brought some small-scale assembly lines from the south into the national economy.19 It also brought some workshops and storage facilities (many in poor condition) and a small, technically-qualified labour force that had been involved in production. Northern engineers were sent to the south to assist in the rehabilitation of these plants and the Union of Enterprises for Electronics and Informatics (Viettronics) was established to manage the combined group of enterprises. A number of Viettronics enterprises purchased new equipment from abroad to manufacture products, such as printed circuit boards, with the intention of developing a high-tech industry, but due to the general economic situation at the end of the 1970s, this was not possible. Another attempt was made to put these companies into more active production in the mid-1980s, and they received some technical assistance from East European countries, but continued to assemble simple products from components imported mainly from Poland. Both high schools and universities added electronics to their curricula after unification, while other vocational schools and colleges provided courses in computer programming. Research institutes such as the Institute of Computer Science and Cybernetics (ICSC), under the direction of the National Centre of Scientific Research (NCSR) organized a programme of graduate and postgraduate courses in computer science and electronics. The NCSR was later converted into the Institute of Information Technology (IIT).20 Owing to the lack of a coherent policy for the development of the electronics sector and the shortage of investible resources, research programmes at the national and international levels were not efficient vehicles for applied technology and by the end of the second period the country’s competence in electronics was characterized more by theoretical research and training than by

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hands-on productive expertise. Electronics manufacturing was confined to the assembly of consumer products and the production of simple parts and components for the domestic market. There were as yet almost no export activities and a computer industry did not exist in Viet Nam. Stimulated by the reforms of 1986, a number of firms began to make contacts with companies from Japan and other countries to import components for assembly into finished products. Companies from the former Czechoslovakia supplied Viettronics with materials and technological training in exchange for export of electronic parts, such as resistors, condensers and transistors. Thus, the exports of Viettronics companies in 1987 were estimated to be US$ 10 million (UNIDO: 1989, p. 31). During the years 1986 to 1988, while electronics companies (chiefly the Viettronics group) continued to assemble simple consumer goods for the domestic market and for export, there was a simultaneous move of highly educated labour and material sources into computer-related activities in response to contracts received from R&D and higher education institutions. Reforms in the S&T management mechanism gave scientists more freedom to undertake new activities. A number of units within existing R&D institutions thus entered into the supply of consultancy services and limited production activity, while some institutions and their personnel moved to create their own companies. Informatics companies thus came into being, most of them engaged in computer trade and consultancy and in providing services to domestic customers. Several started exporting microcomputers (PCs) assembled in cooperation with foreign partners through joint ventures and contract manufacturing. Most of the assembled PCs retained the brand names of the foreign firms that supplied the parts and components. However, only a few Vietnamese electronics enterprises were able to participate, because although domestic labour costs were lower than in neighbouring countries, the size of investment required to install assembly lines was beyond their means. The small number of companies that were active in this field were therefore content to focus on the production of simple components or to utilize assembly facilities located in neighbouring countries. The quality of PCs assembled in Viet Nam was equal to that of PCs produced by foreign suppliers or in Singapore. Concerning software products, a few companies were able to sell a number of copies to very specific customers, for example, software for cartoon film-making sold to France and some software programmes to Japan. But these sales did not yield more than a few thousand US dollars in value annually and the export of software products remained limited. During 1987 to 1988, a move to more computer-related activities occurred both in the private sector and in state companies. Viettronics brought within its structure a number of computer companies thus opening the possibility to create critical mass, while private companies in computer-related work were mainly small-scale, family enterprises or cooperatives, involved in computer repair and maintenance services for shops and offices.

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Since 1990, consumer electronics and computer companies have developed quite rapidly in terms of both volume of production and product quality. The private sector emerged as a significant force in the industry’s development, especially in informatics. The main body in the state sector, the Union of Enterprises of Electronics and Informatics (Viettronics) now became the Viet Nam Electronics and Informatics Corporation (VEIC) with 15 company members consisting of 12 consumer electronics companies, two computer companies and a trading company, Vietronimex. The number of private companies in both subsectors was about the same as that within the VEIC. In total, by the end of 1991, there was an estimated 40–45 companies in all sectors of medium-scale, ranging in size from 15–20 to 100–500 workers each. In addition, there were about 100 very small-scale units of 5–7 workers each, mostly involved in service activities in different provinces and cities (Ministry of Commerce, 1992; UNIDO: 1990). Although exports of computer products began towards the end of the 1980s with PCs sent to the former Soviet Union and East European markets, the number of companies exporting these products was limited and after 1990, exports declined as a result of the fall in purchasing power in these familiar markets. Computer and consumer electronics products now had to be more reoriented towards the domestic market. The types of products and services had to be diversified and electronics companies not only had to produce TVs but also audio-visual systems. Computer companies not only sold PCs but also software, and provided wholesale package solutions for customers (including hardware, software-related office equipment, installation, training and maintenance). Many companies diversified their activities into completely different sectors, such as real estate, tourism and hotels, construction, biochemicals and garments. This was termed the ‘complex diversification of business’. In order to continue exporting, some companies made specific efforts to find new partners and new opportunities to produce for export. A few SOEs started assembling electronics parts for industrial robots and telecommunications equipment on a small scale to tap into new markets, such as Japan or other Western countries. Those companies still operating in the old export market of the former Soviet Union changed their way of doing business. For example, selling on credit, working in tripartite partnerships, arranging payment for buyers or working through barter transactions. During the post-1986 period the contribution of higher education grew with the development of both small, private and joint state/private efforts to organize formal courses leading to university degrees in computer electronics.21 All told, at the present time, approximately 200 university degrees in electronics and computer science are awarded annually, and many more computer programmers, technicians and workers are trained in computer techniques, etc. If Vietnamese educated in the former Soviet Union and other countries in electronics and informatics are included, the number of persons with university graduate and postgraduate degrees amounts to some thousands.

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Several newly-created research institutions also began research in electronics, such as the laboratory for semiconductors of the Institute of Physics, the Institute of Microelectronics, the Information System Centre (both belonging to the National Institute of Technology) and a number of laboratories of the Ministry of Defence and of the Viet Nam Radio and Television Broadcasting Commission. The Ministry of Heavy Industry has also operated its own research institute in electronics/informatics technology, first established in 1985 with 60 researchers.22 These institutes do research in the fields of solid state physics, optics, electronics, telecommunications and other information technology-related topics. Research in government coordinated programmes in 1986–1990 and the programme in 1991–1995, however, remain diffuse and overly theoretical. Internationally, Vietnamese research institutes participated in the Common Programme of Informatics Development and Application (PIDA) for the expansion and diffusion of electronics and information technology, organized for the benefit of CMEA member countries.23 However, according to some assessments, Vietnamese participants were frustrated because very little, if any, information technology was transferred to Viet Nam within the framework of this programme (UNIDO: 1990, p. 45). With the liberalization of economic activities and the tendency towards the commercialization of R&D results, many R&D organizations and scientists, who were frustrated by wasting their efforts in useless activities under state coordination, moved quickly to grasp opportunities to set up their own companies and commercialize their acquired technological expertise. In January 1989, the Association of Informatics of Viet Nam was created. Although it received official permission from the government for its establishment, the Association was constituted by members drawn from the state-owned and private organizations as well as individuals. It played the special role of acting as a bridge between its members and other similar international organizations, and with Vietnamese experts in informatics living abroad. The mobilization of highly qualified Vietnamese persons in Western countries (especially Canada, France and the United States) possessing competence, expertise and even some resources in IT development, is one of the main orientations of the Association (Nguyen Quy Son: 1992, p. 35). A similar Association for Microelectronics was also created during this period. The coming of the market economy thus has created favourable conditions for the future development of the informatics industry (Bach Hung Khang: 1992, p. 63). This review, however, shows that the Vietnam ese electronics and computer industry as a whole still remained at an incipient stage of development in the late 1980s, with consumer electronics being relatively the most developed sector. There was little industrial activity in computer products, the volume of production and export was small and, more importantly, the industry still exported on a trial basis rather than through systematic trading arrangements. Assembly work was based on completely or semi-knocked down kits (CKD and SKD), particularly for computer products. A

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number of factors explain why the industry has had such difficulties in developing more rapidly. First, although electronics and informatics were considered to be one of the development priorities in Viet Nam, in practice this was viewed only from a research and training perspective. With regard to production, there was a lack of national policy for electronics and informatics development, inadequate investment by the state, and promotional measures were of a temporary nature without any long-term view (Phan Dinh Dieu: 1992, p. 11). Only recently has a policy of national development for informatics technology been approved by the government and a first institutional framework for national IT programmes taken shape. Second, the development of production and exports was too fragmented, based mainly on the self-efforts of companies. Electronics was only one of many directions taken in industrial development and this industry became just one subsector in the Ministry of Mechanical Engineering and Metallurgy (later the Ministry of Heavy Industry). Changes in institutional and organizational structure also caused some confusion. Third, the industry for some years tended to be forgotten by state investment policy makers, which largely explains why it developed so erratically with an alternating fast and slow growth performance. Fourth, the domestic market is weak, the purchasing power of the population is increasing, but until recently has only permitted the purchase of basic consumer electronics.24 As for computers, the main customers are state organizations, which buy computers for small-scale administrative and office work rather than for industrial production. In general, Vietnamese society had always been a poor society in terms of information, and this is one of the main reasons for the weak domestic market in computer products (Phan Dinh Dieu: 1992, p. 11). Poor infrastructure, the embargo imposed by the United States until very recently, and the lack of efficient international cooperation in this high-tech area have so far rendered unsuccessful every effort of Vietnamese companies to overcome their backwardness. Foreign investors have hesitated to invest in electronics. There are few Vietnamese companies engaged in joint ventures with foreign companies to produce TV sets and parts. Recently, representatives of IBM visited Viet Nam to investigate the possibilities of cooperation in the production and assembly of IBM products. Both the Vietnamese businessmen and the IBM team were keen to cooperate and improve IBM business links in Viet Nam (Wall Street Journal, 3, 1993), but these efforts remained in limbo because of the United States embargo.25 Data for the electronics sector are given in Tables 6.10–6.12.

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Table 6.10 Number of enterprises (for both electronics and electrical industries)

Source: Statistical Yearbook, Hanoi, 1992 Table 6.11 Employment in electronics and electrical industries (thousands of persons)

Source: Statistical Yearbook, Hanoi, 1992

III PATTERNS OF BUILDING TECHNOLOGICAL CAPABILITIES IN THE TEXTILE AND GARMENT AND THE ELECTRONICS INDUSTRIES The analysis presented here is based on interviews with fourteen companies: nine in the textile/garment industry and five in the electronics industry. Basic data for these firms are given in Table 6.13. The firms have the following characteristics: eight are state-owned (six in textiles/garments and two in electronics). Four are private companies and two are joint ventures of Viet Nam and foreign partners, one in each industry. Companies in the textile and garment industry were mainly large, ranging from 2,150 to 6,158 employees, with a few companies of smaller size (90 to 600 persons). In electronics, almost all companies were small (with less than 400 employees). Products of the textile and garment companies are very diversified, ranging from upstream products, such as cotton yarn and mixed polyester/cotton and knitwear, to more downstream products, such as garments (baby clothes, blouses, jackets, jeans and underwear, etc.). The electronics companies were producing consumer goods, such as TV sets and radio cassettes and some non-consumer products such as, industrial and telecommunications

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Table 6.12 Exports of electronics industry (US$)

Source: Ministry of Commerce, Hanoi, 1993

equipment on a smaller scale. Computer companies were concentrated mostly on computer assembly and some related products, such as software and computer services. The main export markets for the textile and garment companies were Japan and the European Union, while the electronics companies prior to 1991 exported mostly to the former Soviet Union. Textile and garment companies The level of technological capability achieved by the nine textile and garment firms reviewed varied considerably (for characteristics of technological capabilities of surveyed firms see Table 6.14). Of particular importance in explaining this variance was the date of establishment and the context prevailing at that time. TG1 and TG2 were founded very early in the first period (end of the 1950s) in the context of the DRV economy. TG4 was created in 1968 under the former government of south Viet Nam but was reborn after it became a stateowned enterprise in 1976. During the early 1980s, TG3, TG5 and TG6, were created. Companies TG7, TG8 and TG9 were established, at the end of the 1980s or the beginning of the 1990s, during the period of radical economic reforms, all three are either wholly privately-owned or joint ventures. Thus, the nine companies can be divided into three groups consisting of companies which came into existence in the three periods of development of the textile/ garment industry reviewed above. Depending on the period of establishment, three main patterns in the acquisition of technological capabilities can be distinguished.

Source: This study

Table 6.13 Main characteristics of companies in the sample case studies

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Table 6.14 Technological capabilities in the surveyed companies

Pattern 1: companies established before 1975 The state-owned enterprises TG1 and TG2 were established in the Democratic Republic of Viet Nam in the late 1950s with the aim of producing simple sewn garments and knitwear, respectively, primarily for the domestic market. External sourcing of technological inputs was limited to other socialist countries and what little exports took place were also directed to these countries. Thus, for example, TG2 received 1950s vintage knitting machines from China in the early 1960s and knitting and dyeing machines from the former German Democratic Republic between 1965 and 1970. Together with the machinery came experts who provided on-the-job training of workers and technicians in Viet Nam. The personnel of these companies were given little or no other formal training during the years 1960–1975. Moreover, since the execution of the original projects had been carried out by higher authorities, plant managers did not have the opportunity to learn by participating in investment-related activities. Other sources of technical know-how, obtained through interaction of the firms’ technical personnel with staff of universities and R&D institutes were prohibited. However, the government, through the trade unions, did help to organize ‘technical improvement initiatives’ (a tradition that has continued down to the present) among workers, technicians and other employees in which experiences

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were exchanged and small improvements in production methods were suggested. The organization of competitions was another popular device. In TG2, for instance, quarterly or annual competitions were organized among workers and technicians in which prizes were awarded for CKT, where C stands for ‘Chatluong’, good quality; K stands for ‘Kieu-dang’, beautiful design and T stands for Tietkiem’, productivity and cost reduction. Experience and learning-by-doing were the major avenue for acquiring technological capability at the operational level. The lack of export markets other than in the CMEA, an absence of competitive pressure, even in the domestic market, persistent shortages of clothing apparel along with other consumer goods, and a distribution system based on rationing rather than the interplay of supply and demand, all served to give the two companies a secure feeling about the demand for their products. Since their only obligation was to meet output targets in fulfilment of national production plans, the companies did not have a keen interest in building up technological capabilities other than those directly concerned with current production. This dampened the more positive inducements to learning provided by the unions and CKT competitors. In the period 1975 to 1986 the two companies continued to upgrade their production capabilities. The industrial policy reforms of the early 1980s permitted them to engage in trade directly with other domestic enterprises in sourcing textile-related inputs and to establish technological ties with R&D institutes. They also took advantage of the opportunity to acquire valuable expertise of the kind that is useful in making minor changes, through participation in the planning and execution of new investments. Formal channels for learning took on a new importance at this time as the two companies hired a significant number of engineering—including textile engineering—graduates from either domestic or foreign (East German, Polish and Soviet) institutions. They also took advantage of the supply of technical documentation and of training courses for garment workers organized by MOLI. The full effect of the changes, however, was limited by the continued monopoly of foreign trade by higher state organs and its orientation to the less demanding markets of the CMEA countries. Although both TG1 and TG2 gained some marketing experience by opening chains of retail shops and showrooms around the country, marketing capabilities remained weak. The wave of radical economic reforms introduced in Viet Nam after 1986 forced a change in both the attitudes and actions of companies such as TG1 and TG2. New competition from private firms and from imports threatened formerly secure domestic markets. The opportunity to engage directly in international trade opened up opportunities to manufacture new lines of garments and knitwear, catering to broader, more discriminating tastes of overseas buyers. The increased autonomy meant that they had to be responsible for their own production performance and to seek ways of dramatically improving the level of their technological capabilities. Increased technology transfer from abroad was

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one very important approach. TG1 obtained support from the Swedish International Development Agency (SIDA) for the rehabilitation of its plant equipment. How ever, owing to its limited hands-on experience in previous investment projects, the company was not in a position to play more than a passive role in this one. Involvement of both TG1 and TG2 was more active in investment projects aimed at expanding their product lines towards the end of the 1980s but they still needed guidance even in the selection of technologies. Similarly, although their production capabilities strengthened, they still had not advanced sufficiently by the end of this period to undertake such production activities as quality control, without the involvement of its foreign partners— Sanshin of Japan for TG2 and Korean experts for TG1 (see Box 6). Nevertheless, they were unstinting in their efforts to meet the new challenges and opportunities that confronted them. They greatly increased the density of their linkages with R&D institutions, universities and local businesses. For example, in 1990 TG2 cooperated with Hanoi Polytechnic Institute to smooth out bottlenecks encountered in the operation of its Japanese knitting machines and signed contracts with local firms to supply it with yarn in exchange for training and technical assistance. TG1 created a network of subcontracting units and affiliates to which it accorded technical assistance and participation in its large contracts. Although informal learning continued to be an important means of strengthening routine production capabilities, the companies intensified their use of formal sources. They organized training in vocational schools and prerecruitment and on-the-job training courses with the assistance of universities and R&D institutions. At the same time they made their recruitment programmes more methodical and started looking for personnel with specialized backgrounds in economics, business administration and computer science and knowledge of languages such as Russian, English and Chinese. The companies TG1 and TG2 are representative of a minority of the SOEs, mainly medium-sized enterprises, that were established before 1975 and which succeeded in transforming themselves and upgrading their technological capabilities during the successive periods of reform in Viet Nam. Both companies shifted their entire orientation from the domestic market and some CMEA sales to export markets of mainly industrialized countries within the context of the macroeconomic and liberalization reforms that took place during the years 1986 to 1990. Such a dramatic transformation reflected new investments, intensive contacts with Western companies (especially in the case of TG1) in order to upgrade product quality, and above all a change in attitude. Nevertheless, even for such exceptional companies, there was room for improvement, as illustrated by the example of TG1 which was able only to approach Korean standards of productive efficiency in the joint production plant established with its Korean partner but not in the remainder of its units. Moreover, the majority of pre-1975 vintage SOEs were less able to adjust as smoothly during the country’s transition to a market economy.

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BOX 6 The successful transformer case of TG1 In 1989, the Gun Young Trading Company, Ltd of South Korea and the TG1 entered into a business arrangement involving the production of blouses and three-layer jackets. The Korean partner provided all materials and designs, the Vietnamese partner took responsibility for setting up and partially equipping an independent workshop for the venture, one which was the envy of workers at other TG1 workshops. Gun Young provided specialized machinery, and sent technicians to assist in organizing production and to supervise production lines and quality control. The Korean experts made regular visits of 4 to 5 months each to Viet Nam, training successive teams of workers. After 18 months, when TG1 was reasonably confident of its performance, the visits became less frequent. Unlike Gun Young, other collaborators only sent their experts to TG1 for short periods and at the beginning of the operation only. They played a relatively less active role, therefore. The arrangement was that the foreign companies, such as Quell or Shinton, would send a set of sample designs to TG1 together with technical specifications, for a trial run at a plant organized and equipped by TG1. After the successful completion of the trial runs using the sample designs, TG1 and the foreign companies signed an initial short-term contract. With the successful completion of the initial contracts (after 3 or 4 months) the foreign experts left and production became the sole responsibility of the TG1 staff. In subsequent collaboration agreements, the foreign companies supplied progressively less detailed specifications and TG1 undertook, on the basis of a single or partial sample design, to fill the entire order unaided, including cutting, grading and stitching. After further discussions of technical details, TG1 took responsibility for further contracts, having mastered repair and maintenance functions after a short period of guidance by foreign experts. TG1 also became involved in yarn manufacture, utilizing open end spinning machines that could make use of poorer quality cotton. Between 1989 and 1991, TG1 had already invested $1,750,000 and in 1991 it imported new equipment for dyeing, knitting, and sewing from Japan, Korea and Taiwan Province of China at a cost of $2,100,000. Although it still needed some assistance from foreign partners in the setting up of assembly lines, TG1 had by this time become quite proficient in carrying out most investment activities and had acquired considerable experience and confidence in its capabilities. TG1 established links with domestic R&D and training institutions and with other companies with two aims in view. One was to seek help solving technical and managerial problems. The company cooperated closely with the Polytechnic Institute of Ho Chi Minh City training its personnel and obtaining advice in setting up a new spinning mill that was reputed to be one of the most modern in Viet Nam and became a showcase for foreign technical personnel visiting the country on study tours and a model for assisting in the design and improvement of mills in other parts of the country. The other aim was business-related. TG1 supplied yarn and raw materials to weaving companies in exchange for fabric (or in the case of the Thanh Cong Company, in exchange for technical assistance). Linkages with other companies were the result of prior contacts with

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management personnel of those companies who had attended the same schools or who had worked together for the same employers.

Pattern 2: companies established in the period 1976–1986 The expansion of light industry in this period resulted in a surge of investment in large-scale, modern plants in the textile/garment industry such as the SOEs TG3, TG4, TG5 and TG6. These companies, which received their investment capital primarily from industrialized countries, can be divided into two subgroups: (1) TG3 and TG6, consisting of new turnkey plants; and (2) TG4 and TG5, consisting of former privately owned plants from South Vietnam that were nationalized after re-unification. Both groups of companies had a major advantage over the first tier companies, in that they benefited from a more sophisticated machinery from the very start. TG3 and TG6 received brand-new equipment from Germany, Italy, Japan and Switzerland, experienced managers from existing textile/garment companies were named to head them and the equipment suppliers gave them extensive support in starting up and operating their plants (see Box 7 for a description of the case of TG6). TG4 and TG5 had operated with relatively modern plants in South Viet Nam, kept an important number of experienced management and technical personnel from the previous privately owned companies and maintained access to production and marketing expertise through their pre-existing connections with overseas buyers (see Box 8).

BOX 7 Strong start and vigorous big state player: the case ofNHATEXCO (TG6) The Ministry of Light Industry (MOLI) negotiated with the C.Itoh Company Ltd of Japan for a turnkey plant and the contract was signed in 1977 for a complete cotton and polyester/cotton spinning mill. The contract valued at US$ 50 million, included the provision of spinning equipment with a capacity of 100,000 spindles, building materials, utilities, supervision of installation and training of Vietnamese personnel. The mill eventually became the key production facility of the Nharang Spinning Company (NHATEXCO), company TG6 in the present study. 1Establishment phase: The project was prepared and implemented by experts from both countries—MOLI on the Vietnamese side and C.Itoh and Company Ltd, Shin-Etsu Trading Company Ltd, and Toyobo Engineering Company, Ltd, on the Japanese side. A committee was also set up with technicians from Toyobo Engineering, who were experts in engineering, construction and technical services for industrial plants, especially in textiles. From the beginning, all preinvestment and investment studies were carried out by MOLI specialists and experts from the Japanese companies. Implementation of the project was also

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undertaken by Japanese experts with regard to the choice of technology suppliers, the overall and detailed design of the plant, the supervision of construction and installation work, and start up activities, etc. in accordance with the contract for technology transfer signed between the two parties. Vietnamese staff participated in some of these activities, but did not play a decisive role. A talented director of another large textile plant in Hanoi was recruited to manage the new mill. By renting a storage facility at a nearby airforce base, he prevented loss of equipment and minimized damage caused by the weather. However, the main players in this phase were the Japanese contractors. They not only provided equipment, but also experts to train Vietnamese employees. In total, 46 persons were sent to the site to execute the project (332 man-months spread over general management, construction, electricity installation, utilities and spinning technology) and five persons were later sent for training and advisory purposes. By working together with foreigners, receiving guidance and on-thejob training, Vietnamese staff were able to learn much about investment skills and gain production experience. 2Expansion phase: Their investment capabilities proved invaluable when the company started new production facilities in 1991. The company could now be more active and confident in undertaking new investment studies, negotiating with technology suppliers and in searching independently for other technical assistance, not only from foreign partners but also from local organizations. For example, while cooperating with the C.Itoh Company in new activities in knitwear production, the company also cooperated with the Thanh Cong textiles company in Ho Chi Minh City, receiving technical assistance on how to start and run a newly created knitwear and garment workshop. Later, in addition to the existing production facilities, the company imported two production lines of combing and rotor spinning machines (two more open-end machines per year), improved the carding system, and obtained auto splices, hand fitting and testing instruments.

Thus all four were better positioned than the first tier companies to take advantage of the reforms and other economic changes that took place before and after 1986. They quickly acquired production and minor change capabilities and, like the first tier companies, succeeded in establishing an effective formal relationship with personnel from R&D institutes and universities that had already existed informally prior to 1975. Thus, for example, TG3 cooperated with the Hanoi Polytechnic’s Textile Research Institute to introduce new production technologies; and TG5 cooperated with the Institute of Economics of Ho Chi Minh City and TG4 worked with the same institute in seeking ways of improving its quality control of yarns. Through participation with technology suppliers in the activities associated with the choice of technology, plant design, construction and startup, they also gained valuable knowledge that could be used in planning future investments. In addition, these second-tier SOEs relied extensively on internal mechanisms, similar to those adopted by the first-tier SOEs, in which managers, technical

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personnel and foremen discussed operational experiences and then disseminated them to other employees in order to upgrade skills.26 After 1986, the SOEs of the second tier reacted to the radical changes in foreign economic relations by shifting quickly into export markets other than those of the former countries of the CMEA. Such a shift forced them

BOX 8 Private-turned SOE: the leading fence-breaking case offTG4 Company TG4 was created in 1968 in the south as a private enterprise. By 1975 the owner had left Viet Nam, but a group of old staff members remained and worked for the company (eight managers, including two deputy general directors, the chief of the supply division, the chief of the technical division, the head of the textiles workshop and the head of the company’s administrative office, together with many technicians, engineers and workers). After nationalization, TG4 became an SOE. During the years 1976–1980, it functioned under the conditions of a subsidized planned economy. The management recognized the difficulties of working in these conditions and decided to adopt a new business approach entailing the production of goods in accordance with market demand. The company obtained US$ 180,000 from the Viet Nam Foreign Trade Bank as a credit to buy productive inputs and then sold its finished fabrics to a tourism company in exchange for dollars. The tourism company then resold the fabrics. This was the first example of a Vietnamese enterprise engaging in a profit-making venture. By the end of 1982, the company was earning profits of US$ 1.2 million per annum which subjected it to the criticism of behaving like a capitalist enterprise. A high official of MOLI said ‘I detect a Yugoslavian smell here’ alluding to the self-management model of enterprise development then being followed in socialist Yugoslavia. TG4 reinvested its earnings to purchase raw materials and new equipment and to award incentive pay to its personnel. Two years later there were six more enterprises following this pattern. This fence-breaking activity created pressure for the government to adopt more reform measures. The company started exporting in 1986, indirectly through a barter agreement with Eastern Europe. In 1988, it began direct exports of polo shirt products. Today its major export market is Japan (90 per cent of total exports), and this market has been generally stable for the past four years. The basic type of export relation is that of the subcontracting agreement. TG4 now has 2,433 employees, 180 of whom have higher education qualifications from the Polytechnic Institutes of Hanoi and Ho Chi Minh City, universities and other business and economics colleges.1 The company is engaged in spinning, weaving and garment-making. The company set up a specialized R&D division with eight persons concentrating mainly on product modification and improvement. It spent more than VND 1 billion (US$ 100,000) on this type of applied research in 1992 which it encouraged with bonus pay. The R&D unit cooperated with other divisions to achieve minor changes, such as new designs for some of its polo shirts.

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A selective innovation approach was also used by the company including the introduction of a digital control system and the production of new material such as polyester/wool mixtures. It also established a special library on textiles/ garment documentation for staff use, with regular expenditure on technical journals and reviews set at US$ 100 per month. Staff in the R&D unit were paid higher salaries than other employees (+15–25 per cent). Specifically, the unit carried out research on the application of a new microfibre in the production of fabrics. This kind of material had been the monopoly of a few Japanese and German companies (even Taiwanese and South Korean companies could not produce this material). According to the company, if the research was successful, it would open up opportunities for TG4 to compete even with Japanese firms in the European Union market by producing garments from this fabric. From 1993, TG4 was already able to produce fabrics made from this fibre and the products could compete well with imported material for the garment industry. In addition, the division made feasibility studies for new investment projects enabling the company to move to upstream (spinning) and downstream (garment) activities, including the choice of specific equipment and machines from sales catalogues. The exchange of experience and skills with other spinning companies was quite a common practice. The company offered weaving and garmentmaking competence to some spinning companies and in return received their spinning expertise to assist the development of its new spinning plant in Khanh Hoi, a suburb of Ho Chi Minh City. This R&D division, together with some garment companies, also studied the possibility of producing fabrics for their products. Extensive investment in new technology and equipment was a characteristic of the company and this facilitated its move from a weaving-dyeing enterprise to wholly integrated spinning-weaving-dyeing-garment making activities. The total stock of the company’s technical equipment was renovated. Attention was also paid to recruitment to ensure a high quality of new staff. For example, in addition to the usual method of recruitment, as in other companies, TG4 also used psychological tests to select new workers or graduates from universities for their R&D, technical and marketing divisions. Specifically, knowledge of technology, economics and management and facility in foreign languages were particularly needed.

1

Note: Management staff, 180; textile engineers, 11; other engineers, 160 (no designers); workers, 2,253, of whom 1,117 in garments, 397 in spinning and 739 in weaving and dyeing. Qualification of workers: grades 5, 6 and 7, 389 persons; grades 3 and 4, 1,475 persons; grades 1 and 2, 389 persons

to take action in a number of areas, for the most part, more vigorously than that taken by the first tier companies. They diversified the range of their products in order to make them appeal to a broader range of markets. Company TG3 branched into knitwear from yarns, TG6 from yarns to polo shirts and TG4 and TG5 from weaving into garments. In doing so they relied increasingly on their own (rather than state) financial resources for financing the necessary investment.

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They reinforced the network of domestic linkages. The advent of material incentives helped to strengthen technological cooperation with R&D institutes and universities. At the same time they began signing contracts with local consultancies and with various state institutions and ministerial bodies. In this connection, TG4 set up an economic and technical data base in cooperation with the state-owned Technology Development Company in Ho Chi Minh City. TG5 arranged with the State Commission for Cooperation and Investment to obtain assistance in the preparation of new investment studies. Between these and other firms and among themselves, there developed a web of inter-relationships through which they supplied one another with raw materials and exchanged job opportunities. Such inter-firm cooperation, in turn, has led to the creation of new producer organizations with the aim of creating a forum for discussion of common problems and an instrument for acting in their common interest. The companies intensified their linkages with foreign technology suppliers. Indicative of some of the specialized areas covered are TG3’s solicitation of assistance in the manipulation of cotton and polyester blends, refinements to cotton spinning technology and dyeing and improvement of techniques for polishing knitwear.27 Often these technology suppliers turned out to be trading companies, as in the case of TG6’s cooperation with C.Itoh in the establishment of a plant for the export of garments to Japan and TG5’s engagement of Hong Kong and Korean trading companies to assist it with its capacity expansion. Vietnamese expatriates were also brought into the picture, as in the case of a proposal to involve Vietnamese living in the United States with Singapore designers to create a centre for high fashion design in Viet Nam. The companies made organizational changes in order to adapt to the new economic environment. In some instances, these changes contributed to the strengthening of minor change capabilities and established the basis for being able to undertake some design activities in-house. TG4 created a special R&D unit consisting of 10 researchers responsible for following improvements in new technological processes and for preparing feasibility studies and investment plans (see Box 8). It was also intending to set up a small design group.28 TG5 assigned the responsibility for creating new models to its marketing division in order to have a quick feedback from the market. Although several companies took advantage of opportunities to send personnel abroad for export marketing activities, they were with one exception only able to develop domestic marketing capabilities and had to rely on their contacts with foreign partners to export their products. TG3, TG4 and TG6 established special units within their companies for handling marketing activity and opened shops and showrooms in big cities aimed at domestic clientele. The exception was TG5 which opened up, in cooperation with foreign partners, sales offices in Moscow and Paris. It formed a joint venture with a French company of Vietnamese expatriates to produce lingerie in France and sell some products abroad under the joint venture company’s label, including in the more demanding markets of the European Union.

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None of these SOEs had advanced to the point of being able to generate genuinely new designs or product innovations. Although both TG4 and TG5 were involved in design cooperation with foreigners, their products remained essentially modifications of existing foreign models. Pattern 3: companies established after 1986 The opening up of the Vietnamese economy and the formal recognition of the legitimacy of private enterprise during this period saw the creation of many privately owned companies, such as garment firms TG8 and TG9 as well as SOEs. In addition, there were joint ventures such as the thread manufacturing enterprise TG7. The common features of those three companies are their initial development of investment and production capabilities, coupled with a heavy reliance on foreign connections for getting started and for exporting. Individual local initiative appears to have been the main factor in carrying out the investment in the cases of TG8 and TG9. As a private family business, TG8 made all of its pre-investment and investment decisions unaided, including the choice of technologies, design of the plant and programming the execution of the project. In implementing the investment, it engaged local construction companies to construct its plant facilities. In contrast TG7, a joint venture between a Vietnamese SOE and Tootal, a private investor from the United Kingdom, relied heavily on foreign assistance in performing the activities needed in order to accomplish the investment, including the choice of technology, plant construction and installation of equipment. As a local partner, the SOE in this joint venture took the main initiative in those activities requiring specific knowledge of local conditions, such as obtaining permits, selecting a plant site and contracting with local providers of services. It was typical of local counterparts in other joint ventures which participated passively in the important decisions but were able to build on the knowledge so acquired in order to undertake subsequent investments in the expansion of plant capacity with much less guidance. All three companies relied strongly on their foreign connections or counterparts for assistance in both starting up and in the effective operation of their production facilities. TG8 was assisted by a Japanese trading company Nisho Iwai in the supply of its equipment and in implementing quality control procedures, whereas German and Hong Kong firms provided technical assistance to TG9. Under the terms of the joint venture agreement, TG7’s foreign partner trained its managerial and technical staff to operate, maintain and repair the equipment. To a varying extent, these firms built on the skills acquired in setting up and operating their plants by acquiring other types of technological capabilities. TG9 established a unit attached to its technical division whose staff worked on making minor changes to models and designs found in imported suppliers’

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catalogues permitting the company to diversify its products by introducing new designs, colours and decorative details. All three companies began exporting shortly after their establishment, with TG8 and TG9 selling their total output in overseas markets. TG7 and TG8 depended on a strong network of linkages with their foreign partners, mainly through subcontracting arrangements, for exporting their products. On the other hand, TG9 established its own local subcontracting network for filling its orders. While relying on its foreign partners for much of its exports it was actively involved in setting up overseas sales offices to cover some of its markets (see Box 9). The main feature of this group of companies is their early achievement of at least partial capabilities in investment and production, coupled with a heavy reliance on foreign connections for start-up and export activities. Other capabilities developed more slowly, except for TG9 which quickly built up some marketing and minor change knowledge. Private entrepreneurs, who had never disappeared completely from Viet Nam, in spite of the campaigns against private enterprise waged by the state, felt that their time had come during this third period. Accordingly, their first concern was to

BOX 9 Foreign-supported private entrepreneur: the case ofTG9 As a private company, TG9 started exporting in 1990 soon after its establishment. Initially the company was a group of cooperatives and production units producing different types of products (colouring materials, dyestuffs, plastics, various kinds of oil products and sewing products). In May 1990, the company was specializing in garments for export and for use in the construction business. In August 1992, TG9 obtained a licence to enter into a joint venture with a Russian company to operate a construction business abroad. Current export products are garments, such as coats, jackets, sportswear and windbreakers. Whenever the company receives simple shirt orders it puts them out to its satellite network of small cooperatives (6,000 people). Thus it concentrates its own production on up-scale products with particular specifications. Although the company now exports to various markets including the former Czechoslovakia, former Soviet Union, Germany, Hong Kong and South Korea, all of which demand different qualities and types of products, it tries to ensure that the quality of products supplied to the Czech and Slovak Republics and to the former Soviet Union is as high as that of its products made for other markets in order to maintain the prestige of the company. The company opened sales offices in Moscow to take care of business in Eastern Europe, but customers from Germany, Hong Kong and South Korea come directly to Viet Nam to discuss orders. The company intends to open new offices in either France or Belgium to serve West European countries, and also has plans to expand its exports to the North American and Scandinavian markets.

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On a recent trip to the United States organized for the first time in April 1993 by the Viet Nam Chamber of Commerce, the company was able to become acquainted with trade practices, needs and potential sales opportunities in this market. To prepare for the lifting of the United States trade embargo on Viet Nam, TG9 concluded a preliminary agreement with several United States companies (valued at US$ 4–5 million) to begin to acquire United States technology in textiles and garments, and to organize an exhibition of United States textile/garment equipment in Viet Nam. The company has also started to explore new business possibilities either in the form of a joint venture or in assisting some United States companies in setting up a wholly owned United States investment firm in Viet Nam in exchange for opportunities for TG9 to export Vietnamese textiles and garment products to the United States market.

get a company started. TG8 and TG9, which were both located in the south reflected well the business mentality of southern families. They were ready to fall back on foreign partners initially in order to obtain contracts, start manufacturing and realize export sales. For this reason they entered into simple subcontracting relations for export from the start. In the absence of state support, the responsibility for providing their own resources made them more active in obtaining knowledge about investment. This is why the elements of investment and production capability were a feature of these two companies from the very beginning of their operations. In sum, it can be said that three types of experiences in building technological capabilities can be distinguished among the companies depending on the time period and the context of their initial establishment. The firstpattern is characteristic of the first-tier of SOEs created before 1975 that were able to adjust smoothly to changes in the economic environment through the gradual upgrading of their technological capabilities with support from the state. The second pattern emerged with second-tier SOEs starting strongly as turnkey plants using more advanced technologies from Western suppliers and recruiting experienced managers. By 1986 this group had already achieved a fairly high degree of technological capability. Differences between the first- and second-tier SOEs were marked during the pre-reform period. But both of these groups moved quickly into export activities and new markets, with the involvement of foreign partners, under the stimulus of the opportunities created by economic liberalization and changes in market demand after 1987. The third pattern is seen in companies that were born under the influence of the dramatically changed business conditions of the post-1987 period, strongly characterized by the emphasis on private entrepreneurship and inputs from foreign partners. Electronics companies In this industry the TC picture is even more varied than in the textile/ garment industry. Of the five companies surveyed, two were engaged in consumer

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electronics production, both of them SOEs (EI1 and EI2), and three companies in production of computers and related products. Two were private enterprises (EI3 and EI4) and one company was a joint venture between the Vietnamese state and a French company (EI5). Depending on the ownership of the firms and their respective fields of specialization, Vietnamese electronics companies can be divided into two groups, according to their pattern of TC acquisition. One is the group of consumer electronics companies, established in the first and second time periods and mainly consisting of SOEs (EI1 and EI2). The second is the group of computer companies created mostly by private efforts after the economic reform period began in 1986 (EI3, EI4 and EI5). These two patterns are illustrated in Boxes 10 and 11. Pattern 1: companies established before 1986 The first group of companies, in particular EI1, began their existence in the early 1970s with the production of simple audio equipment. They relied on two kinds of experts for technical support—local technicians who studied radio and microelectronics technologies in the former CMEA countries and foreign technicians, such as those from the former Czechoslovakia who came to provide general guidance including assistance with quality control and equipment maintenance for a condenser plant. Over the ensuing years, in addition to mastering the relatively simple production technology required, companies introduced various minor changes in the production technology and product specifications. Company EI2 replaced several components of its radio cassettes with other parts not in the original design and company EI1 replaced some components in its TV sets to take account of tropical conditions and it re-arranged assembly techniques in order to improve conditions for its less productive workers. The reform of the science and technology system in the early 1980s made it possible for companies to forge direct linkages with R&D and academic institutions. The SOEs EI1 and EI2 participated in the intensification of technical cooperation between industry and R&D institutions and universities that took place after the radical economic reforms of 1987, through consultancy agreements concluded with the Hanoi Polytechnic and Ho Chi Minh City Institutes of the National Centre for Scientific Research (NCSR). For example, with the cooperation of NCSR, EI2 was able to produce a new kind of welding rod to replace material previously imported from Japan and Germany. The economic reforms of 1987 also gave a boost to the acquisition of investment and some marketing capabilities by permitting EI1 and EI2 to participate actively in investment activities and exports with foreign partners than had hitherto been possible in a closed economy. It was only after 1986 that a consumer electronics company like EI1 was allowed to use its foreign exchange

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receipts to source its wire and metal band inputs from the least-cost sources located in East Asian countries, thereby raising the profitability of its export activities. And it was not until 1989 that EI2 began production and exportation of industrial robot parts for Japanese companies, as a direct consequence of assistance from foreign technology suppliers

BOX 10 A public player: from teaching to producing: the case ofEI2 Company EI2 is owned by Hanoi City, and the Director was formerly the Dean of the Radioelectronics Faculty of Hanoi Polytechnic. Many of the company’s engineers were also recruited from universities and especially the Hanoi Polytechnic. From its beginning in 1985 it aimed at the production of consumer electronics for the domestic market. It also produces some control equipment. The company had about 100 employees at its inception and now has five member enterprises specializing in materials, mechanical engineering, industrial electronics, consumer electronics and repair and maintenance activities. The total labour force is about 350 persons (averaging 70 per enterprise). Initially the company produced black and white TV sets from Polish components, simple radio cassettes and some audio equipment. It now also produces colour TV sets, some parts of TV tubes, sample production of VCR and other hi-fi equipment. The company has two assembly lines for completely knocked down (CKD) and semicompletely knocked down (SKD) consumer electronics for about 60,000 colour TV sets per year (eight working hours per shift) and another assembly line for SKD products is due to be completed in the near future. In cooperation with JVC, it intends to venture further into the assembly of incompletely knocked down (IKD) products. It has also recently entered a joint venture with Daewoo (investing US$ 170 million) to build a plant in the high-tech special zone near Hanoi to produce tubes (and later other parts) for Orion colour TV sets for export. In its first phase the joint venture will produce 1.6 million tubes and 4 million tubes in its second phase. Recently, it also began to produce industrial electronic components for export to serve the robotic lines of a Nissan car plant. This new activity constitutes a major change in the company’s orientation. In assembling consumer electronics, the company has introduced some minor changes to upgrade its product specifications: changes in the organization of production lines; changes in the amount of labour used per unit of product to suit the conditions of Vietnamese workers; changes in assembly operations (procedures and schemes); the replacement of some components used in radio cassettes and TV sets, in order to make them multi-system or more suitable for use in Viet Nam (unstable power supply). These changes were made to expand the usage of TV sets in the country. With video tapes imported from many countries and thus made to suit different broadcasting and transmission systems, such as NTSC (Japan and the United States), PAL (European and ASEAN countries) and SECAM (France and former Soviet bloc countries), Vietnamese consumers prefer to have a TV and VCR set compatible with all of these systems.

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Minor change capabilities developed in tandem with the acquisition of production capability. With staff recruited increasingly in recent years from higher education institutions, the quality of expertise and skills of the engineers and technicians has increased. When there is a need to introduce minor technical changes, these employees, in cooperation with their colleagues (often former classmates) working in other companies or in R&D and training organizations, are ready to solve the problems. Linkage capabilities are a key asset of this company. In addition to the support of other local firms, research institutions, universities and the National Scientific Research Centre, foreign technology suppliers assisted the company in acquiring capabilities in management and production operations. Foreign experts were provided along with the imported equipment and technical guidance was given in its use. Quality control, in particular, had to be carried out strictly in accordance with requirements and under the supervision of the technology suppliers such as JVC (procedures, measurement equipment and methods, etc.). Maintenance and repair activity was also guided by the suppliers. Currently, the company has a special unit to take care of quality control, which fixes quality standards for the various production units of the company and controls implementation of these standards. Training was important for improving the skills of the company’s technical labour force, and JVC brought engineers and technicians to Japan for short-term courses (the duration of these ranging from a few weeks to one month) and also sent Japanese experts to provide on-the-job training for EI2’s workers. Direct supervision by Japanese experts was also carried out during the initial start-up period. After two/three years of working together, EI2 staff were able to handle almost all production functions, including quality control and repair and maintenance services efficiently. The quality of its products is a key element in the company’s future. The quality of its consumer electronics is equal to that of Korean and South-East Asian products. In industrial electronics, product quality is being accepted by Japanese contractors as complying with Japanese standards. Additional training is now also being organized by the company for its workers through local training institutions. Until recently, the company’s marketing capability was very weak. It served the local market only by opening shops and showrooms in big cities and in a few provincial towns, and provided some after-sales maintenance and repair services. As for the foreign market, marketing has only recently been given consideration, and for industrial electronics products, the company has explored marketing possibilities through its Japanese partner. By participating in the subcontracting available to small firms in Japan, it can use its partner’s contacts to enter the Japanese market indirectly. The next step would be to set up a joint venture marketing office in Japan and some planning was done on projects (Yokohanel— a joint venture with Yokohama city authorities of Japan) in early 1992. When this office is established, EI2 will first develop its marketing of existing products, and will then be looking for new partners and outlets for new products in Japan.

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and the opportunity to send its technicians abroad for study tours financed by the foreign partners. As regards the ability to carry out major design changes, it is evident that neither of these two companies had acquired the requisite expertise, nor were they positioned to manage fully their own export marketing. In this and other respects, their pattern of accumulating technological capabilities resembles that of textile/garment firms of approximately the same vintage. Pattern 2: companies established after 1986 The second group of companies (computers) had a very different background. Companies EI3 and EI4, for example, had for the most part been established by research personnel that had moved away from R&D institutions. An important part of the knowledge base of these companies was derived from the thenexisting competence in R&D for computer sciences. EI5 began as a joint venture between an SOE and a French company. All of the top management of these firms had received higher education abroad in France or East European countries in computer sciences, and had then worked for many years in R&D institutions, universities or ministries.

BOX 11 From scientists to businessmen: the case of EI3 Created as a shareholding company, EI3 had 17 shareholders when it began in 1989. These were scientists and engineers educated in the former Soviet Union or in East European countries. After many years of working for the state in R&D, in training or in other organizations, they felt the need to commercialize their research potential and, at the same time, to create the necessary conditions to work at their professional interests. They maintain close ties to the Institute for Informatics and Cybernetics as well as other R&D institutions in the country. The initial capital was US$ 25,000. The main products were the computer model 3C-286 and some software. The 3C-286 is assembled in Singapore on the basis of EI3’s design for export to the former Soviet Union. Some other activities such as the test production of small parts, components, industrial software, measurement and communication equipment are undertaken in Viet Nam. The managers of EI3 learned of their Singapore potential partners through joint seminars, workshops and trade fairs, as well as through the introduction of friends, and they began thinking in 1988 about the possibility of using Singapore facilities for production. This group of Singapore companies later contacted EI3 in Viet Nam and they started cooperating in 1989 soon after the start up of the firm. There were several reasons for choosing Singapore contract manufacturing: good technological facilities; reasonable cost of manufacturing (to establish a manufacturing facility in Viet Nam would have entailed much higher cost); and good, well-established personal relations. Moreover, these Singapore companies

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wanted to enter the former Soviet market, but could not do it by themselves (lack of market knowledge, contacts, knowledge of Russian, capability to make suitable products for this specific market). EI3 has minor change capabilities. The creation of 3C-286 machines is based on an old Singapore model, with some upgrading and adjustment in EI3, together with the Russianization of both its hardware and software. The company has changed the architecture of the old model, adding some chips (IC), and an improved keyboard and mainframe. In order to do so, the company developed two main departments, each specializing in hardware and software development. In software, EI3 created a Soft Centre with 30 engineers and other experts in computer sciences specializing in development of software packages. This Centre has very good technical facilities (cost of equipment approximately US$ 300,000). Employees of the Centre receive higher salaries compared to the average national salary (US$ 150–200 per month). In hardware, the company also has a Centre with eight persons and a network of many other collaborators working in different institutions. Besides research activities, this Center also takes part in maintenance and repair work in Moscow on a regular basis. After the collapse of the Soviet market, EI3 retained its relations with this group of partners, not for production of computers for export, but for providing various services to the Vietnamese domestic market. In recent years EI3 has expanded its activities to communications, control equipment, garments, and into construction, real estate and tourism, etc. EI3 started with 15 persons, but since 1990 it has employed about 50 staff. It now has four main units established in Hanoi, Ho Chi Minh City, Moscow and Singapore.

Although these companies only began their existence in the post-1987 period, their managers had already acquired firsthand expertise and knowledge of the computer business while working in these other organizations. Minor change capability came as a founding asset in these companies. Their most salient characteristic was that they were rooted in an existing research and development environment. Although their skills in promoting technological innovation were simple and mostly associated with former Soviet and East European technologies, the managers/technicians already knew before going to work for these new companies how to make technical improvements or to acquire certain skills through appropriate research. More importantly, they understood the need for securing such technical improvements for production better than those managers who came from a non-technical background. When they started to create these companies themselves (EI3 and EI4), these managers were simply transferring their traditional activities to a business context. Their ability to make technical modifications and minor improvements was an advantage that permitted the constant upgrading of their products. Participating in R&D programmes organized by other private institutions or by state organizations, and also by themselves in their own R&D units, significantly increased the skills of the companies.

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In addition, the existing contacts between the managers of these companies and their friends, with whom they had been educated and had worked together in R&D and academic institutions, have been retained and reinforced as the Vietnamese electronics industry has developed. Such informal, personal contacts among academically related persons constituted the most effective means for Vietnamese consumer and software companies to acquire and develop both minor change and linkage capabilities. Thus EI3 and EI5 cooperate very closely and some of their managers have worked in both firms at various times. For example, the deputy director of EI3 worked for EI5, and the director of EI3 was also an adviser to the directorgeneral of EI5. Such an informal network of scientists in electronics and informatics has created healthy competition among them, but has also promoted cooperation. The activities of the Association of Informatics and Microelectronics have also contributed to this cooperation within the context of a small business community. Similarly, marketing capabilities had been acquired before the creation of the firms. The managers were already familiar with countries and markets, and had facility in foreign languages, together with many friends and colleagues working for former Soviet and East European organizations; so these informal contacts again played a role. For example, a director of EI3 had lived for many years in Russia, spoke Russian fluently and held a Ph.D. degree. He was a deputy director of the planning division of the Vietnamese State Commission for Pricing, through which most of his business knowledge of the former Soviet market (in terms of pricing and international payment procedures) had been acquired. As for EI4, one director had studied and worked in France for many years before returning to Viet Nam. Beyond his knowledge of technical matters, he also had familiarity with various aspects of the French market that was to prove valuable in selling software to French users. The French partner in EI5 proved to be a source of knowledge of the principles of market economy and business management, both for the Vietnamese partners in EI5 and subsequently for EI3 staff that had gained prior experience from working in EI5. Since they aimed initially at producing and selling to the market of the former Soviet Union, the companies needed knowledge and skills for dealing with that market, which their Western partners could not provide. Here, the role of domestic linkages proved to be important. Almost all companies had their own informal ‘think-tank’ consisting of many experts working in the Ministry of Finance, the Viet Nam Foreign Trade Bank, the Ministry of Foreign Trade, the Ministry of Heavy Industry, and export-import companies. The think-tanks ensured that companies could obtain the necessary marketing know-how—for example, on how to transfer convertible roubles into goods marketable in third countries and how to sell these goods to such countries in exchange for hard currencies. It is to be stressed that much of this knowledge had been accumulated during the period prior to 1987. To capitalize further on this initial knowledge endowment, the companies continuously upgraded it and accumulated new

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experience from their production activity and their interaction with local and foreign partners (buyers and suppliers). Minor change capability was instrumental to the achievement of production and market development objectives, as illustrated by the case of EI3 (box 11). Similarly, company EI4 had an R&D unit of seven persons responsible for resolving both pre- and after-sales technical problems and an after-sales service for maintenance and repair. It also introduced a new model of computer design (modified from Taiwanese models) as a specific product aimed at the Russian market. The brand name adopted for this was KB (Knowledge Base) and it received a good response from customers. In a joint venture with the French company Bull SA for the assembly of Bull computers, company EI5 did not have the opportunity to use and strengthen such a minor change capability, due to the fact that production norms and specifications were strictly determined by the foreign partner, with all models, components and parts being kept exactly as supplied. The marketing capability of the companies was upgraded through collaboration with their customers. Through close contacts with customers, involving rapid feedback of information on defect rates, market trends and other specific requirements, companies could react quickly. Flexibility and an activist approach to day-to-day business transactions also enabled companies to retain the loyalty of their customers. With the advent of the restructuring of the exSoviet market, Russian buyers encountered problems in making payments. As a consequence, the Vietnamese were often obliged to facilitate payment for their customers through tripartite partnerships and barter arrangements. Through a combination of prior knowledge of the market and technical expertise from their partners, EI3, EI4 and EI5 were successful in entering the former Soviet market and selling their products. One specific requirement was knowing how to transform convertible to hard currency through merchandise and services transactions with third countries. Similarly, companies EI3 and EI4 entered the former Soviet market with products specifically designed for that market (see Box 11). Company EI4 had obtained market footholds in France and Japan, where it could sell software products such as those for cartoon moviemaking, although not very sophisticated and only in a limited volume. Due to this kind of capability—product development at the right time and for the right market—companies could sustain their export performance for several years. However, given the fact that this was specific marketing know-how (tied to one market and one product), it was not obvious that these companies would be able to leverage their export strength to capture other markets for other products. Since 1987, relaxed economic conditions and reforms in the science and technology system also helped companies to form denser ties among themselves. In the beginning, company EI5 did not need to interact with domestic partners. It did cooperate with scientists, but only through personal ties. With the move towards greater domestic market orientation as exporting became less easy, it developed relations with other local software firms. Such linkages were developed not only between companies but also between divisions of the same

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companies. In company EI4, the R&D division was responsible for maintenance and repair activities that normally were the responsibility of the production division in other companies. This enhanced the possibility of EI4 obtaining feedback on defect rates and needs of customers for its R&D purposes. Production capability was reasonably well developed, except for company EI3, which indicated that it did not have adequate resources to establish production facilities locally and that it was less profitable to do so (Box 11). Company EI5 acquired production experience leading to increased capability through its joint venture with a French partner. In order to start assembly of PCs company EI4 had to rely on the technological expertise of its Taiwanese suppliers. Although these suppliers did not participate directly in assembly activities, their advice and knowledge were readily available to EI4. In matters of a less technical kind, the companies acquired their production knowledge (planning, working arrangements, organization of accounting and bookkeeping, etc.) by cooperating with local consultants or through a variety of personal contacts. Only in the period since 1987 did companies begin to show some knowledge of investment matters. EI3 was the only company studied in the sector which had an initial capacity to plan and undertake an investment. This knowledge is now being directed beyond computer electronics, as the company has become involved in banking, construction, fashion garments, gemstone mining, publishing and tourism by taking up shares in other companies. The joint venture company EI5 has not acquired such experience, all investment functions were carried out under the leadership of the foreign partner. Those activities in which Vietnamese partners can exercise some responsibility, such as management and domestic financial matters, do form an important element of overall capability, but cannot evolve as fully as if EI5 had been a wholly owned Vietnamese company. Once again, the area of greatest weakness is in major change and design. None of the computer companies introduced radical modifications in production processes or made major improvements in the design of products. However, elements of such capabilities can be found in company EI3 and to a lesser extent in EI4. The principal means used by the companies to acquire ability to make technological advances has been through the creation of inhouse R&D facilities. Two software and hardware centres in EI3 and an R&D unit in EI4 were the first attempts by companies to evolve from minor to major change activities. The management of these companies provides strong ongoing support to these units by offering high salaries, favourable living and working conditions and financial incentives. However, up to now they have been content to concentrate on relatively minor adaptations of existing technology rather than pursuing significant innovations. The second pattern of technological capability building (computers) followed a different sequence from that of the first (consumer electronics). The contrasting sequences were the outcome of the different contexts in which the two subsectors were developed. Having emerged earlier as an industrial as distinct

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from a laboratory activity in the pre-reform period, because of the government’s desire to diffuse widely the use of radio and television broadcasting facilities, consumer electronics companies achieved production capabilities sooner than computer companies. Although the domestic market for radios and television sets was not large, that for computers and computer software was virtually nonexistent in the 1970s and most of the 1980s, as only a handful of enterprises and state organizations could afford computers, and those that were in operation were under-utilized. In the meantime, the former Soviet Union offered a large potential market for computer products. This was a unique opportunity for those who were aware of this market and had the potential to satisfy its needs. Thus, taking advantage of their pre-existing assets in the form of knowledge of the CMEA market, knowledge of computer science and an early contact with Western countries which Soviet computer users did not have, the founders of computer companies such as EI3, EI4 and EI5 turned these assets into real productive capabilities in the period after the radical economic reforms in Viet Nam, and built upon them over time. Conclusions There are several mechanisms that companies in both the textile/garment and electronics industries used to acquire their technological capabilities. Training of employees was one. The forms of training varied and included: on-the-job training and various in-house courses as well as more formal instruction, provided by both foreign partners (technology suppliers) and local experts in universities and R&D institutions. The substance of formal training was technical, economic and managerial, with some employees being trained abroad. Such formal training, coupled with informal inhouse training, learning-by-doing and investment in minor changes and incremental improvements in process and products constituted important means for developing technological capabilities at the company level. The exploitation of contacts with Vietnamese living abroad was also an effective channel for acquiring know-how, especially in the area of international trade. Such connections were vital to companies both in getting established and in opening up new market opportunities. The heavy emphasis placed on the recruitment of highly qualified staff (including new university graduates and scientists from R&D institutions) through the provision of attractive working conditions was also an important factor. The prior experience of company managers played a very important role in their attitudes towards the acquisition of technological capabilities. In electronics companies, many managers already had relevant experience from their previous work, the most specific example being the case of company EI2 whose director had been the Dean of the Radioelectronics Faculty of the Hanoi Polytechnic Institute for many years before coming to this company.

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Prior to 1981, when direct contact between industrial companies and R&D institutions was not allowed and R&D activities were regulated by the planning process, there remained a need for companies to resolve various technical and operational problems that would crop up. For this reason and because the existing potential of R&D institutions was underutilized, there arose between companies and R&D institutions an informal network of personal contacts. When economic and R&D management mechanisms were liberalized, this informal network surfaced and obtained favourable conditions for its officially recognized development, which was especially vital for consumer electronics and computer companies but played a role in the textile sector as well. Almost all electronics companies reviewed in this study had R&D-related linkages of varying intensity with local or foreign institutions. Those companies without access to foreign expertise had recourse to the domestic R&D network to resolve their problems at a reasonable cost and with an acceptable quality of service. Others accessed the services of both foreign technology suppliers and local R&D institutions in complementary fashion. This domestic technological networking continues to develop today. Differences in the existence and sequential evolution of technological capabilities in the textile/garment and electronics industries can be mainly explained by differences in their key assets. While textile/garment production started on the basis of an abundance of cheap labour and local subcontracting activities, activity in electronics began with an existing accumulation of certain R&D-related knowledge and the skills of technicians working in research and training institutions. The way in which companies changed their market focus also differed in the two sectors. Textile/garment production evolved in a similar way to that of most Vietnamese industries, first serving the domestic market during the years 1960– 1970, then moving towards exports (depending on opportunities) during the second half of the 1970s and early 1980s. National development policies (irrespective of the delay in assigning priority to light industry) and the existence of a domestic market gave momentum to the industry’s development. In electronics, the domestic market was also important, but at a later stage. The production of TV sets and radio receivers was not assigned a high priority in meeting the basic needs of the population of this agrarian society. Organizational changes in ministries and government departments and inconsistent policies as regards the priorities given to electronics production very much hindered the development of this industry. The extraordinary opportunities that stimulated the export of computers and software did not apply to consumer electronics. Thus, consumer electronics companies were under no compulsion to develop an export marketing capability before the end of the second period of their development (1985–1986). Serving the domestic market still remains the main orientation of these companies. On the other hand, the possibility of exports to the market of the former Soviet Union was the main rationale for the establishment of the first computer

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companies. With the decline of these market opportunities, companies turned to the domestic market, which although initially weak, was beginning to develop. This ‘export first’ attitude was also seen in the start up of several companies established after 1986, such as TG8 and TG9, and is reflected in the boom in garment production for export. However, after following an ‘export only’ strategy for a time, most companies—including EI5, EI3 and TG1—realized that the move from being 100 per cent export-oriented to serving both markets in complementary fashion was a safer way to do business than relying on only one market. Although all companies sought contacts with foreign firms for access to technology, capital, raw materials and marketing channels, not all of them did so to the same extent. First, not all companies saw the importance of upgrading the level of their technological capabilities. Companies such as TG1, TG3 and EI3, whose managers had clear plans, made conscious efforts to upgrade capabilities, but companies such as TG8 were quite content with business as usual. The means that companies used to secure new technologies and investment funds also varied. Companies TG7 and EI5 started out as joint ventures, but many other companies began by simple subcontracting and moved on (or intended to move on) to more technologically sophisticated relationships such as OEM or ODM (TG1, TG5). Some companies, such as EI2, even contemplated creating joint ventures or overseas offices as part of their business. Motives for such a move varied, but few (such as TG1) were the companies capable of perceiving it as part of a grand strategy to acquire and diffuse skills and know-how throughout the whole of their operations. However, all recognized the value of joint ventures in accessing technology together with markets. The vigour with which companies pursued the upgrading of TC also varied. Some allocated substantial resources and set up special units responsible for R&D, training or marketing (EI2, TG4, EI3), while other companies, such as TG7 and TG8, invested little in raising the level of technical competence. Most SOEs in this study did rather well in making the adjustments required in the transition to a market economy. In common with a large number of SOEs in the Vietnamese economy, they invested in plant modernization early and ‘broke down barriers’ by adopting new ways of doing business. State and foreign economic assistance and bank credits were essential to companies seeking to shift their market orientation and secure the means to diversify their production. A very important factor was the existence of a new breed of manager in these SOEs, ready to invest in building up the capacity of his company to innovate, adopt improved business practices, search for new foreign and local partners and seek out new market niches.

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IV NEW CHALLENGES TO SUSTAINED EXPORT PERFORMANCE Formerly made up primarily of the state sector, the Vietnamese economy has been undergoing radical changes. These changes affect first and foremost the SOEs. No longer the passive beneficiaries of state subsidies, these companies now have to rely on their own devices in order to survive in the market-place. However, the conventional wisdom concerning the poor performance of most SOEs in this transitional period is not persuasive. Many have suffered crises but some have been quite successful in overcoming them. It may be asked why some SOEs can be successful, while others apparently cannot. The answer might be found in the behaviour of particular managers, in more or less favourable specific conditions under which individual companies operate, or in the differing flexibility with which they adapt to the new economic setting. With respect to the latter, our findings in this study suggest that SOEs that have invested in strengthening their technological capabilities, both through their own efforts and through collaboration with foreign partners, are better positioned to adjust flexibly and compete in the present economic setting. Nevertheless, the enterprises in the two industries are compelled to respond to a number of challenges in sustaining their economic and, in particular, their export performance. The main challenge centres around the continued shortcomings of the incentive system—the configuration of policies and institutions that affect the environment for continued investment in technological capability building and which remains in need of improvement. In this connection, it must be noted that the socialist construction period offered certain advantages to enterprises which are no longer available. An example is the system of free education (elementary, secondary and even higher education) which led to a high rate of literacy and created favourable conditions for the recruitment of trainable personnel at different levels of qualification. The end of free education will most seriously affect the ability of companies to recruit workers with secondary level education. The impact of the government’s outward-oriented trade and investment policies on the inflow of foreign direct investment remains to be seen. Although a significant volume of foreign investment has flowed into the textile and garment industry, the same cannot be said for electronics. The inadequate supply of qualified technical personnel and the limited domestic market for these products is the main reason for the hesitation of investors. More generally, a scarcity of good plant facilities and other infrastructure such as housing, office space at affordable rent, electric power and water supply have also been cited by investors for their lack of interest in Viet Nam, not to mention continued shortcomings in the legal and institutional framework. The macroeconomic environment, especially as regards the cost of domestic credit and taxation, imposes financial constraints on companies. Producers

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complain that the increase in the lending rate from 0.81 per cent to 1.8 per cent is higher than their companies can bear (interview with science and technology department of MOLI: October 1992) and that despite the economic reforms, banks still treat customers differently in different sectors, with priority often given to the unprofitable state sector. Both textile/garment and electronics companies argue that they have to pay too many different taxes (e.g. duties on imported material, turnover taxes and commercial taxes) which augment the cost of production and make it difficult for domestic products such as fabrics and TV sets to compete with imported products. This is said by some to be part of the reason that the total cost of producing a TV set in Viet Nam is higher than the cost of importing the same product, thereby encouraging companies to trade instead of engaging in production (Nguyen Ngoc Ngoan: 1992). Recently, the government decided to allow textile and garment companies to recover taxes paid on imported materials used in the manufacture of exported articles. However, due to the time-lag between importation of raw materials and exportation of finished products and to the cumbersome procedures that have to be followed, companies complain that they have to borrow from banks at high lending rates in order to pay the taxes on time. For SOEs, taxation of investment capital is a further burden. Depreciation on assets purchased with loans provided by the state cannot be deducted from income tax liabilities. This effectively diminishes what would otherwise be an important source of own funds available for reinvestment to renovate plant facilities. Several aspects of the legal and institutional infrastructure are also bad for the industrial environment. Although protection of intellectual property rights is enshrined in Vietnamese law, the absence of enforcement measures makes it difficult for both local and foreign investors to protect their products (especially computer software) from infringement. Standardization and basic business services such as consultancy, quality control and information/intelligence are inadequate. The lack of standardization is leading to a potential ‘Tower of Babel’ syndrome in the computer and software industry which is an obstacle to investment in technical change. Human resource development presents two kinds of challenges to the companies. First, absence of a modern industrial ethic among workers and insufficient knowledge of business administration, economics, marketing, accounting and foreign languages among white collar personnel are keeping companies from adapting as rapidly as they might to the new economic setting. Second, communication problems have provoked labour relations difficulties for foreign managers of companies; and insufficient training has led to shortages of engineers, technicians and skilled workers for the export sector, particularly in garments. The collapse of the former Soviet Union and East European economic bloc has created much uncertainty concerning future relations between Vietnamese companies and this market. Specialization of some computer companies on one

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product for one market has stopped being relevant, and although the market of the former Soviet Union and Eastern countries has not disappeared, Vietnamese companies now encounter strong competition from East Asian and West European electronics companies, which have entered the market on their own. Other challenges are more specific to particular industries. Lack of Vietnamese membership in the Multi-Fibre Arrangement (MFA), the United States trade embargo and higher demands in terms of quality and delivery times, etc., have created formidable barriers for textile/garment companies wishing to enter Western markets. Although there is no quota restriction in Japan and other Asian markets, the product quality, fashion and delivery time requirements are no less stringent. Some companies are giving priority to the Japanese market in order to circumvent the quota issue and, at the same time, hoping to learn how to compete in this most demanding market. However, not all Vietnamese companies will necessarily be able to gain sufficient competence to meet the requirements. Pressures are also growing in the domestic market, where SOEs see strong competition coming from the private sector in consumer electronics and a fortiori in clothing, which is easier to enter than spinning which requires investment in large-scale plants. In the textile industry, the absence of a domestic source of raw materials like cotton and chemicals, shortages of spare parts and obsolescence of equipment are major bottlenecks. The fact that garment companies are unable to source high quality fabrics locally reduces their room for manoeuvre in dealing with their overseas suppliers and customers on whom they must depend for fabrics as well as for access to marketing channels. Vietnamese subcontractors competing with one another to supply given markets sometimes find themselves having to accept unfair prices. When they try to become more independent by buying all their materials, producing to their own designs and doing their own marketing, they invariably face financial and other constraints that render them unable to compete. Electronics companies complain that they do not have a precise picture of the government’s attitude towards the development of the industry. Therefore, each must fight for its own survival, depending on its particular circumstances. Moreover, in Viet Nam both textile/garment and electronics companies suffer from a lack of the kind of stimulus to innovation that normally takes place in more industrialized countries where such companies are surrounded by clusters of supporting industries such as mechanical and chemical engineering. Smuggling has undermined the sales performance of Vietnamese companies. With the normalization of relations with China, control of Viet Nam’s northern border with China has become more relaxed and, since 1991, Chinese fabrics and yarns have increasingly been smuggled into Viet Nam. Fabrics have also been smuggled from Thailand. Those companies relying on the domestic market to supplement their export receipts, have been handicapped by having to compete with untaxed yarns and fabrics smuggled into the domestic market whose production cost, for reasons already stated, is lower than the selling price of the

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domestic articles. Smuggling has generated a similar problem for consumer electronics. Moreover, garment companies have also encountered competition from the import of second-hand or cheap garments originating from the same two countries. Many textile companies have thus had to build up inventories of their merchandise because of low sales volume. Companies responded to market pressures in three ways. First they diversified products and markets and adopted more flexible methods of doing business. Reliance on labour cost advantages to keep unit costs low is not regarded as the sole way of meeting competition. Many companies thus seek to gain a competitive edge by offering products of better quality, or of new, multiple functions (electronics), maintaining reliable delivery schedules and building up a good network of after-sales service centres (electronics). Companies have chosen different options as regards markets. Some computer companies continue to serve the old markets of the former Soviet Union and East Europe, while introducing more flexible methods of doing business: offering customers credit and easier conditions of payment, accepting barter as a form of payment and arranging customer payments on the basis of tripartite agreements. Some have plans to open production facilities in the former Czechoslovakia to serve the Russian market. Despite a higher labour cost, other benefits such as the lower cost of transport and better infrastructure make this worth considering (EI3). This may prove to be the first Vietnamese attempt at outward investment in electronics. Other companies have expanded into or concentrated on the more demanding markets of the European Union, Japan, and other non-socialist countries where they can earn hard currency. Various flexible approaches are used to achieve this goal: personal contacts, reliance on Vietnamese expatriates living in these markets, and working through third parties to avoid embargoes. However, diversification of markets does not exclude companies from also moving into the domestic market, which can become an additional outlet for such companies based on a comprehensive strategy of ‘walking on two legs’. Another tendency is to diversify into new associations with foreign partners in order to gain access to virtually all inputs: capital, technology, markets, materials supplies and expertise. Such associations are indispensable for companies if they wish to remain able to compete in both domestic and foreign markets. A second response is aimed at increasing specialization and over-all competitiveness. Such responses represent a deliberate effort to remain or become ‘competitive’ by increasing the quality and efficiency of business operations through organizational re-structuring, investment in R&D, formal training courses, on-the-job training, and special recruitment campaigns to attract the most qualified researchers, managers and skilled workers. Some companies move up quite consciously to higher value added products or endeavour to enter a ‘niche’ market. Attempts by com panies to enter high fashion design (TG4, TG5), produce software for specific users (EI3, EI4), and electronic controls for industrial robots (EI2) are a few examples of this trend. After trying to sell

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software itself, some companies such as EI3 have realized that it is a very tough business and that they would, therefore be better off joining an international network of specialized software producers/sellers and playing a small part in this network with their specific products. Thus, one option for the computer industry was to join up with a foreign company to produce part of its product package and, by doing so, gain access to new technologies, markets and some material inputs. However, only a few Vietnamese companies, such as TG4, TG9 and, to some extent, EI2, have been able to move in this direction. Some companies have combined both of these types of responses, as in the case of TG5 whose garment and footwear workshops are diversifying, whereas some of its fashion design units are moving in the direction of specialization. Finally, the third type of response consists of what may be referred to as consolidation of strengths based on domestic networking . The development of trade associations such as those created among garment and electronics/ informatics companies, respectively, is in part an attempt by the companies to group themselves so as to defend their common interests before the government bureaucracy. The strengthening of the network of inter-company relationships based on old school ties and previous professional contacts, such as those established between EI5 and other electronics companies, is a related trend which increases opportunities for ‘cooperation through competition’ and reinforces the ability of Vietnamese firms to meet competitive challenges in the global marketplace. The need to survive against very tough market pressures has forced companies to devise responses based on various strategies of diversification, specialization and consolidation of strengths. But the ability to sustain their performance, particularly in the export market, is strongly influenced by the policy environment. Remedial action is sorely needed in many areas of government policy, including most notably the supply of adequate infrastructure, the elimination of discrimination between sectors (particularly between public and private enterprises) in the supply of credit and in the application of laws and regulations, the removal of anti-export biases in the implementation of trade policies and in the operation of the tax system and (especially as regards computers and software) the more effective enforcement of intellectual property right legislation. Changes in Viet Nam today continue to take place very rapidly and the future of the two industries considered in this chapter will depend on the way individual companies deal with these changes. Although they have been able to export their products in the past by exploiting labour cost advantages and accumulating technological capabilities, their future performance will be even more strongly dependent on the further development of those technological capabilities. The state can exert a strong positive influence on the willingness and ability of firms to invest in technology through its impact on the economic environment.

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NOTES 1 At the largest textile plant, Nam Dinh, the annual level of production thus hardly increased over the 20 years after 1920. 2 From September 1945 to December 1946, there were 95,665 voluntary instructors to teach 2,520,678 people. 3 For example, by the end of 1960, 79 per cent of workers in heavy industry were in spare-time classes. In 1961, the Office of the Prime Minister issued an instruction on the organization of ‘on-duty’ studies to raise the technological level of workers. 4 The aim of the reform was to reduce private accumulation of wealth by limiting the amount of currency which could be converted, but the economy depended on transactions in the free market for its day-to-day functioning. Thus, the value of cash-in-hand of enterprises (now restricted by convertibility limits) was reduced as was also their working capital. 5 State subsidies were officially eliminated (partly in 1981 and then more fully during 1986 to 1988), and this forced many enterprises to use internally generated funds or to obtain working capital and investment financing from the banking system. 6 A garment company was set up in the Ministry of Home Trade in addition to the military garment units. All of these organizations were constituted as one Viet Nam garment company in 1971. 7 In recent years, most of the textile plants have been equipped with new garment workshops (utilizing modern Japanese and German machines, such as Tajima, Juki, Pfaff and Brother) to produce garment and embroidery products from their own fabrics for direct export or to meet subcontracting orders. 8 There are 15 garment enterprises (seven in the north, eight in the south), two research centres (one in each region), two specialized machinery plants and two vocational training schools for technical workers also established in the two regions. The corporation in total embraces 26,000 skilled workers and 10,000 sets of industrial sewing machines and specialized equipment (Tran Thi Sanh: 1992, p. 17). Similarly, the Union of Textile Enterprises consists of 33 major firms with 60, 000 employees and some smaller enterprises. Of these firms, there are 20 textile plants for spinning, weaving and knitting production (nine in the south, seven in the north and four in the central part of Viet Nam), one silk textile factory, eight other plants producing threads, woollen products and jute carpets, three textile machinery factories, an Institute of the Textile Industry with an affiliate in Ho Chi Minh City and several shops, showrooms and trading centres. 9 The main functions of these two research institutions are to carry out research in textile and garment technology, to apply technological improvements to production, to assist in the transfer of technological innovations from abroad to Vietnamese companies, such as adaptation and assimilation activities; and to provide a source of information and technological expertise for the industry. 10 For example, the Institute for the Textile Industry in 1988 had financing for its R&D activities from the state budget (VND 101 million), but in 1990 it had more diversified financing from the state budget (VND 487 million), bank credits (VND 101.6 million) and company contracts (VND 385.4 million) (Hoang Tu Khoa: 1990, p. 78).

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11 Sales of garment products increased rapidly from VND 201.4 billion in 1987 to VND 3,266.7 billion in 1991. The structure of household expenditure in 1990 was 5 per cent for clothing per person per month (VND 2,399) and 3.3 per cent for a peasant family (VND 813). 12 A survey in 1988 revealed that, in spinning, 60 per cent of some 900,000 spindles were more than 20 years old. This percentage was 80 and 90 for weaving and the cloth printing and dyeing activities, respectively. In 1993, more than 50 per cent of equipment in spinning and weaving was older than 30 years, 39.5 per cent of knitting equipment and 62.3 per cent of dyeing equipment was older than 20 years and only 30.5 per cent of knitting equipment and 17.5 per cent of dyeing equipment was less than 10 years old. This explained why at this time the rate of utilization of industrial capacity was about 66 per cent for weaving, 67 per cent for printing and dyeing and about 50 per cent for spinning. As for knitting, 50 per cent of equipment was less than 10 years old and the rate of capacity utilization was also just 50 per cent. 13 Centrally managed SOEs invested more in innovation affecting two-thirds of their equipment, thanks to more easily accessible funding. Locally managed enterprises and military enterprises could renovate only 50 per cent of their equipment. A recent survey on the technological level of the industry (which includes criteria other than obsolescence, such as quality of products, organization and management and economic efficiency), indicates the following: in textiles the rate of energy and materials consumption was 70 per cent; proportion of products of export quality standard was 41.6 per cent; lack of highly qualified engineers and technicians was cited as a major cause of low productivity. In garment production the proportion of total product reaching export quality standard was almost 100 per cent, due to subcontracting. In general, the industry displayed a medium productivity performance. 14 In 1957, for example, a first national broadcasting station was built with help from the former Soviet Union. Towards the end of the 1950s, a broadcasting system was developed based on radio receivers and transmission through wires. Television broadcasting started around 1960 in black and white with a studio and small system of transmission. A few hundred TV sets were made available, imported mostly from Poland. 15 In the north, Soviet or East German built machines, such as Minsk-22, Minsk32, ODRA-1340 and Robotron, had been brought into operation with the help of foreign technical experts. 16 By 1975 there were about 28 IBM computers and some IBM and HewlettPackard minicomputers in use by the government of the south and military organizations. About 400 to 600 people were working in computer activities; of these there were some ten analysts, and ten were engaged in teaching; the rest worked in computer centre operations. 17 For example, there were two plants which produced parts of a telephone system, simple radio receivers from transistors, and local components such as loudspeakers and other products for telephone and telegraph activities as well as transmitters, small antenna towers for broadcasting, and other mechanical parts and components for amplifiers, etc. These plants were later reorganized to serve the needs of the Post, Telegraph and Telephone Department.

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18 This latter plant was operated by the Ministry of Defence and was associated with the Military Institute of Technology for experimental purposes. However, it was later converted to the production of more simple electronics. 19 These small-scale (less than 100 workers) factories produced mostly black and white TV sets and radios (assembled from imported parts and components) for the domestic market and military needs of the south and had started their operations during 1973–1974. 20 The IIT was set up in the second period with some 150 persons, of whom 8 were professors and 45 holders of Ph.D. degrees. It was given good infrastructural conditions for research purposes (25 workstations and more than 50 microcomputers, connected in a local area network (LAN) based on minicomputers). The Institute has developed many collaborative links with foreign institutions. 21 One example is the private Thang Long University specializing in computer science. This university started with support from Hanoi Polytechnic, Hanoi University and Vietnamese expatriates living in France (with some support from the CNRS of France). It trains students in mathematics, computer science and French to university degree standard (similar to the degree requirements in the French university system). Another example is the Université francophone d’informatique (UFI) organized as a joint effort by the University of Nice and Hanoi Polytechnic (UNIDO: 1990, p. 29). 22 Formerly, the Institute belonged to the General Department for Electronics and Informatics and had seven laboratories. It was involved in research on digital technology, automation, industrial control systems and computer applications to management. In 1990 it started postgraduate and other training programmes for production enterprises. 23 Until the collapse of the CMEA in 1990, the PIDA programme of 1986–1995 was divided into five general groups of activities: large-scale management information systems (MIS); application to government agencies; development of MIS for small and medium-scale application in enterprises; research related to appropriate computer hardware; and the development of computer software packages and the training of computer specialists, as well as of user groups. 24 Some 80 per cent of urban families have TV sets, most of them colour, while in rural areas there is a market for black and white TV sets. The rate of sale of consumer electronics is increasing; millions of audio-visual products (TV sets, radio cassettes, videos, etc.) are purchased annually and during the five years 1988– 1992, the number of radio-cassettes purchased increased from 1.9 million to 6 million, and TV sets purchased increased from 0.8 million to 4.5 million (Pham Van Tam, 1993). 25 The same barriers obstructed Motorola, which could only assist in organizing a seminar in Hanoi (in April 1993) on areas of common interest (VOV, 4, 1993) and frustrated the intention of Apple Computers to support the creation of a Mackintosh-user group in Viet Nam in 1992. Vietnamese organizations have signed agreements with Microsoft and Digital Corporations to act as their sales representatives in Viet Nam. However, these large companies still do not have serious plans to produce their products in Viet Nam. The embargo was eventually lifted in February 1994 and, hopefully, should open new opportunities for the industry’s development.

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26 The system of labour management suggested by the Ministry of Labour includes a seven-grade system to be applied to workers. These grades are not based on the number of working years spent in the industry, but on the level of skill achieved. In order to move to a higher grade (and therefore to a higher salary), workers have to pass examinations in theoretical knowledge and a test of practical skills in certain functions related to their specialized field. Workers usually begin in a company at grade 3 and very few workers manage to achieve grade 7 before their retirement. 27 One example is the case of TG3. It had various relationships with foreign partners in the improvement of certain product features and/or solving in technological problems of production. For example, with Kurarau (Japan) since 1988, in finding more appropriate technologies to use with mixed cotton/ polyester yarns; with CIBA-GEIGY (Switzerland) in methods of using chemicals for dyeing knitwear; with SANDOZ (Switzerland) since 1992, in the application of methods of polishing knitwear material; and with Sanshin (Japan) in the refinement of cotton-spinning technology. 28 This group did not consist of professionally educated designers, but rather of people with different backgrounds doing design work on the basis of self-learning experiences, such as the study of catalogues and old models to create new assortments of products.

BIBLIOGRAPHY Asia-Pacific Centre for Technology Transfer (APCTT) (1988) Technology Policiesand Planning Socialist Republic of Viet Nam,APCTT Country Study Series, Bangalore. Bach Hung Khang (1992) ‘About research in informatics in Viet Nam’, Viet Nam Association of Informatics, Hanoi, proceedings of third informatics week, July (in Vietnamese). Beresford, M. (1989) National Unification and Economic Development in Viet Nam,Macmillan, London. Bow, J. (1992) ‘Hongkong companies stitch up the garment export market’, VietNam Today,Vol. 1, No. 4, pp. 10–11. Buttinger, J. (1982) A Dragon Defiant: A Short History of Viet Nam,David and Charles, Newton Abbot. Dau Hoan Do and Svensson, U. (1992) Liberalization of the Financial System inDeveloping Countries: The Case of Viet Nam, Minor field study series No. 20, Lund University, Lund. Dutta, M. (1995) ‘Vietnam: marketization and internationalization of its economy’, Journal of Asian Economics,Vol. 6, No. 3, pp. 311–326. Fforde, A. and Paine, S. (1987) The Limits of National Liberation: Problems ofEconomic Management in the DRV,Croom Helm, London. Hoang Ngoc Nguyen (1990) ‘Economic renovation in Southern Viet Nam: challenges, responses, prospects’, paper presented at the Conference on “Doimoi”, Viet Nam’s economic renovation policy and performance, ANU, Canberra. Hoang Tu Khoa (1990) ‘Final report of project on economic democratization’, Institute for Science Management, Hanoi (in Vietnamese).

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——(1992) ‘Final report of project on economic autonomy in R&D institutions in Vu Cao Dam. ‘Viet Nam’s Science and Technology on the Way of Democratisation’, paper presented at 4S/EASST Conference, Gothenburg, August. Irvin, George (1995) ‘Viet Nam: assessing the achievements of Doi Moi’, Journal ofDevelopment Studies,Vol. 31, No. 5, pp. 725–750. Le Van Sam (1992) ‘Four layers in garment for export’, Liberated Saigon, No. 8 (in Vietnamese). Marr, D. (1981) Vietnamese Tradition on Trial, 1920–1945, University of California Press, Los Angeles. Marr, D. and White, C. (eds) (1988) Postwar Viet Nam: Dilemmas in SocialistDevelopment,Cornell University, Ithaca. Ministry of Commerce (1992) Final Report of UNDP/ITC Project VIE/89/024 onTentative Research of Foreign Trade Strategies,Hanoi. Nguyen Ngoc Ngoan (1992). ‘To develop electronics there should be harmonised coordination’, Liberated Saigon,19 September. Nguyen Quy Son (1992) ‘General context and some activities of the Viet Nam Association of Informatics’, Hanoi, Viet Nam Association of Informatics, proceedings of third informatics week, July (in Vietnamese). Pham Van Tam (1993). ‘Market of electronics and electrical products in Viet Nam’, Viet Nam’s Economic News, No. 38, September. Phan Dinh Dieu (1992) ‘Some suggestions about national policy to develop information technology in our country up to the year 2000’, Hanoi: Viet Nam Association of Informatics, July (in Vietnamese). Post, K. (1989) ‘Socialism in half a country’, in Revolution, Socialism and Nationalism in Viet Nam,vol. 3, Dartmouth College, Hanover. Iran Thi Sanh (1992) ‘Viet Nam tailoring branch’, in Vietnamese Trade Unions,Viet Nam General Confederation of Labour Review, Hanoi, No. 4/1992. UNIDO (1989) Viet Nam’s Industrial Development: An Assessment,United Nations, New York. ——(1990) Microelectronics and Information Technology in Viet Nam: An Overview,United Nations, New York. Vo Nhan Tri (1988) ‘Party policies and economic performances: the second and third fiveyear plans examined’, in Marr and White (eds) Post-War Viet Nam:Dilemmas in Socialist Development,Cornell University, Ithaca. Vu Cao Dam (1988) Strategies for Development: Theories and Practices,Institute for Science, Institute for Science Management (ISM), Hanoi (in Vietnamese). ——(1992) ‘Vietnam’s science and technology on the way of democratization’, Institute for Science Management, paper presented at 4S/EASST (Society for Social Studies of Science/European Association for the Study of Science and Technology) joint conference, Gothenburg, Sweden. Wall Street Journal (1993) ‘Investment in Viet Nam during first two months is equal to all of ’89’, New York, 8 March.

7 Learning, technological capability building and sustainable export growth Lynn Mytelka, Dieter Ernst and Tom Ganiatsos

This book interprets technological capabilities broadly to include the management, strategic marketing and linkage capabilities which small and medium-sized local firms must develop if they are to sustain competitiveness under the changing competitive conditions that characterize the global economy today. It thus emphasizes the great diversity of knowledge and skills which firms need in order to carry out productive activities, including those involving new initiatives—that is, innovation. Such a definition is also more in keeping with our understanding of the process of innovation characterized by a constant interaction among a great variety of economic agents and institutions, a combination of both formal training and learning-by-doing and the incremental upgrading of products and processes. While our definition of technological capabilities is broad, the five case studies presented here adopt a narrow, result-oriented interpretation of competitiveness as constituting the ability to export. Exports were our principal focus because what set the dynamic Asian countries apart from other developing countries was the speed with which they integrated into the world economy as exporters of manufactured goods and the apparent sustainability of export growth in the front runners over several decades despite the emergence of newcomers in the Asian region. Drawing heavily on firm-level experiences in the five countries studied, we considered the following questions: 1 How did these countries manage to enter into the export of manufactures and to sustain rapid growth of exports over time? 2 What role has technological capability building played in this process and at what points during the export drive? 3 What kinds of technological capabilities have proved to be the most important in launching and sustaining the growth of manufactured exports? 4 What policies, institutions and agents have been most instrumental in stimulating the formation of technological capabilities?

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I RECONCEPTUALIZING THE TECHNOLOGY CAPABILITY BUILDING PROCESS Placing learning at the centre of the technological change process, as we have done in this volume, brought with it four major conceptual changes. First, it enabled us to break with earlier linear conceptions of the technology capability building process. This led us to envisage the possibility that different sequences could come at different times as well as in different places, a point to which we return below. Second, a focus on learning obliged us to break with a static and quantitative concept of technological accumulation and instead view technological capability building as a continuous, iterative and interactive process. Critical elements in that process could thus vary across time and space. Third, an approach based on learning and technological capability building led us to examine the relative importance of ‘public’ or ‘codified’ knowledge and tacit knowledge in the relationship between technology capability building and export performance. For most firms in our study, access to ‘public’ or ‘codified’ knowledge remained important. But it was the firm’s capacity to organize innovation as an interactive process that was determinant. This applied as much to the firm’s interaction with foreign buyers and suppliers as to internal relations within the firm. The development of firm-specific, tacit knowledge embodied in organizational routines and collective expertise or skills of specific production, R&D and marketing teams thus emerged as a critical factor in differentiating enterprises which built up their technological capabilities and used them to sustain their export performance and those which did not. Fourth, in reconceptualizing the technological change process, we were better able to identify factors that shaped a firm’s capacity to develop and upgrade its technological capabilities. We began this process by breaking down the distinction between the firm and its environment. This was done by identifying the interactive effect between the firm, its historical practices and habits and the variety of policies designed to influence its behaviour over time, through the concept of policy dynamics and by looking more carefully at the changing nature of the relationship between the firm and a set of market forces—price relations, strategies of competitors, structure of demand—which shape the choices available at different points of time. In so doing, we avoided the tendency to impose a rigid classification of policies and their impacts, which allowed us to deal more flexibly with the issue of firm options and strategies.

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II THE IMPORTANCE OF FOREIGN DIRECT INVESTMENT INTECHNOLOGY CAPABILITY BUILDING For developing countries, the effective acquisition of foreign technology has been an essential prerequisite for building their own technological capabil ities. More than 90 per cent of world R&D expenditures are located in OECD countries and most of this is concentrated in large TNCs in leading industries. Roughly 75 per cent of total capital goods exports in the world, moreover, come from the seven leading OECD countries and over 85 per cent of all technology licence transactions originate from just five countries: the United States, Japan, Germany, the United Kingdom and France. Attempts to restructure and rationalize the organization of firms and industries have also originated in only a few major OECD countries. Of critical importance, therefore, are conditions of access to foreign technology, the extent to which local firms have learned to participate actively in all of the different phases of production, and the effectiveness with which they have been able to internalize the knowledge created through such participation and thereby open possibilities for the reproduction, adaptation and further development of the imported technology. Earlier research tended to focus primarily on the role of foreign direct investment in international technology diffusion, either through ‘internalized’ technology flows within a corporate group linked through equity control, for example, from parent companies, to their affiliates, or through market-driven transfer of technology arrangements, such as the purchase of capital goods, licensing and technical agreements. These studies biased the perspective towards direct forms of technology diffusion which occur when the foreign company makes conscious efforts and resource commitments to transfer certain product or process technologies or technical support services. This mainly relates to some basic production and quality assurance capabilities and the transfer of ‘good manufacturing practices’. But there is a great variety of more indirect and informal technologydiffusion mechanisms which, particularly in East Asia, have played an important role in the acquisition of technological capabilities from foreign sources. These do not result from any conscious effort by the foreign company, but occur as a side effect of interactions with a foreign firm. Our case studies show that in the East Asian NIEs, indirect mechanisms of technology diffusion have been at least equal to, if not more important than direct mechanisms of technology diffusion in building technological capabilities. External sourcing of technological inputs, whether through foreign direct investment or other means, figured prominently in the build-up of the technological capabilities of East Asian firms. Foreign investors played an important role in launching capital intensive industries such as petrochemicals in Korea and Taiwan Province of China. Foreign investment contributed to the

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establishment of industries such as polyester fibres and yarns in Indonesia in which capital requirements exceeded the financial resources that local enterprises were able to muster. It also became significant in the labour intensive segments of industries having a high knowledge content. Foreign aid has played a similar role in the modernization of Viet Nam’s textile industry. In the 1960s and 1970s Japanese foreign direct investment was rather inconspicuous since the internationalization of Japanese firms had barely begun at that time and exporting from Japan was still their forte. However, some Japanese firms, particularly in the home appliance and consumer electronics industries, did invest in import substituting industries within the region. Their affiliates had a number of very positive characteristics for technology capability building—and being decentralized, using local inputs and employing at least some local managers, they encouraged local learning. Where the transfer of production capabilities entailed above-average attention to quality control and production efficiency, as in semiconductor assembly, foreign direct investment could be instrumental in building technological capabilities through knowledge transfers. Both United States and Japanese electronics firms invested heavily in the region, as the chapters on Korea, Taiwan Province of China and Thailand illustrate. Foreign direct investment was far less crucial than other channels for technology transfer and capability building during the first wave of investment in export-oriented garment manufacturing and textiles, except for synthetics. In particular, subcontracting-type arrangements, whereby the foreign partner supplies inputs such as patterns, cut pieces and accessories to local firms and subsequently markets the finished garments, became vehicles for technical assistance in plant operation, quality control and management routines. So, too, did close links to suppliers following the purchase of new machinery and equipment, especially in Viet Nam. Not all local partner firms succeeded in building up their technological capabilities. But those which did, acquired the production and investment capabilities that enabled them to source inputs and, over time, to make minor modifications and small design changes, thus beginning the process of ‘learning to learn’. Japanese, German and United States partners were in the forefront in providing a combination of designs, technical know-how, marketing intelligence and export distribution services. But in Indonesia, joint venture partners continued to occupy most technical, engineering and management posts leaving less room for Indonesians to build indigenous investment, minor change and linkage capabilities. This contrasted with the performance on these indicators of wholly domestically owned firms in the Indonesian textile and clothing industries. Surprisingly, later waves of clothing investment—in Indonesia and Viet Nam, involved more direct foreign investment, but this time some of that investment came from Korea, Taiwan Province of China, Singapore and Thailand, rather than Japan, the United States or Europe.

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Similarly, development in the consumer electronics industry in second tier NICs, such as Thailand, as well as in Viet Nam was driven by foreign investment, much of which involved a significant participation of local personnel in top management and local sourcing of some components. When Japanese affiliates in consumer electronics shifted from sales in the domestic market to exports, however, the share of expatriates in key man agerial positions rose and domestic sourcing declined, with a consequent reduction in opportunities for learning. Japanese takeovers of the remaining independent television set producers in Thailand also signal a rollback in opportunities for technological capability building—at least at the higher managerial level, and give grounds for concern. The contribution to technological development in other segments of the electronics industry, especially as regards affiliates of United States TNCs, was stronger. In establishing wholly-owned production facilities in Taiwan Province of China in the 1970s, for instance, IBM deliberately sought to create a network of local suppliers of a wide range of components needed for its export operations. Affiliates of semiconductor TNCs are also gradually establishing links in Thailand but not as yet in Indonesia. The lack of local components suppliers in the electronics industry in Indonesia was identified as one of the central factors limiting the export competitiveness of this industry in the future. One of the key externalities from foreign direct investment in electronics was the on-the-job experience acquired, not only by engineers but by marketing and other managerial personnel who subsequently left the subsidiary in order to start up their own companies as in the Thai semiconductor industry. Such experience was also important in at least one management buy-out of a TNC subsidiary in the computer peripherals sector in Thailand and of similar, though less successful, buy-outs in the Indonesian semiconductor industry. III POLICY DYNAMICS AND THE PROMOTION OF EXPORTS The state was active in shaping the formation of technological capabilities in these East Asian countries. In Korea, Taiwan Province of China, Singapore and more recently Malaysia, the path of development experienced a major turning point as a direct result of decision-making at the highest level. In each case it involved a decision to ‘look East’ towards Japan as a role model whose practices could be studied, modified and adapted, rather than ‘looking West’ to the historical trajectories of the advanced industrial countries of Europe and North America or to the former Soviet Union. The emulation effect has been far less pronounced in second tier NIEs—Thailand and Indonesia and in Viet Nam. Although the paths taken were different across these countries, all four were inspired by a number of salient features of the role of the state in the Japanese approach to development, including the following:

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1 efforts to reduce the costs and risks of exporting by providing low cost capital, facilitating access to foreign technology, stimulating the emergence of trading companies and providing market intelligence; 2 keeping wages low and undervaluing the exchange rate, thereby rendering difficult the transfer of Western models of consumption. This reduced imports of finished goods for consumption, freeing foreign exchange for the purchase of raw materials, capital goods and intermediates needed for manufacturing. As the domestic market remained small, increased productivity could go directly to exports; 3 leaving a space open for the emergence of local entrepreneurs. In Korea this took the form of limiting foreign investment, whereas Taiwan Province of China ensured that business legislation did not discriminate against small enterprise. In Indonesia, the requirement that foreign firms take local partners enabled some local entrepreneurs to emerge;1 4 building a social consensus on the preceding approaches to development again differently in each of the countries. In working towards a consensus, the state exercised a steadily decreasing amount of overt coercion over popular expression (education and the media), spatial and vertical mobility and political participation. The first economic impetus to export in our five case study countries invariably came from a foreign buyer or investor—a Japanese trading company looking for low-cost supplies of textiles and garments in Korea in the late 1960s, United States electronics firms investing in Thailand in the 1970s, subcontractors to Vietnamese firms from the former socialist countries of Eastern Europe in the 1970s and later from other East Asian countries. Slow-downs in domestic demand or over-supply in the domestic market were also important in stimulating textile and garment exports from Taiwan Province of China in the late 1950s and early 1960s and in Indonesia two decades later. In all instances, exporting was based on knowledge and experience acquired during a phase of import substitution and in all of the countries in our study, there was a conscious move towards export promotion policies to further encourage exports. However, this did not mean that they abandoned protection of the domestic market. In all first and second tier NIEs export promotion was accompanied by continued protection of the domestic market. In this connection, it is important to emphasize that the kinds of export stimuli used varied from country to country and, as has been shown in the country studies, these policies had different consequences. They depended not only on the type of products being exported (textiles vs. garments, consumer electronics vs. semiconductors) and the period in which the export promotion began, but above all on the dynamics generated by the interaction of the new export promotion policies with the actors whose behaviour they were designed to influence. Local firms that still had an option of concentrating on a profitable domestic market, as in Thailand, had far less incentive to export than newcomers who were drawn into the industry in order to

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export. In textiles and garments these were, for the most part, locally owned firms, whereas in electronic components and computer products they were almost exclusively wholly-owned subsidiaries and joint ventures. Since few of the older producers took advantage of the new export promotion incentives to change their habits and practices, a dualistic structure emerged in the textiles and clothing and later in the consumer electronics industries in Thailand. However, the same was not true in Taiwan Province of China and Korea. In the former, a policy of promoting and strengthening local small and mediumsized enterprises at the same time as foreign direct investment was encouraged and export processing zones were created which meant that foreign investment did not crowd out these smaller firms and horizontal and vertical linkages developed in both textiles and garments and later in electronics. In Korea, existing producers were not only encouraged to export through financial incentives as in Thailand, but more importantly, they were implicated in a policy dialogue with the state that led to the establishment of performance criteria such as annual export targets in exchange for credits and risk reduction incentives. This dialogue broke earlier habits and practices and propelled Korean firms into competing with themselves for export growth and into emulating their local rivals in their diversification into new products and sectors. Later entrants, such as Indonesia and Viet Nam, had far more regulated economies. Before export promotion could be effective, regulations governing foreign investment, foreign exchange allocation and—in Viet Nam—the right to engage autonomously in contractual and trade relationships had to be relaxed. IV THE ROLE OF TECHNOLOGICAL CAPABILITIES INSUSTAINING EXPORT SUCCESS Technological capability became increasingly important over time in sustaining an export success that was initially based on labour cost advantages. One way it did so was to make firms able to adjust to trade restrictions such as the MultiFibre Agreement or to new cheap labour competitors by moving to more sophisticated products, diversifying markets and over time becoming ‘partners’ with their collaborators—contributing not just labour skills, but design, organizational and other capabilities. As competitive pressures intensified in textiles, clothing and electronics, the ability to innovate in products, processes and organizational structures and management routines became an even more important asset for firms from Japan and later Taiwan Province of China and Korea2 as they shifted production to second and third tier exporting newcomers, such as Indonesia and Viet Nam.3 As a result, the period during which firms are able to exploit static comparative advantage in sustaining their initial export success is shortening. In the textile industry, for example, Japanese firms were able to capitalize for nearly 20 years on their static comparative advantage before technological change and

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the emergence of lower cost newcomers forced them to undertake a continuous process of innovation in products, processes, organizational routines and strategic marketing capabilities in order to remain among the world’s major textile exporters. First tier NIEs could count on barely 15 years before their static comparative advantage in textiles and clothing began to erode. Taiwan Province of China moved more quickly than Korea to invest in improvements in product quality and diversify to higher value added products which depended on in-house design and development capabilities, linkages to the domestic technological infrastructure for R&D support and a growing domestic market for more sophisticated products. Even then, its position among the world’s leading textile and garment exporters declined far more rapidly than had Japan’s. For second tier NIEs the erosion of comparative advantage in this industry has been even faster. Barely ten years after emerging as a major garment exporter, Thailand has been forced to innovate or exit. In electronics, growing competition has also shortened the time over which firms could enjoy comparative advantage in given product markets. As compared with textiles and garments, the importance of competitors’ locational shifts in eroding labour cost differentials was somewhat outweighed by the impact of constant technological change and rapid product turnover. Firms that remained in the market were those that adapted. Taiwanese SMEs found themselves constantly having to adjust to competition from large Korean firms exploiting scale advantages of mass production in a succession of products from transistor radios to colour TVs that became standardized and mature. This experience strengthened their ability to exploit emerging market trends and identify new market niches and it accounted for the success of Taiwanese computer manufacturers in developing laptop and notebook computers very shortly after they became popular in the market. Hemmed in on one side by the product differentiation advantages of their Taiwanese competitors and on the other by the cost advantages of Japanese rivals shifting some of their new production to lower labour cost locations elsewhere in Asia, Korean electronics firms responded by a massive increase in the level of R&D expenditures aimed at developing improved, cost-reducing technologies and speeding the introduction of new products. Thai consumer electronics and computer manufacturers have exploited improved capabilities in production engineering, inventory management and quality control to lower defect rates. Almost all Thai electronics firms have also sought to reduce production costs by introducing new vintages of automated equipment. Supervisors and team leaders have given intensive training to line workers and technicians to ensure that they operate and maintain the new equipment efficiently. A number of Thai manufacturers have also been increasingly compelled to seek ways of increasing local sourcing of components and raw materials in order to lower costs and diminish response time for meeting export orders. In contrast to their Thai and Chinese competitors, Indonesian

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electronics producers have encountered greater difficulties in sourcing components and parts domestically. The comparative advantage of the two Vietnamese firms that had astutely managed to commercialize Russian language-based personal com puters and software in the wake of limited economic liberalization in their country came to a particularly abrupt end in 1989 with the collapse of the Soviet Union and, with it, their captive market. But by using a combination of their previously acquired marketing know-how, investment capabilities and linkages with foreign collaborators, these firms also proved capable of adjusting. They did so by seeking new overseas as well as hitherto untapped domestic markets for their products and diversifying into related activities. V TECHNOLOGY CAPABILITY BUILDING AS A NONLINEAR, INTERACTIVE PROCESS Our research suggests that ‘learning to learn’ is a critical component of the technology capability building process and fundamental in providing the firm with a strategic advantage in choosing among available options. This is quite different from Michael Hobday’s finding that electronics firms in the Four Dragons learned to improve both their technological and export marketing capabilities simultaneously and that this process was marked by a number of definable stages. In contrast, our study shows much greater variation across companies and sectors in the specific kinds of technological capabilities that are built. No firmly demarcated stages emerge from these case studies nor is the process of technological capability building and its relationship to manufactured exports a linear one. Some firms, for example, developed a broad range of technological capabilities, including sophisticated marketing techniques, but sold exclusively in the domestic market for many years before exporting. In other instances, firms were created by marketing people who designed the building of production capabilities as a function of their knowledge of foreign markets and their requirements. In still others, a network of domestic linkages between suppliers and clients and between R&D and consulting firms and manufacturers were critical in moving production upscale and stimulating new product development and productivity increases though the firms in question in Korea, Taiwan Province of China and Viet Nam had not developed a corresponding level of marketing capability. This is a powerful argument against stage theorylike interpretations of the technology capability building process and it suggests that the range of possible strategies is greater than such theories would imply. In this connection, our research also suggests that it is misleading to continue to regard successful exporters of sophisticated electronics or textile and clothing products from Korea and Taiwan Province of China as latecomers simply because they remain Original Equipment Manufacturers (OEMs). It is our belief

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that these firms now have the technological capabilities to choose which mix of strategies is better for them under existing conditions. This means that they may move among or simultaneously engage in strategies such as OEM, own design manufacture (ODM) for export or own brand manufacture (OEM) for the local or export markets, depending on the product and its designated market. However, OEM sales abroad are so costly in terms of advertising, production facilities and knowledge of foreign markets, that this option has thus far proved prohibitive for all but the largest Asian firms. For the most part, size has also been a barrier for firms seeking to keep up and get ahead, but its role has been quite different in Taiwan Province of China and Korea. In the former, where the industrial structure is dominated by many small firms, the manufacturing sector has exhibited a high degree of flexibility in responding to shifts in demand in major export markets. Faced with increasing barriers to the continued pursuit of a strategy of producing low-cost clones of products mostly designed in the United States, Japan or Europe, some Taiwanese firms, for example, were able to shift to products with design enhancements which complement, rather than compete directly with, products offered by the market leaders. On the other hand, Taiwanese firms have not been able to compete for market share in areas on the technology frontier. Left on their own, they are hard-pressed to make the massive capital investments required to produce core components like advanced integrated circuits or liquid crystal displays. Korean firms, by virtue of their greater financial resources, have been better able to hurdle the escalating barriers to entry into products requiring large capital investments and where economies of scale are still significant. They have also substantially increased their investments in R&D, the effectiveness of which, however, has been fairly low. In addition, the oligopolistic structure of Korean industry may have had adverse effects on the diffusion of new technologies, depending on the strategic interaction of firms making up this industry. Although some incentives to technology transfer are built into the relationships between the chaebol and their domestic subcontracting networks in electronics, these have become less evident over time in the textile and clothing industry. Size barriers to technology capability building can, however, be partially overcome through the strategic use of OEM production. Like licensing, OEM production can be used as a substitute for the development of new products and processes, thus eliminating the incentive to innovate and reducing the possibility that the local firm can build the technological capabilities it needs to become a manufacturer of its own branded products or it can be used, as in Taiwan, to increase quality standards and to open a window on the world. In the latter case, through technology diffusion within the firm, OEM production helps to ensure best practice in all of the firm’s activities at the same time as it enables the firm to build up the volume of production it needs to sustain new product development or an OEM strategy.

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Size barriers to firms seeking to establish their own brands or move to the technological frontier can also be overcome through networking and strategic partnering activity. Alongside some of the OBM export successes of large firms like Samsung, the Lucky Goldstar group, Hyundai or ACER, our study revealed that a number of small Taiwanese and Korean firms have become successful exporters in electronics and in textiles and clothing respectively. For these firms, size-related barriers were overcome by being part of production networks (tangible) or alliances (intangible). The key here was the transformation of earlier one-way hierarchical relationships into two-way interactive linkages that facilitated informational exchanges and learning. Even for larger firms, the costs of entry are higher today for newcomers as well as for those seeking to keep up and get ahead. Participation in broad-based production networks or alliances is helping such firms to spread the costs and risks of competing in a world where uncertainty has been heightened by the rapid pace of innovation and change in competitive practices. VI DOMESTIC MARKETS AS A STIMULUS TOTECHNOLOGICAL CHANGE Lastly, the five case studies presented here also shed light on the historical debate on domestic market-led vs. outward-oriented industrialization. The most widespread current interpretation of the relatively more successful economic growth performance of the East Asian countries over the past several decades singles out the superiority of outward-led industrialization strategies when compared to domestic market-oriented approaches. The latter entailed the erection of trade barriers that sheltered a country’s firms from competition and removed the incentive to maintain high levels of efficiency and to invest sufficiently in product and process innovations. By exporting—primarily to the United States and other countries of the ‘Triad’ (Japan and the European Union) —firms exposed themselves fully to the discipline of bringing goods to market rapidly and dependably, selling at world market prices and meeting the exacting demands of overseas customers and buyers for sophisticated products of a high standard of quality. The main engine for innovation, following this argument, is exports primarily to Triad markets. Under a reductionist version of this reasoning, it is claimed that the only way developing countries can enjoy growth in the manufacturing sector is through exports of manufactures to the Triad and, therefore by extension, austerity measures that depress domestic demand can be imposed on developing countries with impunity. In contrast, our case studies illustrate the way in which firms that built up their technological capabilities and their linkages to the domestic science and technology infrastructure were able to move over time towards the manufacture of more sophisticated products even amongst newcomers in Viet Nam. Strong domestic supplier networks (i.e. linkage capabilities) were particularly critical in

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moving garments upscale and enabling electronics firms to change products frequently, as the Taiwanese and Korean country studies demonstrate. Moreover, as urbanization and incomes increased, the market both domestically and in the region began to grow and to become increasingly more sophisticated. This was especially true in consumer electronics where the region’s urban elites are knowledgeable about the most advanced products and have the income to buy them. Thus, just as local sources of technology have become important in some segments of the electronics and textile and clothing industries for firms in the first and second tier NIEs, so too, our findings show, is technological change in locally based firms now being driven, in part, by domestic demand for sophisticated products. These results strongly suggest that there now exists an opportunity for dynamic growth in the manufacture of sophisticated products destined for markets in the region, thus reducing the heavy reliance these countries had in the past on exports to countries of the Triad. These findings also call for a more extensive analysis of the role that domestic demand can play in technology capability building over time, and they introduce a note of caution in the heavy reliance on overly tight financial controls and deflationary policies in periods of crisis such as that which struck several of the NIEs in late 1997. NOTES 1 In Malaysia, the Bumiputra policy played a similar role. Singapore initially practised a policy of inviting in foreign investment and built much of its initial export success on manufactures by their foreign subsidiaries. More recently, however, it has moved to develop local support industry through very innovative policies with components, materials and other intermediates used by these downstream industries being the target of current investment. 2 This applies to both Hong Kong and Singapore. 3 In addition to these two countries from our study, firms from the NIEs are also investing heavily in the People’s Republic of China.

Index

Abernathy, W.J. and Utterback, J.M.31 accumulation theory1–2 Advanced Computer Environment (ACE) 78 AFTA259 Akrasanee, N.160 Amsden, A.32, 90, 93, 95, 113, 127 Antonelli, C. and Foray, D.37 Arrow, K.J.12 ASEAN Free Trade Area (AFTA)202, 255, 258, 259 Asia-Pacific Centre for Technology Transfer (APCTT)280 Association of Informatics of Viet Nam284 Association of Vietnamese Garment Factories273

Chesnais, F.14 Chinese-American Joint Commission on Rural Reconstruction47–8 Christensen, S.R. et al.159, 160 Chun Doo Hwan89, 92 Ciborra, C.37 clothing industry: competitive challenges/strategic options in256–8; historical experience238–41; and incentive systems257; and investment240, 295, 299–300; management control in240–1; and marketing194, 239, 240–1, 242, 245–6, 257; pre- investment/project execution in239, 245; production capabilities in239, 242–3; R&D in290, 291; strengths/weaknesses in245–6; technological capability-building in238–1; see also textile industry, textile/clothing industries Common Programme of Informatics Development and Application (PIDA, Viet Nam)284 competition: in clothing256–8; in electronics197, 201–2, 258–61; global11, 142; in textiles254–6 computer industry61–2, 70–1, 116, 120–1, 128–31, 136, 172–3, 195, 201, 280–1, 282–3, 311, 312, 318, 329 Computergram130

Bach Hung Khang284 Bain, J.S.113 Balasubramanyan, 221 Bank Dagang Negara220 Bark, T.93, 123 Bell, M. and Pavitt, K.20 Beresford, M.268, 270 Bernais, D. de31 Bloom, M.90, 113, 138 Bow, J.278 brand names61–2, 77, 197, 199, 259 Business Korea102, 105 Business Week60 Buttinger, J.266 Cantwell, J.14 catch up strategies32–3, 114, 127–31, 142 Chen, M.P.52 334

INDEX 335

consumer electronics113, 114–15, 117, 136, 172, 221, 226, 253, 283, 311, 332; building technological capabilities in247–50; and competition258–61; see also electronics industry Council of Mutual Economic Assistance (CMEA, Viet Nam)268 Cumings, B.92 Dahlman, C. et al.127 Dataquest114, 131 Dau Hoan Do and Svensson, 268 design capabilities197, 311, 332; in clothing239–40, 257–8, 299; in electronics249, 260; in textiles299 Director-General of Budget, Accounting and Statistics (DGBAS, Taiwan)80 diversification strategies33–5 Djang, T.K.59 domestic technology networks36–7 Du, W.-t.48 East Asian Miracle6, 7 economic development, debates concerning5–7, 11–12 Economic Intelligence Unit (EIU)101, 108 education and training83, 91–2, 161, 204, 269, 312, 318; in clothing289–90, 291; in electronics176, 188–90, 191, 196–7, 200, 205, 247–8, 280–2, 283–4, 305; in textiles73–4, 97, 107, 181–2, 206, 244–5, 256, 289–90, 291 Electronic Engineering Times130 Electronic Industries Association of Korea (EIAK)114, 137, 140 Electronics122, 140 electronics industry112, 187, 302–3, 318, 328–9, 330, 332; adaptive capabilities in206; basic characteristics246–7; catch up process in114, 127–31; chaebols in122–4, 127–8, 132, 134, 136; challenges to60, 78–9;

and competition135–6, 201–2, 221–2, 258–61; component sourcing in189–90, 200–1, 206; and cooperative network70, 79–80, 82– 4; and deregulation226; difficulties in285–6; diffusion-oriented policies in121–2; dualism in172; and economies of scale199; education/ training in176, 188–90, 191, 196–7, 200, 205, 247–8, 280–2, 283–4; and European Single Market79; and exports59, 69–72, 112–16, 175–7, 223–4, 226–7, 282–3, 285, 313–14; fragility of115–16; getting ahead131–9; and government policies116–22; growth/development of58–9, 60, 62, 112–16, 205–6, 280–6; historical experience of247–51; and human capital70–1; impact of incentive systems on173–7, 222–4, 226–7, 252–3, 280–6; and import substitution59, 173–5, 192, 205, 222–3; and innovation126–7, 135–9, 308, 317; and investment140–1, 176, 187–90, 224, 311; and ITRI71, 81; and joint ventures59, 60, 132, 133, 172, 174, 188, 190, 192, 206, 221–2, 223, 246–50, 260, 310; keeping up131–5; labour in113; linkages in60, 248–50, 251, 253–4; and local content regulation59–60, 79; market focus313; and marketing202, 248, 253, 303, 306, 309–10; and mass production116, 117; meeting new challenges in199–202; minor changes in190–4, 251, 260, 303– 6, 309; mission-oriented policies in121; production capabilities in127, 187–90, 250, 259;

336 INDEX

quality control in247–8, 251; quantitative restrictions on222–3; R&D in84, 127, 134–5, 136–9, 190–4, 253, 282, 284, 303, 306–8; second-sourcing agreements in131; sectoral and product-specific targeting in117, 121–2; and SMEs124–6; and strategic alliances71–2; strategies in122–6, 258–61; strengths/ weaknesses in77–8, 253–4, 311; structure of60–2, 122–6, 168–73, 173– 5, 221–2; and subcontractors125, 197, 259; technological capability-building in69– 72, 121, 126–35, 247–51; and upgrading/diversifying product mix69–70 Electronics Industry Promotion Act (1981, Korea)117 Electronics Technology Research Institute (ETRI, Korea)121 Encouragement of Investment, Statute of (Taiwan)51 EPB103 Ergas, H.121 Ernst, D.12, 123, 131; and O’Connor, D.15, 113, 131 ESMODE Korea107 Evans, P.7 export performance6–7, 325, 326; challenges to315–20; and family kinship69; and FDI68; and incentive systems175–7; and OEM production63; and overseas Chinese67–8; and personal connections63, 67; and technology capability formation227–54 export processing zones (EPZs)50, 83, 161, 176, 219, 253, 260 export promotion48, 49, 59, 88–9, 90, 160– 1, 203, 329–31; in clothing239, 241–2; in electronics59, 174–5, 187, 223–4, 226–7;

in textiles241–2 external technology sourcing36 Fagerberg, P.2 Fair Trade Act (Korea)94 Fashion Institute of Kolon (Korea)107 fast second strategies136 Federation of the Thai Textile and Garment Industry204–5 FEER87, 140 Fforde, A. and Paine, S.271 Foreign Capital Investment Act revision (1984, Korea)89 foreign direct investment (FDI)48, 68, 82, 83–4, 89, 108, 116, 161, 205, 270, 278; importance of326–9 Fransman, M.33 free market7 Freeman, C.1, 35 Fruin, M.124 General Agreement on Trade and Tariffs (GATT)102 generic knowledge23 Gerlach, M.L.124 get ahead strategies35, 131–9 globalization11–12 Granstrand, O.34, 35 growth theory1–2 Haggard, S. and Chung-in Moon92 Hamilton, C.87, 90 Hanoi Polytechnic Textile Research Institute295 Heeks, R. and Slamen-McCann, A.6 Hikino, T. and Amsden, A.113 Hill, H.215, 217, 219 Hoang Ngoc Nguyen272 Hobday, M.6 Hsinchu Science-Based Industrial Park (Taiwan)71 import substitution6–7, 48, 90, 159–60, 162, 202, 211, 213; in electronics59, 173–5, 192, 205, 222– 3; in textiles51–2, 76, 95, 165

INDEX 337

incentive systems49–51, 83, 211; in clothing257; effects of on export performance175–7; effects of on industrial structure173–5; in electronics173–7, 221–4, 226–7, 252–3, 280–6; in textiles/clothing165–8, 215–21, 241– 4, 256, 270–80 Indonesia211–14; electronics industry in221–7; government policies in211, 213, 262– 3; impact of incentive system on electronics industry221–7; impact of incentive system on textile/ clothing industry215–21; new competitive challenges and strategic options in254–61; technological capability-building and relationship to exports over time in227– 54, 261–2; textile/ clothing industry in215–21 Indonesian Academy for Fine Arts (ASRI) 244 Industrial Development Act (1986, Korea) 93, 106, 137 Industrial Development and Investment Centre (Taiwan)48 industrial electronics113–14, 117, 123, 173, 222, 226–7; and competition261; technological capability-building in250–1; see also electronics industry Industrial Technology Research Institute (ITRI)71, 81, 120 Industrial Upgrading, Statute of (1990, Taiwan)51 Information System Centre (Viet Nam)284 innovation331; and the chaebols137–8; defined12–13; in electronics126–7, 135–9, 308, 317; and internal/external interactions13– 14; and knowledge accumulation14–15; and learning accumulation15–16; push-pull theories of13;

in textiles102, 317; weaknesses in135–9 Institute of Computer Science and Cybernetics (ICSC, Viet Nam)281 Institute of Economics (Ho Chi Minh City, Viet Nam)295 Institute of Information Technology (IIT, Viet Nam)281 Institute of Microelectronics (Viet Nam) 284 Institute of Physics (Viet Nam)284 Investment by Foreign Nationals, Statute of (1954, Taiwan)49–50 Investment by Overseas Chinese, Statute of (1955, Taiwan)50 investment capabilities18–19, 97, 126, 160, 328; in clothing240, 295, 299–300; in electronics140–1, 176, 187–90, 224, 311; in textiles101–6, 109, 204, 295, 299– 300 Investment Promotion Law (1972, Thailand)160 ITCB101 ITMF103 Japan Robot Leasing Corporation26 Johnson, C.89, 127 joint ventures89, 91, 160, 328, 330; in clothing238, 240–1, 242, 243–4, 299, 300–2; in electronics59, 60, 132, 133, 172, 174, 188, 190, 192, 206, 221–2, 223, 246– 50, 260, 310; in textiles97, 100, 164, 183, 215, 236, 242, 243–4, 299, 300–2 Katz, J. and Bercovich, N.24 keep up strategies33–5, 131–5 Keesing, D.B.60 Kim Hee-Nam117, 136 Kim Ilyong and Sunyang Chung138 Kim Ji-Hong107, 108; and Lau, L.J.1 Kim Linsu137, 139; and Dahlman, C.J.91, 94

338 INDEX

Kim Seung Hee90 Kim, T.B.95 Kim Young-Sam94 Kirkpatrick, C.H. and Nixson, F.I.88 Kline, S.J. and Rosenberg, N.20 knowledge accumulation14–15, 126 Kodama, F.33 Kohama, H. and Urata, S.123 Korea: basket case image of87–8; crises and adjustment in92–4; declining competitiveness of87; education in91–2, 97, 107; electronics industry in112–39; export performance of88–9, 94, 139– 40; and FDI89; future prospects for142; government-chaebol interaction89, 91– 4, 122–3, 141; historical practices of firms in91–2; and innovation90, 93, 141–2; investment and finance in89–90, 94, 140–1; and inward investment123; policy dynamics in88–91; textile/clothing industry in95–112, 142 Korea Academy of Industry Technology107 Korea Development Bank120 Korea Electronics Technology Institute (KETI, Korea)121 Korea Exchange Bank89 Korea Institute for Industrial Economics and Trade111 Korea Sewing Science Research Institute107 Korean Federation of Textile Industries111 Korean Institute of Electronics Technology (KIET, Korea)121 Krugman, P.1 Kuo, W.-J.48 labour136, 164, 175–6, 187, 196, 201, 241, 257, 318, 332 Lall, S.7 leadership strategies35

learning-by-doing model6, 70, 126, 191, 290 Lee Hahn-Koo93 Lee Jinjoo127 Lee Kyu-Uck92 Lee Soon-Jae101 Lee, T.-H.48 Levin, R.C. et al.23 Levy, J. et al.70; and Samuels, D.33 Li, K.T.47 Liang, K.S. and Liang, H.C.I.52 licensing technology129–30, 132, 133 Lim, Y.90 linkage capabilities60, 90–1, 92, 142, 166, 190, 192, 291, 313, 325, 328, 333, 334– 5; benefits of138–9; in clothing239, 243, 298–9, 300; in electronics173, 175, 183, 187, 196, 201, 222–3, 248–50, 251, 253–4, 261, 309; inter-firm21–2, 132, 319; intrafirm21; S&T infrastructure22; in textiles50, 51, 53, 57, 243, 256, 298– 9, 300 Liu, K.C. and San Gee69 major change capabilities22–3, 100, 238, 249, 260, 262, 311 management capabilities196–7, 250–1 market forces27–30, 182, 326 marketing capabilities20, 203, 262, 325, 331; in clothing194, 239, 240–1, 242, 245–6, 257; in electronics202, 248, 253, 303, 306, 309–10; in textiles97, 100, 110, 167, 182, 184– 5, 194, 198–9, 204, 242, 244 Ministry of Commerce (Viet Nam)283 minor change capabilities20, 126, 203, 204, 261–2, 328; in electronics190–4, 251, 260, 303–6, 309;

INDEX 339

in textiles/clothing184, 237, 242, 244, 295, 300 Mowery, D. and Rosenberg, N.21 Multi-Fibre Arrangement (MFA)96, 101, 167, 219, 317 Mytelka, L.23, 29, 35 National Agency for Export Development (BPEN, Indonesia)240, 243 National Centre of Scientific Research (NCSR, Viet Nam)281, 303 National Electronics and Computer Center (NECTEC, Thailand)192–4 National Exhibition of Export Products (PPE, Indonesia)240 Nelson, R.14, 22, 23, 25; and Pack, H.1; and Winter, 14 newly industrialized countries (NICs)161, 203 newly industrialized economies (NIEs)37, 219, 252, 329, 330, 331, 332 Nguyen Ngoc Ngoan316 Nguyen Quy Son284 North American Free Trade Area (NAFTA)255 Odagiri, H. and Goto, A.34 OECD23, 34, 138; Frascati Manual22 original equipment manufacturing (OEM) 63, 90, 120, 142, 189–90, 206, 257, 333, 334 own brand manufacture (OBM)333–4 own design manufacture (ODM)314, 333 Pack, H. and Westphal, L.E.88 Park Chung Hee89, 90, 92, 96, 117 Petri and Leipziger, 94 Phan Dinh Dieu285 Poapongsakorn, N. et al.176; and Suzuki, P.194 policy dynamics25–7, 88–91, 100–6, 116– 22, 211, 213, 262–3, 326, 329–31 pre-investment/project execution19, 236, 238, 239, 245, 299

production capabilities18, 126, 203, 291, 295, 311–12, 328; in clothing239, 242–3; in electronics127, 187–90, 250, 259; in textiles95–6, 97, 167, 177, 181–4, 238, 242–3, 244, 295 project execution see pre-investment/ project execution protectionist policies79, 93, 162, 164, 218, 223, 241, 262 quick follower strategies136 quota/non-quota markets110, 166–8, 219– 20, 256, 278 Ranis, G.48 research and development (R&D)22–3, 90, 206, 269, 273, 327, 332; in clothing290, 291; in electronics84, 127, 134–5, 136–9, 190–4, 253, 282, 284, 303, 306–8; and linkages313; in textiles107, 141–2, 205, 290, 291 reverse engineering127, 130, 190, 192 Rhee, S. et al.88, 91 Rho Tae Woo89 Rodrik, D.7 Romer, P.2 San Gee80 science and technology (S&T)22, 23, 205, 206, 266, 282, 303, 310 semiconductor industry113, 115, 121, 127– 8, 131–5, 205, 223, 329 sequencing patterns: catching up32–3, 114, 127–31, 142; getting ahead35, 131–9; keeping up33–5, 131–5 small and medium-sized enterprises (SMEs)50, 82, 92, 96, 106, 109–11, 124– 6, 141, 196, 325, 331 Soh Chagrok128 state: custodian/demiurge role7, 11; midwifery/husbandry role11 structural adjustment policies3–4, 51, 53– 4, 57, 60–2, 103–6, 160–1, 203, 268–9

340 INDEX

subcontractor networks90, 92, 97, 125, 168, 198, 330, 334; in electronics125, 197, 259; in textiles105–11, 125, 141, 164, 204, 276–7 Swedish International Development Agency (SIDA)290 Syngman Rhee91 Taiwan Garment Association (TGA)73 Taiwan Province46–7; development/status of electronics industry58–62, 83; development/status of textile industry51–8, 83; export performance/technological capability in general63–72, 82–4; export performance/technological capability of textile industry72–7; historical background47–9; industrial transformation of82; macroeconomic environment and incentive system49–51, 83; new challenges/responses for electronics industry77–80; new challenges/responses for textile industry80–2 Taiwan Textile Federation (TTF)73 TDRI173 technological capability325; alternative approaches to formation35– 7; awareness24; building6, 24–30, 157, 159, 177–94, 203, 227, 236–44, 247–53, 287–314; changing requirements30–2; classification of18–23; and collective learning processes16; defined17–18; dynamics of30–5; and export success331–3; and family kinship69; and FDI68, 326–9; historical practices30; Korean model121, 126–35; linear conception of building6; and macroeconomic stability24–5;

and market forces27–30; as non-linear, interactive process333– 5; and OEM production63; and overseas Chinese67–8; and personal connections63, 67; and policy dynamics25–7; reconceptualization of326; sequencing patterns32–5 technological change74–5, 80, 335–6 technological learning15–16, 126, 326; formal16; informal training16; non-formal16; public element of14–15; tacit, firm-specific element of15 technology: absorption16–17; access to6, 15; accumulation211; acquisition131–2, 211, 312; debates concerning5–7, 11–12; local6; mastery6; transfer6, 16, 19, 59, 290, 328, 334 technology diffusion16–17, 121–2, 327; investment inducement22; knowledge spillover21; learning facilitation21 textile industry331–2; and automation73; challenges to52, 54, 254–6; and competition106–12; and downstream firms81–2; education/ training in73–4, 97, 107, 181–2, 206, 244–5, 256, 289–90, 291; and exports72–7, 95–6, 241–2; and failure to modernize100–6, 108; and financial subsidies/incentives75; growth/development of51–2, 54–5, 57– 8, 75–7; historical experiences104–5, 106, 236– 8; and in-house design81; and in-service training73–4; and innovation102, 317; and investment101–6, 109, 177, 181–4, 204, 295, 299–300;

INDEX 341

and joint ventures97, 100, 164, 183, 215, 236, 242, 243–4, 299, 300–2; labour in80, 100–1, 104, 108; linkages in256; and marketing97, 100, 110, 167, 182, 184–5, 194, 198–9, 204, 242; policy dynamics100–6; pre-in vestment/ project execution in236, 238; problems in72, 80–2; production capabilities in95–6, 97, 167, 177, 181–4, 238, 242–3, 295; and quota system73; R&D in107, 141–2, 205, 290, 291; role of52; strategy in72–3, 254–6; strengths and weaknesses in244–5, 317; structural changes in53–4, 57, 103–6; technological capability-building in72– 7, 96–7, 100, 236–8; and technological change74–5; and technological cooperation74; and use of subcontractors105, 106, 107– 8, 109, 110, 111; see also clothing industry; textile/clothing industries textile/clothing industries328, 330; adjustments by194, 196–7, 199; basic features236; effect of war on270–1; and exports163, 166–8, 218–19, 241–2, 270–80, 275–9; financial policies in243, 245; and foreign partnerships299, 300–2; and government policy278; growth/ development of162, 203–5, 215–21; impact of incentive systems on165–8, 215–21, 241–4, 256, 270–80; and investment204, 272, 278, 300; linkages in165–6; market focus313; minor changes in184, 237, 242, 295, 300; modernization of204–5;

organizational changes in companies established between 1976– 1986293–9, 302; pre-investment in299; private entrepreneurship and companies established after 1986299– 302; production increases in273–5; and quota systems219–20; R&D in273; reforms in272–3; restrictions on164–5; shortage of trained personnel in164; strengths/ weaknesses of279–80; structure of162, 164–5, 215; and tariff protection218; technological capability-building in241–4, 287, 289–302; upgrading of companies established before 1975289–93, 302; see also clothing industry; textile industry TG4, as leading fence-breaking case296–8 TG9, as foreign-supported private enterprise301–2 TGI, as successful transformer292–3 Thailand157–9; development of electronics industry in168–73; development of textile/clothing industries in162–8, 203; economic overview159–61; effects of incentive system on export performance in175–7; effects of incentive system on industrial structure in173–5; export boom/FDI in161; export promotion/structural adjustment in160–1, 203; import-substitution industrialization in159–60, 202; land speculation in207; new challenges to sustained export success in194–202, 203–4, 206–7; technological capability-building in177–94, 203–6 TVTEC, and learning-by-doing191

342 INDEX

UNCTAD12, 46, 157 UNIDO279, 282, 283, 284 Union of Enterprises for Electronics and Informatics (Viettronics, Viet Nam)281, 283 United States National Science Foundation22 Viet Nam: adjustment to market economy314; challenges to sustained export performance in315–20; and contacts with foreign firms314; education and training in312; electronics industry in280–6, 302–12, 313–14, 317; and exploitation of expatriates299, 312; financial assistance in314; and foreign contacts314; government policies in315–16; and human resource development316; impact of incentive system on development and export performance270–86; legal/ institutional infrastructure in316; macroeconomic environment of315– 16; as market economy291, 314; market focus of313; political divisions in266–7; private enterprises in299; R&D in313; reforms in268, 282, 290; responses to market pressures in318– 19; smuggling in317–18; stages of industrialization in266–70; structural changes in268–9; technological capability-building in287–312; textile/clothing industries in270–80, 287–302, 317; uncertainties in316–17; and unification281 Viet Nam Electronics and Informatics Corporation (VEIC)283

Vietnam Garment Manufacturing and Trading Corporation273 Von Hippel, E.23 Vu Cao Dam269, 278 Wade, R.7, 27 Wall Street Journal285 Westphal, L.E.7, 90, 92, 136; et al89 Wong Poh Kam21, 124 Wongkanlayanut, A.160 World Bank88, 97, 103, 161, 215, 218 Wymenga, P.S.J.217, 218 Young, A.1