Local Economies and Global Competitiveness

Local Economies and Global Competitiveness

Also by Bruno Dallago YOUTH ENTREPRENEURSHIP AND LOCAL DEVELOPMENT IN CENTRAL AND EASTERN EUROPE REGIONAL DIVERSITY AND LOCAL DEVELOPMENT IN THE NEW MEMBER STATES

Local Economies and Global Competitiveness Edited by

Bruno Dallago and

Chiara Guglielmetti

Editorial and selection matter © Bruno Dallago and Chiara Guglielmetti 2010 Individual chapters © Contributors 2010 All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission. No portion of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, Saffron House, 6–10 Kirby Street, London EC1N 8TS. Any person who does any unauthorized act in relation to this publication may be liable to criminal prosecution and civil claims for damages. The authors have asserted their rights to be identified as the authors of this work in accordance with the Copyright, Designs and Patents Act 1988. First published 2010 by PALGRAVE MACMILLAN Palgrave Macmillan in the UK is an imprint of Macmillan Publishers Limited, registered in England, company number 785998, of Houndmills, Basingstoke, Hampshire RG21 6XS. Palgrave Macmillan in the US is a division of St Martin’s Press LLC, 175 Fifth Avenue, New York, NY 10010. Palgrave Macmillan is the global academic imprint of the above companies and has companies and representatives throughout the world. Palgrave® and Macmillan® are registered trademarks in the United States, the United Kingdom, Europe and other countries. ISBN 978–0–230–25272–1

hardback

This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources. Logging, pulping and manufacturing processes are expected to conform to the environmental regulations of the country of origin. A catalogue record for this book is available from the British Library. Library of Congress Cataloging-in-Publication Data Local economies and global competitiveness/edited by Bruno Dallago, Chiara Guglielmetti. p. cm. Includes bibliographical references and index. ISBN 978–0–230–25272–1 1. Economic development. 2. Economic policy. 3. Strategic planning. 4. Competition. 5. Globalization—Economic aspects. I. Dallago, Bruno, 1950– II. Guglielmetti, Chiara. HD82.L53 2010 338.9—dc22 2010027502 10 9 8 7 6 5 4 3 2 1 19 18 17 16 15 14 13 12 11 10 Printed and bound in Great Britain by CPI Antony Rowe, Chippenham and Eastbourne

Contents List of Tables, Figures and Maps

vii

List of Contributors

x

List of Abbreviations

xiii

Introduction: Local Economies and Global Competitiveness Bruno Dallago and Chiara Guglielmetti 1 Context and Proximity in Competitiveness and Cohesion: Theoretical and Empirical Challenges Chiara Guglielmetti Part I

Territories, Development and Competitiveness

1

15 43

2 Globalization and Local Economic Growth in South Africa Wim Naudé, Waldo Krugell and Marianne Matthee

45

3 Provincial Systems of Innovation and Globalization in South Africa Mario Scerri

75

4 Institutional Approach in China’s Local Development: The Cases Studies of Jiangsu and Zhejiang Zhikai Wang

95

5 Cluster Development in Hungary: Searching for a ‘Critical Mass’ of Business via Cluster Mapping Miklós Szanyi, Ichiro Iwasaki, Péter Csizmadia, Miklós Illésy, and Csaba Makó 6 Local Government Corruption in Hungary Zoltán Szántó, István János Tóth and Tünde Cserpes 7 Cluster Identification, Firm Culture and Cooperation Activities in a European Metropolitan Region: The Case of Nuremberg Lutz Eigenhüller, Stefan Fuchs, Nicole Litzel and Joachim Möller 8 Beyond Commons: New Perspectives and Roles for Common Properties Alessandro Gretter, Ilaria Goio, and Geremia Gios v

113

134

154

175

vi

Contents

Part II

Firms, Context and Proximity

191

9 Innovation Driven Growth: Analytical Issues and Policy Implications Pier Carlo Padoan

193

10 The Social Impact of Innovation at the Local Level: Microsoft Corporation and Grameen Bank Zoltan J. Acs, Connie L. McNeely and Joseph Sany

209

11 The Public Interest in Economic Development and Creativity: A Knowledge Governance Perspective Silvia Sacchetti and Roger Sugden

232

12 Global Sourcing and Business and Social Networks: Quality Heterogeneity and Firms’ Efficiency Giuseppe Vittucci Marzetti, Maria Luigia Segnana and Chiara Tomasi

242

13 Does Outsourcing Increase Labour Productivity? Evidence for a Local Production System in Emilia Romagna (Italy) Sandro Montresor, Davide Antonioli, Massimiliano Mazzanti and Paolo Pini

257

Index

280

List of Tables, Figures and Maps Tables 2.1

Sigma convergence in South Africa 1990–2000

54

2.2

Employment creation in South Africa’s cities, 1996 and 2001

64

3.1

Gross Geographic Product (GGP) for by province

84

3.2

Percentage contribution to industrial output by sector and province (2004)

85

Percentage of the population aged 20 years and above by province and educational level, 2001

86

Human Development Index by province and population group, South Africa, 2003

88

3.5

Net migration by province for 1996 and 2001

89

4.1

Views of development in the ‘Wenzhou Model’ and the ‘South Jiangsu Model’

103

FDI inflows in selected cities in the provinces of Jiangsu and Zhejiang, 1999

107

FDI inflows in selected cities of the Yangtze River Delta, 2005

108

Results of cluster mapping in Hungary using the 2005 census data

124

6.1

Summary of typical areas of corruption

141

6.2

Summary of typical actors in corruption situations

143

6.3

Causes of corruption

148

6.4

Consequences of corruption

149

6.5

Suggestions on how to counter corruption

149

7.1

Overview of the criteria for cluster identification and how strongly they are fulfilled by different fields in the reference region

162

8.1

Value expressed by the utility flow of forest functions

182

8.2

Utility flow generated by forest and pastures

183

3.3 3.4

4.2 4.3 5.1

vii

viii List of Tables, Figures and Maps

13.1

Regression results: Outsourcing dummies per activity, 2002–5; 2002; 2005

265

13.2

Regression results: Outsourcing intensity per activity, 2002–5

268

Regression results: Outsourcing intensity per activity, 2002 and 2005

270

13.4

Reggio Emilia: Representativeness of the sample

273

13.5

Descriptive statistics and variable construction (116 observations)

275

13.3

Figures 2.1

Basic outline of South Africa and urban agglomerations

49

2.2

Density of per capita GDP (1996, 2000, 2004)

56

5.1–5.2

Potential clusters in the processed food, apparel, automotive, and communications equipment industries in Hungary, 2005

127

6.1

Suspected corruption cases by actor type, 2001–7 (%)

142

6.2

Suspected corruption cases by sectors, 2001–7 (%)

143

6.3

Suspected corruption cases by sectors, 2001–7 (%)

144

6.4

Suspected corruption cases by institution involved, 2001–7 (%)

145

Suspected corruption cases by procedure involved, 2001–7 (%)

146

7.1

The complexity of cluster-related aspects

157

7.2

The Federal State of Bavaria

160

7.3

Answers to the question: ‘Has your company already cooperated with the following partners?’

165

Cooperation activities of differently sized companies with other companies, universities and universities of applied science as well as with networks and initiatives

166

6.5

7.4

7.5

Cooperation activities of active and potential members of regional clusters and firms with no connections to clusters

167

7.6

Obstacles and problems in joining a cluster

168

List of Tables, Figures and Maps ix

7.7 Differently strong interlinkages between clusters

169

8.1 Ecosystem services and human well-being (adapted from De Groot et al., 2002)

180

11.1 Governance of, and interests in, economic development

236

12.1 Critical points of n when ␧ ⬎ 2

253

Maps 5.1 5.2

Regional administration units of Hungary: Comitats (NUTS-3)

129

Regional administration units of Hungary: Regions (NUTS-2)

129

List of Contributors Acs, Zoltan J. School of Public Policy, George Mason University, US Antonioli, Davide Department of Economics, Institutions and Territory (DEIT), University of Ferrara, Italy Cserpes, Tünde Eötvös Loránd University (ELTE), Budapest, Hungary Csizmadia, Péter Institute of Sociology, Hungarian Academy of Sciences (HAS), Budapest, Hungary. Eigenhüller, Lutz IAB Institute for Employment Research, Nuremberg, Germany Fuchs, Stefan IAB Institute for Employment Research, Nuremberg, Germany Gios, Geremia Department of Economics, University of Trento, Italy Goio, Ilaria Department of Economics, University of Trento, Italy Gretter, Alessandro IASMA Research and Innovation Centre, Fondazione Edmund Mach, Trento, Italy Illésy, Miklós Institute of Sociology, Hungarian Academy of Sciences (HAS), Budapest, Hungary Iwasaki, Ichiro Institute of Economic Research Hitotsubashi University, Tokyo, Japan Krugell, Waldo School of Economics, North-West University (Potchefstroom Campus), South Africa x

List of Contributors xi

Litzel, Nicole University of Regensburg and IAB Institute for Employment Research, Nuremberg, Germany Makó, Csaba Institute of Sociology, Hungarian Academy of Sciences (HAS), Budapest, Hungary Matthee, Marianne School of Economics, North-West University (Potchefstroom Campus), South Africa Mazzanti, Massimiliano Department of Economics, Institutions and Territory (DEIT), University of Ferrara, Italy Möller, Joachim University of Regensburg, IAB Institute for Employment Research, Nuremberg and IZA, Germany Montresor, Sandro Department of Economics, University of Bologna, Italy Naudé, Wim World Institute for Development Economics Research (WIDER), United Nations University, Helsinki, Finland McNeely, Connie L. School of Public Policy, George Mason University, US Padoan, Pier Carlo OECD and University of Rome, Italy Pini, Paolo Department of Economics, Institutions and Territory (DEIT), University of Ferrara, Italy Sacchetti, Silvia Stirling Management School, University of Stirling, UK Sany, Joseph School of Public Policy, George Mason University, US Scerri, Mario Institute for Economic Research on Innovation (IERI), Faculty of Economics and Finance, Tshwane University of Technology, South Africa

xii List of Contributors

Segnana, Maria Luigia Department of Economics, University of Trento, Italy Sugden, Roger Stirling Management School, University of Stirling, UK Szántó, Zoltán Corvinus University of Budapest, Hungary Szanyi, Miklós Institute of World Economics, Hungarian Academy of Sciences (HAS), Budapest, Hungary Debrecen University, Faculty of Economics and Business Administration, Hungary Tomasi, Chiara Scuola Superiore Sant’Anna and University of Urbino, Italy Tóth, István János Institute of Economics, Hungarian Academy of Sciences (IE HAS), Budapest, Hungary Vittucci Marzetti, Giuseppe Department of Economics, University of Trento, Italy Wang, Zhikai School of Economics, Zhejiang University, China

List of Abbreviations ABC

Architecture, Building and Construction

ANOVA

Analysis of Variance

BSN

Business and Social Networks

CAP

Common Agricultural Policy

CIF

Cost, Insurance and Freight

CORIS

Cluster-Oriented Regional Information System

CPC

Communist Party of China

EC

European Commission

EMR

European Metropolitan Region

EU

European Union

FAO

Food and Agriculture Organization

FDI

Foreign Direct Investment

FIE

Foreign Investment Enterprise

GDP

Gross Domestic Product

GGP

Gross Geographic Product

GPT

General Purpose Technology

HAS

Hungarian Academy of Sciences

HDI

Human Development Index

IAB

Institute of Employment Research, Germany (in German Institut für Arbeitsmarkt – und Berufsforschung)

IBM

International Business Machines Inc

IC

Industrial Clusters

ICT

Information and Communication Technology

IDC

International Data Corporation

IMF

International Monetary Fund

IP

Intellectual Property

IT

Information Technology

JHB

Johannesburg xiii

xiv List of Abbreviations

KZN

KwaZulu-Natal

LPS

Local Production System

MA/MEA

Millennium Ecosystem Assessment

MAR

Marshall-Arrow-Romer externalities

MNC

Multinational Corporations

MNE

Multinational Enterprises

NACE

Statistical Classification of Economic Activities in the European Community (in French: Nomenclature statistique des activités économiques dans la Communauté européenne)

NEG

New Economic Geography

NGO

Non-Governmental Organization

NUTS

(EU) Nomenclature of Territorial Units for Statistics

OAP

Offshore Assembly Program

OECD

Organization for Economic Cooperation and Development

OEM

Original equipment manufacturer

PANAC

Pannon Automative Cluster

PES

Payment for Ecosystem Services

PHARE

French: Poland and Hungary Assistance for Economic Restructuring Programme (in French: Pologne Hongarie Assistance à la Reconstruction des Economies)

PIMSS

Provincial Information Management Support System

PR

Public Relations

R&D

Research and Development

RCA

Revealed Comparative Advantage

RE

Reggio Emilia

REX

Regional Economic Explorer

SME

Small and Medium-sized Enterprises

SSA

Sub-Saharan African

TCE

Transaction Cost Economies

TFP

Total Factor Productivity

List of Abbreviations xv

TVE

Township and Village Enterprise

UR

University of Regensburg

USA

United States of America

VAC

Voluntary Action Cumbria

WTO

World Trade Organization

This page intentionally left blank

Introduction: Local Economies and Global Competitiveness Bruno Dallago and Chiara Guglielmetti

This book1 is concerned with the factors that shape the local ability to withstand, cope with and benefit from the increasing openness of the economy and focuses on the interplay between local and global dimensions, which constitutes the role of local capacities, opportunities and constraints. Amidst a growing concern about territorial competitiveness over the recent decades, and in a context of increasing globalization and keener international competition, local competitiveness has been attracting considerable research and policy interest. An academic and political demand for a broader and deeper knowledge of the interaction between local, national and global forces, as well as for the identification and the assessment of viable institutional framework and policy options, have strongly come out. This book has been developed in response to these demands, and maintains that the globalized economy relies critically on factors which are localized and context specific. Pivotal determinants can be found at the local level which boost or hinder the economic performance of firms and the socio-economic development of territories. Consequently, there is the necessity of combining sound economic principles with local capabilities and constraints, tailoring institutional arrangements and policies to distinctive local needs. The volume builds on the combination of academic research and political analysis in addressing two intertwined levels of analysis, local economies and firms. It draws primarily on an economic approach, taking at the same time advantage of the contributions offered by other disciplines, notably by sociology. The book includes contributions dealing with the way in which the basic assets of an economy and a society – institutional setting, 1

2

Introduction

organizational solutions and knowledge, particularly when applied to innovation – lead to global competitiveness, and hence superior economic performance and social well-being, by upgrading local development. This is under the constraint of negative assets, of which the book considers particularly corruption, and the effect of the accelerated change of the basic assets themselves and their interaction, namely transformation. The book deals with these issues both theoretically and methodologically, and by devoting individual chapters to case studies of particular importance or significance. The single contributions employ different analytical tools and frameworks. The perspective adopted implies that the analysis of specific case studies, within a solid theoretical framework, represents a substantial contribution to the development of the field, a powerful tool to investigate processes of change and to explain and shape the local competitiveness. The case studies the book deals with refer to different levels of development: the Nuremberg region in Germany and the province of Reggio Emilia in Italy, two highly developed economies; the provinces of Jiangsu and Zhejiang in China and South Africa, two middle income emerging global actors. These are all important cases of local development and are, to a different extent, leading players both in their own continent and in the global scenario. Furthermore, the book considers three countries, China, Hungary and South Africa, which represent paradigmatic cases of different transformation strategies and paths with distinct outcomes. In all of them local development has been and still is a critical strategy for enhancing national competitiveness, in a context of high internal spatial disparities.

I.1 Plan of the book In the first chapter, ‘Context and Proximity in Competitiveness and Cohesion: Theoretical and Empirical Challenges’, Guglielmetti frames the problem, critically discussing the complex and debated linkages between theoretical premises, methodological choices and political responses around the concept of local competitiveness. Being addressed by competing paradigms which deal with economy in space rather than by dominant orthodoxy, local competitiveness remains a disputed, yet critical issue in the literature. The chapter throughly analyses the notion, the determinants and the measurement of local competitiveness, discussing whether and how heterodox approaches – notably institutional, evolutionary and structural realist approaches – and mainstream economics have dealt with the territorial context in which the

Bruno Dallago and Chiara Guglielmetti 3

agents act. As far as mainstream economics is concerned, the author first reviews the deep scientific tradition of spatial economics which developed from the early nineteenth century, failing to gain acknowledgement among the economics profession until Krugman’s seminal paper (1991). Guglielmetti then critically considers the emergence since the 1990s of bodies of literatures which are increasingly accounting for the spatial aspects of the economy, notably New Economic Geography, as well as for the role of history in economic development. The chapter argues that what is needed is a clear distinction between the competitiveness of firms, local economies, and national systems, as well as a greater attention by research and policy on local contexts. The latter, however, entails the following pivotal issues which need to be considered by public policy not only in dynamics internal to local economies, but also across different localities: the potential trade-off between national growth and spatial equity, the relative and dynamic nature of competitiveness, and the combined and counterintuitive effects of agglomeration and dispersion forces. I.1.1 Part I – Territories, Development, and Competitiveness Chapter 2 by Naudé, Krugell and Matthee, and chapter 3 by Scerri open the first part of the book, addressing the tension between national growth and sub-national inequality. The chapters focus on the spatial distribution of economic activities in South Africa, on how national growth relates to it as well as on how policies, institutions and first and second order geographical determinants influence growth and equity. Chapter 2 sheds light on the local economic development in South Africa, following the growing literature on spatial inequalities in developing countries, and, in particular, the World Bank (2009) distinction between economic integration policies in the urbanization, territorial development and regional economic dimensions. South Africa is a notable case study, given the country’s emerging role in the global scene, its significant steps towards integration in the global economy, trade liberalization and the strengthening of local governance after the democratic elections in 1994 and the ending of apartheid. Furthermore, the availability of consistent and reliable socio-economic data at the sub-national level represents an exception among developing countries, in particular as far as Sub-Saharan Africa is concerned. Naudé, Krugell and Matthee use data from integrated databases known as the Regional Economic Explorer on 354 magisterial districts. Estimating the degree of convergence or divergence that has taken place in per capita incomes from 1994 to 2004, they find that spatial inequality is a persistent feature

4

Introduction

of the country’s economy. They employ the most widely used methods to test spatial inequality, namely beta convergence, sigma convergence, kernel density analyses and Markov chain in order to complement the previous analyses by examining the dynamics of the spatial income distribution in terms of its intra-distributional dynamics. They also analyse the size, functions, integration and labour market of South African cities, and conclude that improving the structure, functioning and competitiveness of cities is one of the most critical development strategies to be pursued. The chapter furthermore analyses how South Africa’s spatial economy depends on international trade, and notably on exports into international markets, examining the impact of greater openness and exports on local economic growth rates. The authors consider ‘both institutional and geographical determinants of local economic growth, and […] policies and interventions to increase economic integration in manner which may promote both (uneven) growth and inclusive development’ through investments in human capital, transport services and infrastructure, and in urban planning. The chapter offers an indepth analysis of spatial socio-economic development patterns in South Africa, substantially contributing to fill the vacuum of studies on local economic development in Sub-Saharan African countries and to identify and critically analyse policy options. In line with the previous chapter, in ‘Local Systems of Innovation and Globalization in South Africa’, Scerri addresses the institutional framework which emerged after 1994. Drawing on the literature on regional systems of innovation, the chapter focuses on the linkages between the current administrative design of South African provinces and the development patterns shaped by the apartheid planning system. The chapter critically examines whether the current institutional arrangement is capable of addressing the most compelling issues related to the distribution of economic activities and discusses the impact exerted by the pre-1994 deep ethnic and spatial socio-economic inequality on the current performance of different local economies. The debate around the ‘need to pursue entrepreneurship and innovation policies that reflect […] distinctive local characteristics’ (OECD, 2009, p. 13) acquires a particular relevance in transformation economies. In this book we employ the term ‘transformation’ instead of the most common ‘transition’, which refers to a process in which the starting point, the goal to be pursued and the path leading from the former to the latter are clearly defined. A growing body of literature (Dallago and Uvalic, 1998; Dallago and Guglielmetti, 2010) argues that transformation is a complex and uncertain process of structural, institutional

Bruno Dallago and Chiara Guglielmetti 5

and socio-economic change, in which substantial is the role played by path-dependent and interdependent trajectories which do not end in a pre-defined equilibrium. Chapters 4 and 5 address two paradigmatic case studies: China and Hungary. Chapter 4 by Wang analyses whether and how localized and context specific development patterns have influenced the national economic performance of China, the transformation country which has by far experienced the most rapid economic growth in the global scene since the late 1970s. Wang analyses two nearby areas of the Zhejiang province, the so-called South Jiangsu and the Wenzhou models, which emerged in the last 30 years as distinct development patterns as far as institutional, socio-economic, technological and organizational arrangements are concerned. Being both highly successful and idiosyncratic examples of economic development, they have been at the centre of the national debate on transition to market development. The author contends that Chinese successful transformation hinges critically on the local dimension, and that cooperation and mutual influence between distinct local development patterns is necessary to boost economic development and respond efficiently to international competition. Transformation to market economy in Central and Eastern Europe, as well as in the former Soviet Union, was indeed initially implemented as a narrowly defined and technically circumscribed problem-solving process. It largely disregarded institutions, particularly at the microlevel, and had a dominant quantitative regard to – but hardly any qualitative concern for – local problems and idiosyncrasies. It was thus aimed primarily, if not exclusively, at applying sound, standard general principles of economics and management to reach well-defined general goals in a non-standard context. Szanyi, Iwasaki, Csizmadia, Illésy, and Makó in Chapter 5 focus on the detection and the analysis of industrial clusters in Hungary. The chapter presents the outcomes of an Hungarian-Japanese joint project on ‘Multinational and Local Resources’, carried out by the Institute of Economic Research at the Hitotsubashi University and by the Hungarian Academic of Science. The analysis draws on the literature on industrial clusters as well as on the literature on foreign direct investments, with particular concern to FDIs spillover effects on productivity and export propensity of domestic firms. The authors use Porter’s cluster mapping methodology to detect clusters, to analyse their specialization, composition, structure, competitive and cooperative mechanisms and evolution over time. With respect to previous cluster mapping in the area, based on employment regional data, they adopt a finer spatial

6

Introduction

focus (NUTS-3) and use a more varied set of data, such as number of entreprises, value added, cumulated investment along with number of employees. The authors draw four important implications from their cluster mapping and analysis. First, there are complex and intertwined legacies between the pre-tranformation and the current spatial distribution of economic activity, which show how economic development has been strongly path-dependent. Second, and consequently, it is crucial to foster these context specific and localized characteristics to sustain and enhance local competitiveness. Third, FDIs and MNEs exerted and still exert an important role in the agglomeration processes and in the distribution of economic activity in Hungary. However, they argue that the structure and the organization of clusters in Hungary greatly varies. Along with vertically integrated networks, in which MNEs are pivotal actors, there are clusters in which horizontal linkages between small and medium sized entreprises are strong. Finally, the authors contend that this complex picture calls for tailored solutions in cluster development policies. Chapter 6 by Szántó and Tóth is an interesting complement to the analysis carried out in Chapter 5. Drawing on empirical research of the Corruption Research Centre of the Institute for Sociology and Social Policy at Corvinus University of Budapest, the chapter contributes to the understanding and the explanation of different corruption transactions in Hungary. Rather than relying on perceptions, the authors focus on actual corruption mechanisms through a combined methodology based on in-depth interviews, concept analysis and media content analysis. The detection of players, motivations and mechanisms at work lead the authors to identify the local level as critical in the structure as well as in the penetration of business corruption, with relevant implications as far as institutional and political solutions are concerned. Chapter 7 by Eigenhüller, Fuchs, Litzel and Möller is concerned with cluster identification and analysis, in line with the study carried out in Chapter 5. The authors develop a methodology to identify and analyse clusters in an economic area, applying it to a critical European economic area: Central Franconia in Germany. The chapter presents the results of the research project ‘Clusters and Inter-Firm Networks in the Region of Nuremberg’, a joint work of the Institute of Employment Research (IAB) and the University of Regensburg. There are three main hypotheses on which their approach is rooted. The first is the viability and the policy relevance of a comprehensive economic analysis, notwithstanding the intrinsic fuzziness of the notion of cluster, ‘a black box with no sharp outlines, unknown size and unspecific complexity’. The

Bruno Dallago and Chiara Guglielmetti 7

‘links to well-established methods of economic theory’ allow one ‘to try and shape a comprehensive picture’. However, the authors argue that this picture needs to account for the considerable differences between the structures of clusters. Consequently, their second hypothesis is that data collection and analysis should be designed and employed with the aim of depicting ‘a concise picture of the individual regional clusters’. The third hypothesis is the importance of combining the different methods to approach clusters. They develop a methodology based on semi-structured interviews with experts from institutions and companies, and a company survey in cluster-relevant industries and services along regional supply chains. A set of five criteria is used to check whether fields of functional specialization can be considered as working clusters or as supply chains with potential for clustering. These criteria are concentration in space, labour market pooling, existence of ‘leading companies’, of supporting institutions and network activities. For the late 1990s the authors present evidence that clusters are not isolated conglomerates in their respective fields, but are interlinked, although to different extents. The authors account for vertical integration, diagonal links – which are, for example, links to research institutions and service partners – and horizontal links between companies. Cooperation between companies as well as between companies and institutions, in terms of joint activities with other companies, universities, research institutes or other institutions within or outside the region, is detected as pivotal and investigated in depth. A key aspect that emerges throughout the aforementioned contributions is the significance of the local level of analysis in order to detect and explain the distribution of economic activity, its effectiveness and evolution. The mechanisms that allow some local economies to perform better are often localized and context specific, taking forms, and occuring through channels which can be heavily idiosyncratic and that consequently interplay differently with global dynamics. The importance of responsiveness to context specific features in designing robust and effective institutions is argued by a vast literature on common pool resources (CPRs)2 management. The development potential of the CPRs has remained under-investigated in research as well as in policy. Yet, there is a growing awareness in literature (Ostrom et al., 1999; Prakash, 1998) of the necessity for a deeper understanding of the problems and the opportunities related to their management. Theoretical and empirical studies have been developed in the last two decades which reassess the sharp dicotomy between private and public goods, departing from the literature which followed the seminal

8

Introduction

paper by Hardin (1968). This entails a theoretical and methodological rethinking of how the key features of rivalry and non-exclusion should be addressed, and of how allocation systems capable of distributing benefits and burdens across heterogeneous groups should be designed. Moreover, literature is emerging which stresses how long-term commons management is likely to entail positive social dynamics which are fungible or transferable across entreprises. Prakash (1998) points out that social capital can typically be embedded in both horizontal ties within local institutions and vertical ties across resources scales. In Chapter 8, Gretter, Goio and Gios contend the importance of policy solutions and institutional arrangements which facilitate effective commons management, claiming the pivotal role of the local level in this process. The problems raised by, as well as the potentials of, traditional management systems are pointed out. Crucial here is to identify how different institutional arrangements deal with the two fundamental aspects of the management of the commons: restriction of access and creation of incentives. The chapter surveys how the issue of the commons has been addressed in economics, analysing the main findings of the literature on local commons and the related policy frameworks. The total economic value (TEV) method is identified by the authors as a powerful tool whose potentials need to be further developed. Employing TEV in common pool resources management, they argue, allows one to effectively give account of the complex and interdependent set of values embedded in local resources. I.1.2 Part II – Firms, Context, and Proximity The second part of the volume focuses on the firm level, aiming at catching the processes and the evolution of the role of the firm as an agent of socio-economic change, firmly embedded at the local level and, at the same time, strongly engaged in global dynamics. Chapters 9, 10 and 11 consider innovation in products and processes (Chapter 9 by Padoan and Chapter 10 by Acs, McNeely and Sany) and in governance (Chapter 11 by Sugden and Sacchetti), taking also into consideration the socio-economic impact of innovation at the local level (Chapters 10 and 11). Chapter 9 by Padoan depicts an analytical model aimed at analysing the processes of innovation which have interested the firm in recent years, both from an internal perspective and from the perspective of the interaction of the firm with the external environment. The author contends the necessity of developing a new innovation paradigm capable of mirroring four critical elements of innovation processes. First,

Bruno Dallago and Chiara Guglielmetti 9

the openness of innovation, which entails both collaboration and competition among innovative actors. Second, the new geography of innovation, based on the deep interaction between the global and the local dimensions. Third, the role of intangibles and non-technological innovation, and, fourth, the increasing importance of technological platforms, such as ICT, ‘that are becoming just as important as, or even more important than, “framework conditions” in fostering innovation’. Padoan argues that a systemic approach to innovation is required which overcomes the limits of the traditional, growth accounting, linear relationship between innovation and growth. The linkages among the variables and the interacting channels of innovation diffusion need to be taken explicitly into account. The chapter provides an interesting example in this direction, introducing a model in which the role of ICT is endogenized in the economic system. Important implications are drawn as far as the necessity to rely on diversified innovation policy instruments is concerned, as well as on the critical, yet far from clearcut, role of local and context specific features on innovation processes. Chapter 10 by Acs, McNeely and Sany focuses on a more specific aspect of innovation: its social impact, an issue which has been neglected in the literature on entrepreneurship and innovation and which is, at the same time, difficult to conceptualize and measure. The authors provide comparative case studies of the Microsoft Corporation and Grameen Bank as representative examples of, respectively, commercial and social entrepreneurship. The definition of social entrepreneurship employed in the chapter is based on three basic components: mission and goals, opportunities and means, and outcomes and social impact. According to this perspective, the Grameen Bank is an example of social entreprise despite being a for-profit firm. Both the organizations analysed have pursued scalable and radical innovation, are recognized as highly successful innovative ventures, and have had profound social impact. The motivations at the basis of those outcomes are however very different. The authors argue that the social impact of innovation, as well as the channels through which the local context drives innovation, are still imperfectly understood and therefore require further research. These are critical issues for the understanding of the impact of entrepreneurship on development processes. In Chapter 11, Sacchetti and Sugden introduce a critical perspective of the organization of production and of the related socio-economic outcomes. Adopting a strategic choice approach (Cowling and Sugden, 1998) and rooting their analysis in a Deweyan approach, which poses at the core a ‘public interest criterion for assessing the organization of

10

Introduction

production’ (Sacchetti and Sugden, 2009, p. 290), the authors argue the necessity for ‘societies, communities and territories’ to evolve a model of economic development aimed at responding to those interests. The authors distinguish between the direct participants in a strategic decision, who have private interests in the act, and multiple sets of actors significantly affected by specific strategic decisions, who have public interests in the act. They propose a range of models of governance whose extremes are direction and mutual dependence. The former is a hierarchical system that accomodates the private interests of few, while the latter is an ideal type which entails a participative, inclusive and deliberative process (Sacchetti and Sugden, 2009) in order to identify the interests of the public. Their main hypothesis is that the treatment of creativity3 – in the creation and use of knowledge as well as in strategic choices – is a pivotal factor in this process. The implications that derive from this perspective as far as geographical proximity, spatial development and localization of production are concerned are intriguing. First, the authors argue that mental proximity, which entails shared norms, values, and beliefs is a prominent determinant in explaining collective learning, innovation and creativity. Mental proximity does not necessarily require geographical concentration but is rather consistent with ‘virtual communities’ of actors (Sacchetti and Sugden, 2009). The authors thus share, but from a different perspective, the argument advanced by Padoan as far as the role of creativity and of co-location in innovation processes is concerned. However, the harmonization of the interests of the firm and the interests of the public can be pursued when firms are embedded in local systems in which cooperative, participative and communication dynamics are at play (Sacchetti and Sugden, 2003). Second, the agglomeration of economic activities in few growth poles, and the high concentration of power that derives from that process, hinders the development of societies, communities and territories that better serve the interests of the public. Finally, a spread development based on a diffuse use of creativity is strictly related to the coexistence of institutional variety, which can enable people to ‘shape production consistently with multiple, emerging values and needs […] Recalling a Veblenian argument, a multiplicity of institutional solutions is necessary if production governance is conceived in evolutionary terms’. This holds true also as far as enterprise’s types are concerned. Indeed, in Sugden and Sacchetti’s perspective, large corporations are less likely to fit a socio-economic system serving public interest.

Bruno Dallago and Chiara Guglielmetti 11

The last two chapters further analyse whether, how and to what extent proximity and context specific features influence firms’ performance and interaction at the local, the national as well as international levels. The chapters are concerned with the productivity impact of global sourcing (Chapter 12 by Vittucci Marzetti, Segnana and Tomasi), and of outsourcing broadly defined (Chapter 13 by Montresor, Antonioli, Mazzanti and Pini), thus departing from the majority of the literature on the issue. This has focused principally on detecting the determinants of outsourcing or on assessing its impact on the labour market, neglecting to some extent the effects on firms’ performance. In Chapter 12, Vittucci Marzetti, Segnana and Tomasi develop a model to analyse the costs and efficiency gains of firms’ global sourcing strategies, defined as ‘all subcontracting relationships between firms and their suppliers at an international level’. Global sourcing can increase firms’ productivity via the quality upgrading of intermediates, but, because of the heterogeneity of suppliers, it also increases screening costs given the need to search for good suppliers. The authors show that large firms can better exploit the potential gains from quality upgrading. Nevertheless, business and social networks make both the overall production and firms’ profitability increase via the reduction in firms’ unit screening costs. There are cumulative beneficial effects of these networks: thicker networks imply higher cost saving and thus further incentives to invest in network linkages. Finally, they propose a possible extension of the model to analyse the choice of local vs. global sourcing strategies and how their differences, in terms of costs, suppliers’ heterogeneity and degree of embeddedness in networks, affect firms’ choices and their efficiency. Montresor, Antonioli, Mazzanti and Pini in Chapter 13 draw implications that are related to those of the previous chapter, but from an empirical perspective. They develop a diachronic cross-section econometric model of the productivity impact of outsourcing, and apply it to a sample of firms based in a local production system, the province of Reggio Emilia in Italy. Two aspects are to be mentioned here. First, the chapter considers a sample of small and medium sized enterprises, which have been somehow neglected in favour of large firms in literature notwithstanding the pivotal, yet ambiguous role of outsourcing as a competitive strategy for small and medium sized enterprises. Second, the authors provide two direct indicators of outsourcing, rather than balance-sheet outsourcing proxies. Finally, the chapter considers firms which are based in a local production system, which are therefore embedded in localized and territorial specific institutional dynamics.

12

Introduction

Their aim is to test whether local embeddeddness results in different factors influencing the impact of outsourcing with respect to big companies, such as the specialization pattern of the local production system, its labour division and organization, and its innovative profile. At a general level, they argue that it is mainly the externalization of high value-added activities which can have an impact on productivity. Moreover, the productivity impact is enhanced when, by outsourcing, the firm enters into global value chains. The results change when accounting for the distinguishing features of the local production system, by considering the actual extent to which the different activities are externalized. High value-added activities are efficiently outsourced only through competent foreign suppliers. The externalization is conditioned and actually allowed by the internationalization of the outsourcing firm, showing widespread positive results ‘only when it overlaps with the system of relationships of which the local production system is made up of’. Indeed, in line with the previous chapter, their results confirm that firms’ embeddeddness in a local production system, characterized by idiosyncratic techno-economic and organizational features, influence to a significant extent the effects of outsourcing on their economic performance. At a general level, the single contributions of this project show that, in a world of increasing interdependence, growth and change do not occur in a homogeneous manner. They rather follow locally specified processes and dynamics which are the outcome of the complex interaction between sub-national, national and supra-national determinants. The governance of these processes requires the identification of institutional settings, organizational solutions and policies able to sustain adaptation and to support competitiveness, both of firms and of territories, amidst fast changing internal and external conditions. The relevance of policies capable of supporting competitiveness is enhanced by the fact that macro-policies are increasingly coordinated internationally and are therefore unable to adjust to asymmetric economic and social shocks, thus posing problems of open coordination and horizontal and vertical subsidiary. The book utilizes this common theoretical framework and, at the same time, brings together scholars with different theoretical backgrounds, and from different disciplines, identifying the most compelling questions and analysing the following broad and interlinked issues: a. the changing determinants of growth, competitiveness and development and the role played by proximity and by localized and context specific features (Chapter 1 by Guglielmetti, Chapter 3 by Scerri;

Bruno Dallago and Chiara Guglielmetti 13

Chapter 9 by Padoan, Chapter 11 by Sacchetti and Sugden, Chapter 10 by Acs, Chapter 12 by Vittucci Marzetti, Segnana and Tomasi, Chapter 13 by Antonioli, Mazzanti, Montresor and Pini); b. the firm in its systemic interactions, both competitive and cooperative, with other firms and with the institutional environment, taking into account the organization and the internal and external relations of clusters, firms’ networks and local systems of production, their source of competitiveness and their evolution over time (Chapter 5, Chapter 7 by Eigenhüller, Fuchs, Litzel and Möller, Chapter 12, Chapter 13); c. territorial concentration or dispersal of economic activity and their respective socio-economic outcomes at sub-national, national and supra-national level. Particular attention is devoted to the interaction among different localities (Chapter 1, Chapter 2 by Naudé, Krugell, Matthee, Chapter 3 by Scerri, Chapter 4 by Wang, Chapter 5 by Szany, Iwasaki, Czizmadia, Illésy, Makó, Chapter 11); d. institutional settings, organizational solutions and policies, analyzing the critical role played by the capability of responding to context specific features in designing effective institutions as well as giving account of the informal/unwanted/unforeseen outcomes of different institutional arrangements. Particular attention is devoted to path dependence and evolutionary processes in response to external stimuli (Chapter 1, Chapter 2, Chapter 3, Chapter 6 by Szántó, Tóth and Cserpes, Chapter 7, Chapter 8 by Gretter, Goio, Gios, Chapter 11).

Notes 1. The first idea of this volume was introduced in a conference on ‘Apparent Antithesis: Globalisation and Local Development’ promoted by the School on Local Development of the University of Trento, Italy, in collaboration with the OECD LEED Programme and the UNDP, and held at the University of Trento in October 2008. Eight chapters of this volume are substantially revised versions of papers presented at the conference (namely Chapters 2, 3, 4, 6, 7, 8, 10, 12). The others have been commissioned by the editors from the authors, which we thank for having joined this project. We greatly acknowledge the School on Local Development of the University of Trento, the OECD LEED Programme and the UNDP and Helen Licata for the language assistance. 2. CPRs are here defined, following Ostrom et al. (1999), as resource systems characterized by non-excludability and rivalry, regardless of the property rights involved. 3. Sacchetti and Sugden’s approach regards creativity as a crucial aspect which needs to inform the organization of production in general, thus differing

14

Introduction substantially from the recent debate on the relationship between culture, creativity and local development (Caves, 2000; Cooke and Lazzaretti, 2008; OECD, 2006).

References Caves, R. E. (2000) Creative Industries, Contracts between Art and Commerce (Cambridge, MA: Harvard University Press). Cooke, P. and L. Lazzaretti (2008) Creative Cities, Cultural Clusters and Local Economic Development (Cheltenham; Northampton, MA: Edward Elgar). Cowling, K. and R. Sugden (1998) ‘The Essence of the Modern Corporation: Markets, Strategic Decision-Making and the Theory of the Firm’, The Manchester School, 66(1), 59–86. Dallago, B. (2009) ‘The State and the Transformation of Economic Systems’ in S. Ichimura, T. Sato and W. James (eds) Transition from Socialist to Market Economies (Houndmills, Basingstoke: Palgrave Macmillan), pp. 164–87. Dallago, B. and M. Uvalic (1998) ‘The Distributive Consequences of Nationalism: The Case of Former Yugoslavia’, in Europe-Asia Studies, 1, pp. 71–90. Dallago, B. and C. Guglielmetti (2010) ‘The Missing Dimensions of Transformation’, mimeo, University of Trento. Hardin, G. (1968) ‘The Tragedy of the Commons’, Science, 162 (3859), 1243–8. Krugman, P. (1991) ‘Increasing Returns and Economic Geography’, The Journal of Political Economy, 99(3), 483–99. OECD (2006) Competitive Cities in the Global Economy (Paris: OECD Publishing). OECD (2009) Clusters, Innovation and Entreperneurship, eds J. Potter and G. Miranda (Paris: OECD Publishing). Ostrom, E., J. Burger, C. B. Field, R. B. Norgaard and D. Policansky (1999) ‘Revisiting the Commons: Local Lessons, Global Challenges’, Science, 284, 278–82. Prakash, S. (1998) ‘Fairness, Social Capital and the Commons: The Societal Foundations of Collective Action in the Himalaya’ in M. Goldman (ed.) Privatizing Nature: Political Struggles for theGlobal Commons (New Brunswick, NJ: Rutgers University Press). Sacchetti, S. and R. Sugden (2003) ‘The Governance of Networks and Economic Power: the Nature and Impact of Subcontracting Rlationships’, Journal of Economic Surveys, 17(5), 669–91. Sacchetti, S. and R. Sugden (2009) ‘The Organization of Production and its Publics: Mental Proximity, Market and Hierarchies’, Review of Social Economy, 67(3), 289–311. World Bank (2009) Reshaping Economic Geography: World Development Report (Washington, DC: The World Bank).

1 Context and Proximity in Competitiveness and Cohesion: Theoretical and Empirical Challenges Chiara Guglielmetti

1.1 Introduction The competitiveness of firms has acquired a global scope. This aspect goes well beyond direct market competition. Firms tend to be located in territories1 where they find the contextual specificities that allow for consolidation and growth. It is now widely acknowledged that institutional frameworks and localized and context specific externalities, that go beyond the boundaries of a firm, are pivotal determinants of the latter’s economic performance (Begg, 2002; Feldman, 2000; Glaeser, 2000; Kitson et al., 2004; Pitelis et al., 2006; Porter, 2003; Regional Studies, volumes 37(6&7), 2003, 38(9), 2004 and 40(2), 2006; Scott, 2001). The notion of competitiveness has entered the spatial level of analysis, focusing the academic and political debate on localities as key domains for economic growth and development. Starting from the work of Beccattini (1975), Bagnasco (1977) and Piore and Sabel (1984) on industrial district approaches, economic geography ceased to be considered a ‘second-order empirical topic for social sciences’ (Storper, 1997a, p. 3). Furthermore, Sylos Labini’s work (1966, 1970, 1981, 1983a, 1983b, 1990) on development and innovation has deeply influenced the Italian and international debate upon the critical role of context in development studies, as well as upon the fundamental linkages between history and economics.2 By now the role of public policy in enhancing local competitiveness is widely acknowledged in the literature. Yet, both theoretical foundations and evaluation tools of local development policies are far from clear-cut: ‘there is an elusive concept, flawed indicators and over-prescribed policies’ (Kitson et al., 2004, p. 992). There is broad recognition of proximity and localization as important drivers 15

16

Context and Proximity in Competitiveness and Cohesion

of growth and development; however, firms and territories are often understood as similar in competing for global market shares. This is a critical issue. Furthermore, in regional development analysis the rationale of non-economic features, such as social cohesion, well-being and cultural and human capital, is often unclear, alternating between being a driver of economic development and an outcome to be pursued. The tension between economic efficiency and productivity, on the one side, and spatially balanced development, on the other is a key issue to be addressed by public policy. The discussion centres on territorial concentration or dispersal of economic activity and their respective outcomes at sub-national, national and supra-national level.3 The emerging body of research on the country’s spatial development points out rising spatial polarization of economic activity, incomes, and standards of living at the sub-national level (Kanbur and Venables, 2005; Redding and Venables, 2001, 2004; Venables, 2005). The levels and trends in spatial inequality can be explained by the capacity of local economies to develop as well as to withstand, cope with or recover from exogenous shocks. As Storper (1997b) points out, a fundamental research aim should be to remap the global economy in the light of the tension between territorialization and deterritorialization of economic activities (see also Camagni, 2002; Scott, 2001). In the late 1960s, Myrdal (1957) was already theorizing the fundamental role played by public initiative in containing spatial inequality. His cumulative causation framework partakes of the tension between centripetal and centrifugal forces and, as noted by Meardon (2001), is part of an alternative research programme to mainstream economics counting on public policies in overcoming rising spatial inequality. While regional competitiveness and spatially balanced development tend to overlap in the political discourse (European Commission, 1994, 1999, 2001, 2004, 2007), it is crucial to maintain in principle distinct concepts in connecting the analysis of spatial disparities to that of local development. Three main premises for research and public policy arise here. First, there is a potential trade-off between national growth and spatial equity. The World Bank (2009) has addressed this issue, stating that economic growth is per se an unbalanced process, which is hampered by the spread of economic activity, and that inclusive development can be separately pursued through economic integration. The recent emergence of dynamic models in the New Economic Geography, such as the local spillover (LS) model, suggests a more complex relationship (Baldwin et al., 2003). For example, policies that reduce congestion and enhance knowledge spillover among regions may mitigate the trade-off,

Chiara Guglielmetti

17

being both pro-growth and pro-equity. The LS model, moreover, points out that these policies can have a remarkably non-linear effect, starting to contribute to innovation and growth in lagging regions only after a threshold is passed. Second, competitiveness is by definition a relative and dynamic concept. Design, implementation and evaluation of policies thus need to be developed in a comparative and dynamic perspective. The main issue at stake is the critical role that positive and negative external economies play, driving circular causation effects which are likely to result in lasting spatial disparities, or, in other words, the relative position of local economies within a changing and interrelated environment. While the evolutionary approach to economic geography adopts a dynamic perspective, many studies on territorial competitiveness are based on static representations. Third, the combined effects of agglomeration and dispersion forces as well as counterintuitive effects of policy options need to be taken into account not only in internal regional dynamics, but also across different regions. In the remainder of the chapter I will firstly consider how heterodox approaches have dealt with the notion, the determinants and the measurement of territorial competitiveness, devoting the next section to the analysis of how – if at all – orthodox approaches analysed the territorial context in which economic agents act. A comprehensive review of the current literature on regional development and economic geography is beyond the scope of this chapter. The aim is rather to discuss the complex and debated linkages between theoretical premises, methodological choices and political responses around the concept of local competitiveness.

1.2 Notion, determinants and measurement of local competitiveness 1.2.1 Notion of local competitiveness The very notion of territorial competitiveness had been contested by a substantial body of literature (Group of Lisbon, 1995; Krugman, 1996), which pointed out that firms can compete, while nations cannot. According to the standard model of international trade and economic growth, what matters is the comparative advantage: nations neither play a zero-sum game, nor do they exit the marketplace. In Krugman’s approach this holds true if an economy is large enough to neglect the inward or outward movements of the factors of production. At the regional level, factor mobility, ‘which magnifies the effect of small differences in efficiency’ (Krugman, 2003, p. 35), and external economies,

18

Context and Proximity in Competitiveness and Cohesion

‘which allow[s] a small push in the right direction at the right time to have lasting effects on efficiency’ (Krugman, 2003, p. 35), are likely to give substance to the notion of competitiveness of local economies. Camagni (2002) claims the soundness of the notion of regional competitiveness, stating that regions and localities compete, in single currency areas, over an absolute rather than comparative advantage. At the regional level, price-wage flexibility and exchange rate movement do not act as adjustment mechanisms and both capital and labour are highly mobile. Thus, what matters is the absolute performance of a region, which therefore ‘can well be pushed “out of business” if the efficiency and competitiveness of all its sectors are lower than those of other regions’ (Camagni, 2002, p. 2401). Along with physical externalities and environmental quality and accessibility, the determinants of entrepreneurial capabilities, innovation and competitiveness are relational capital, knowledge accumulation, interpretative codes, models of cooperation and ‘collective learning’ (Camagni, 1991a, 1991b, 2002; Capello, 1999; Keeble and Wilkinson, 1999, 2000, see also Chapters 5, 9, 11 and 13 in this volume). Local economies compete to attract direct external investments and define a distinct role in the international division of labour. Yet, they do this differently to firms. Two broad heterodox schools deal with economy in space: the institutional and the evolutionary (Boschma and Frenken, 2006; Boschma and Lambooy, 1999; see also Storper, 1997a). Although institutional and evolutionary approaches are both non-optimizing and take account of the bounded rationality of economic agents, there are important differences and diversified approaches encompassed by each school. For Lawson (1997, 2006) they assume a ‘conceptual nexus’ different from mainstream economics, putting at the centre of research a ‘institutionshistory-social structure’ approach instead of the ‘rationality-individualismequilibrium’. This unified perspective risks to disregard, however, those critical dimensions which define and differentiate the two approaches and thus have to be taken into account when clarifying the conceptual and empirical basis of local competitiveness. This distinction, in turn, is necessary to rigorously assess whether, to what extent and how public policy can positively impact on regional competitiveness, as well as to evaluate policy processes and their outcomes. Recent literature has brought attention to the features that separate the two schools, also as far as local competitiveness is concerned. Boschma and Frenken (2006) identify the following three features: formal modelling, assumptions regarding the rationality of the agents, and conceptualization of time. Fratesi (2010) adds to this the scale of the argument

Chiara Guglielmetti

19

and the conceptualization of space. He distinguishes between an abstract conceptualization of space, which allows mathematical formalization, and a relational one, which builds on the relations between economic agents (Capello, 2007; Fratesi, 2010). Two more features appear relevant. First, within the relational conceptualization of space the notion of ‘local’ and ‘regional’ economies matters. Second, the scope of analysis in terms of determinants and outcomes of local competitiveness needs to be taken into account. As to the first, different reference frameworks have been established in the literature for the ‘local’ and the ‘regional’ with a blurred distinction between the two. For Camagni (2002) a key feature of the economic concept of territory is ‘a system of local governance, which brings together a collectivity, an ensemble of private actors and a system of local public administrator’. There is no agreement on the efficacy of considering administrative borders as relevant boundaries in the analysis. For example, Boschma (2004) from an evolutionary perspective points out that a region is a dynamic and flexible entity which evolves over time. A region becomes relevant only when ‘co-evolutionary processes result in place-specific development’. This analysis is part of a major trend in the local development literature. Giovannini (2001) distinguishes between territorio, luogo and società locale (territory, place and local society), where the latter takes place only when specific economic and social practices arise within a territorial entity that becomes socially, historically and culturally distinct in some way. However, local competitiveness seems to imply a system of public and private actors whose interplay results in an economic and social outcome which goes beyond the performance of the individual agents. Those public bodies which have the regulatory and administrative competences to pursue development strategies, as well as the disposal of financial, human and material resources, need to be accounted for in the analysis. Although empirical evidence clearly shows that interdependencies and linkages do not necessarily follow administrative boundaries, as shown in Chapters 5 and 7 of this book, governments are a key actor to be taken into account in regional competitiveness analysis. Concerning the scope of the analysis, there are recent claims for the necessity of a broader approach to regional development, which accounts for allocative diversity, non-economic spheres of relations (Hadjimichalis, 2006; Moulaert and Mehmood, 2010). The approaches of industrial districts, regional innovation systems, new industrial space, milieu innovateurs, and industrial clusters – the so-called territorial innovation models – are regarded as characterized by an instrumental

20

Context and Proximity in Competitiveness and Cohesion

consideration of institutional dynamics and a narrow notion of path dependence (Moulaert and Mehmood, 2010, p. 108). Human, socioinstitutional and cultural capital are considered only in the light of their influence on firms’ performance and innovation capability. The recognition of the quality of the local context, of soft externalities or untraded interdependencies, of the role of the different private and public actors, and of informal and formal institutional dynamics is instrumental to productivity. Partly related to this is the criticism of the overterritorialized view of embeddeness that Moulaert and Mehmood (2010) make with regards to territorial innovation models the so-called localist trap. Macroeconomic dynamics, as well as policy at the sub-national, national and supranational level, affect development potentials of regions and localities to a large extent, and, ‘in the absence of appropriate … policies only a limited number among them will succeed’ (Moulaert and Mehmood, 2010, p. 107). Formal and informal institutions play a pivotal role in enabling a complex system to develop. This has consequences both for the analytical perspective – how a territory needs to be conceived – and for the normative perspective. A broader approach to local development has been developed within the political economy of regional development (Hudson, 2001; Lipietz, 1977; Markusen, 1983; Massey, 1984; Moulaert et al., 1988; Peck and Tickell, 1992; Sum, 2006; and the regulation approach to local/regional development, Leborgne and Lipietz, 1990). Further attempts are advanced by the approaches of strategic coupling (Coe et al., 2004), social embeddedness (Hess, 2004) and relational geography (Yeung, 2005) and, notably, the meta-theoretical framework (Moulaert, 1987; Storper and Walker, 1983) proposed by Moulaert and Mehmood (2010), who claim the relevance of the ‘old’ institutional tradition of the German Historical School (Schmoller, 1884, 1905) and of the works by Myrdal, Perroux, the French School of disequilibriated spatial development and radical geographers of the 1970s. This approach integrates network theory, regulation approach and cultural political economy in a structural realist approach to regional development. 1.2.2 Determinants and measurements of regional competitiveness Local competitiveness has been addressed through employing different scales of analysis. While NEG adopts a microeconomic perspective, institutional approaches have employed macro – the region or the district levels – meso and micro perspectives. As noted by Fratesi (2010),

Chiara Guglielmetti

21

evolutionary economics tends to employ a meso level of analysis – networks, industries, sectors – even though the applications encompass both economic agents, typically individual firms, and regional aggregates (Frenken, 2007). Cellini and Soci (2002) argue that the notion of competitiveness changes according to the scale of analysis. There is competitiveness of countries, at the macro level, competitiveness of local economic systems at the meso level, which is further divided into regions and industrial districts, and competitiveness of firms at the micro level. This distinction produces useful insights as far as the determinants and measures of regional competitiveness are concerned. As already mentioned, two broad heterodox approaches have dealt with the notion of regional competitiveness: the institutional and the evolutionary. There are many strands of research which are broadly defined as institutional because of the shared recognition of the influence of localized and territorial specific institutional dynamics on the performance and innovation capacity of firms. The territory becomes central for the organization and coordination of economic activity: ‘a nexus of untraded interdependencies’ (Storper, 1995). Seminal in this respect has been the Italian industrial districts school which identified proximity, flexibility and specialization as fundamental determinants of small and medium sized firms’ performance, pointing out the significance of cooperation and partnership along with competition (Bagnasco, 1977; Beccattini, 1975, 1978, 1987, 1989, 1991; Bellandi, 1986; 1989; 1995; Bellandi and Trigilia, 1990; Brusco, 1982; Dei Ottati, 1990, 1994; Russo, 1986; Sforzi, 1990; Solinas, 1982; Trigilia, 1985, 1986, 1990). In the approach of the Milieux Innovateurs, innovation emerges in a system of regional practices, formal and informal institutions and actors (Groupement de Recherche Européen sur les Milieux Innovateurs – GREMI: Aydalot, 1986; Aydalot and Keeble, 1988; Camagni, 1991a, 1991b; Maillat et al., 1990, 1993; Perrin, 1993). The notion of milieu, which echoes Granovetter’s embeddedness of economic actors in a given territory, includes both tangible and intangible features which allow innovation to take place. The network, which can be the region itself, or the economic agents which are part of the input-output system and act in the region, is the pivotal organizational arrangement in the milieu. The evolution of the transaction-cost-based theory of the California school, the so-called new industrial spaces approach, is paradigmatic as far as the relevance of institutions in economic development processes is concerned (Storper, 1997a). According to the new industrial spaces approach, the division of labour leads to interdependence between firms, which externalize their production to gain flexibility and specialization

22

Context and Proximity in Competitiveness and Cohesion

and to minimize costs (Christopherson and Storper, 1986; Scott, 1988a, 1988b, 1990, 2001; Scott and Storper, 1991; Storper, 1989; 1991; 1992; Storper and Christopherson, 1987; Holmes, 1992). The advantages from externalization are enhanced by agglomeration (Storper and Salas, 1992; Storper and Scott, 1989, 1990; Storper and Walker, 1983). The focus is on those organizational arrangements, which allow innovation to take place, rather than on context specific institutions. This, in turn, leads to the existence, at the very initial stage of an industry, of a ‘window of locational opportunity’ as Storper (1997a) puts it, which is rapidly shrunk by external economies once an industry is established in a given context. While the new industrial spaces approach was focused on the organization of production and the division of labour, its development at the end of the 1980s partakes the institutional approach in the work of Piore and Sabel (1984) and the Italian industrial districts approach. With this the role of localized institutional frameworks gets fully recognized in enabling successful coordination of economic transaction and agglomeration, thus fostering innovation, (Saxenian, 1988, 1991, 1994; Scott and Storper, 1987). Within the Californian school two other strands of literature can be identified. The first analyses the drivers of high technology based regional development, in particular in Silicon Valley and Route 128, and attributes a crucial role to research and university spin-offs (Markusen et al., 1986; Scott, 1990), while the second focuses on the role of public policy in fostering high technological development (Markusen, 1986; Markusen et al., 1991). Among the heterodox approaches to regional growth modelling it is also worth mentioning the cumulative causation spatial econometric approach (Fingleton, 2000, 2001, 2003, 2004; Fingleton and McCombie, 1998; McCombie and Roberts, 2007). Furthermore, the region is conceived as a catalyst for economic development processes through endogenous dynamics of knowledge and technological development in the learning regions and new-institutionalist approaches (Cooke, 1996; Cooke and Morgan, 1998; Florida, 1995). Porter’s work (Porter, 2006), notwithstanding being regarded quite distant by regional science (Moulaert and Mehmodo, 2010), opens a new body of research on clusters of innovation. It offers a crucial point of entry as far as the role of proximity in innovation and performance is concerned. The evolutionary theory of economic change (Nelson and Winter, 1982) conceptualizes technological development on assumptions which are drastically different to those advanced by mainstream economics. Development follows trajectories which are truly path-dependent, the

Chiara Guglielmetti

23

outcome of irreversible interdependent, and thus uncertain, choices which do not end in a predefined equilibrium. The evolutionary perspective is thus intrinsically dynamic, not only departing from the orthodox comparative static (equilibrium) but also from the static perspective adopted in work on proximity and innovation (Boschma, 2004, 2005a, 2005b). In evolutionary economics (Arthur, 1987, 1989, 1990; Dosi, 1987, 1988; Dosi and Orsenigo, 1985; Dosi, Pavitt and Soete, 1991; Dosi and Salvatore, 1995) technological change is an endogenous process in which technological spillovers (Perroux, 1950a, 1950b, 1955), informal exchanges and untraded interdependencies play a pivotal role. Those spillovers are found to be strongly localized and territorially specific. This, in turn, leads to an increasing economic specialization both at national and sub-national levels. The evolutionary approach to economic geography takes into account the necessity of considering dynamic processes and adopts formal modelling of multiple equilibria, path dependence and irreversibility (Boschma and Frenken, 2006; Fratesi, 2010). Evolutionary models are based on stochastic logic, which has been initially applied to locational dynamics emerging from research commercialization and spin-offs (Arthur, 1987, 1989, 1990; Klepper, 1996, 2002a, 2002b) and to the spatial evolution of firm networks (Albert and Barabasi, 2002; Andersson et al., 2003, 2006; Barabasi and Albert, 1999; Barrat et al., 2005; Castells, 1996; Guimerà and Amaral, 2004). Attempts to classify emerging strands of research encounter the risk of blurred boundaries of concepts and simplification. For example, regional innovation systems (Braczyk et al., 1998; Cooke et al., 1997; Cooke, 2001; Doloreux, 2002; Doloreux and Parto, 2005; Howells, 2005), detecting the basis for innovation in a systemic network made up of institutional and organizational elements at the regional level, have given rise to a growing interest and produced an extensive body of literature since the 1990s. Their theoretical foundation can be traced in the literature on systems of innovation (Edquist, 1997; Freeman, 1995; Lundvall, 1992; Nelson, 1993), which is rooted in institutional and evolutionary economics, in the theories of interactive learning (Lundvall, 1992), as well as in Penrose’s (1959) resource-based view of the firm. Along with different drivers it is possible to single out different measurements of regional competitiveness. Storper (1997b, p. 191) differentiates between regions whose performance is determined by geographical distribution of demand, and regions that are the ‘locus of untraded [production] interdependencies’. The latter are the basis for ‘strongly territorialized’ (1997a, p. 41) economic activities. Therefore,

24

Context and Proximity in Competitiveness and Cohesion

the focus is on export shares, in the Keynesian tradition of export-base regional economies, and on the capacity to attract high quality foreign direct investments. Even though the relevance of export capacity is underlined also in Porter’s research on clusters, the focus of his work on competitive advantage is productivity, which entails efficiency in standard units of production and in product prices. In Porter’s work competitive advantage, both at the national (1990) and at the regional (2001a, 2001b) levels, ‘is created and sustained through a highly localized process’ (Porter, 1990, p. 19). Location affects competitiveness essentially through its influence on the level and the growth of productivity (Porter, 2000, p. 19). Productivity, both as a goal to be pursued and as a measure of competitiveness, is central in current scientific and political literature (see Chapters 12 and 13 in this volume), both on countries and regions (Brown, 2001; Council of Competitiveness, US, 2001; DTI UK Department of Trade and Industry, 1998, 2003a, 2003b, 2004; European Commission, 2003, 2004; HM Treasury, 2000, 2001, 2003, 2004, 2006; Krugman, 1996; O’Mahony and Van Ark, 2003; Porter, 1998a, 1998b, 2001a, 2001b; Sapir et al., 2004). However, the overwhelming focus on productivity as key indicator of regional competitiveness and, consequently, as principal focus of public policies, has been contested in the literature. Kitson, Martin and Tyler (2004) claim the necessity of considering a wider set of socio-economic dimensions as the basis of regional competitive advantage, which consists of regional productivity, employment and standards of living. In particular, they identify six elements – productive, human, socio-institutional, cultural, infrastructural and knowledge/creative capital – which need to be considered on the supply-side, while pointing out the importance of demand-side developments (Kitson et al., 2004; Fothergill, 2004). In turn, this entails the inappropriateness of generally applicable policies for local and regional development (see Chapter 7 in this volume). The criticism of the universalist attitude, which does not consider the fact that ‘both history and geography will have a major impact on the relevance of particular drivers’ (Kitson et al., 2004, p. 996), is shared by a growing body of literature (Kenny and Williams, 2001).

1.3 Context matters: The mainstream approach and scope for policy Mainstream4 economics has traditionally remarkably neglected the context within which households, firms, investors and political bodies

Chiara Guglielmetti

25

operate. This holds both for the location of the economic activity and for the specific economic, institutional, social and cultural features of the environment in which the agents act. As Krugman stresses, ‘the location of production is an obvious feature of the economic world […] and yet there is almost no spatial analysis in mainstream economics’ (1995, p. 33). Economic agents act as ‘dimensionless points’ in a ‘disembodied economy’ (Fujita et al., 2001; Krugman, 1991, p. 483). If there is a general agreement on the long and ‘curious disdain of location theory on the part of mainstream economics’ (Blaug, 1997; see also Nordhaus, 2006), the role of history in economics seems to be a far less debated issue in mainstream economics as we will see below. The necessity of context specificity of public policies is claimed by Rodrik (2007), whose work as part of the neoclassical stream is of particular significance for our argument. Rodrik’s attention is on policy application rather than on the theoretical or methodological debate: neoclassical economics remains, in Rodrik’s view, par excellence the discipline capable of effectively and sensibly analysing economic activity. This notwithstanding, Rodrik departs from the mainstream consensus on development policy, answering positively to the pivotal question put by Boschma on ‘whether the[se] bases for interaction differ in different socio-economic contexts in space and time’ (Boschma, 2005a, p. 41). The environment in which economic agents act varies widely in terms of incentives, opportunities and constraints, which, in turn, exert a deep influence on individual behaviour. This opens crucial room for public policy to act and gives institutions a pivotal role in stimulating development. Rodrik claims the necessity of institutional arrangements capable of sustaining growth and positively managing opportunities and constraints which may derive from an increasing openness of economies. Despite Rodrik’s focus on the level of national economies, three important implications can be derived for our discussion of regional competitiveness. Firstly, empirical evidence acquires a crucial role in the analysis. The relative competitiveness of countries, the spatial distribution of production and the rate of national growth is strongly influenced by a wide range, or a lack, of political and institutional strategies. The distinctiveness of individual responses to external shocks needs to be carefully read and understood. Secondly, the relative success of a country in responding to external shocks is strictly related to its capability to leverage context specific features, namely, the capability of political bodies to adapt policies and institutional arrangements to local specificities, as well as the capability of entrepreneurs to innovate

26

Context and Proximity in Competitiveness and Cohesion

adapting technologies to local conditions. Thirdly, successful policy reforms combined ‘element of orthodoxy with unorthodox institutional practices’ (Rodrik, 2007, p. 39). Since the 1990s spatial aspects of the economy as well as the role of history in economic development are increasingly present in the literature. History and geography are understood either as separate alternative determinants of economic development or as two interplaying factors of it. 1.3.1 Spatial economics Spatial economics has a long and deep scientific tradition which, since the early nineteenth century, has included different successive fields of research. This tradition, whose comprehensive review is beyond the scope of this chapter, helped to detect pivotal issues concerning the location of economic activity but, at the same time, failed to gain acknowledgement in the entire economics profession. The German tradition played a substantial role in location theory, developing different strands of literature at the beginning of the last century. The seminal model of land use developed by von Thünen (1826) remains best known among urban economists. To be mentioned further are Alfred Weber (1909), with his optimal plant location theory, and the centralplace theory, advanced by Christaller (1933) and Lösch (1940), which underlined the role of different goods in shaping a spatial economic system with cities of distinct size and type. Fujita et al. (2001) differentiate between the tradition of urban economics and that of regional science, even though the two strands of research are focused on basically the same issue. Nevertheless, if the former tended to employ a formal modelling, making it easier to accept for mainstream economists, the latter is regarded as characterized by ‘looseness in reasoning’ (Fujita et al., 2001). The new and ‘valuable insights’ generated here have not been accepted or taken into account by mainstream economists. Part of urban economics, along with von Thünen, are the models of urban systems which started with Henderson (1974), and the strand of local external economies (Hoover, 1948), which follows the seminal work of Marshall5 (1920). The Anglo-Saxon tradition in regional science developed during the second post-war era with the school of social physics in the US, with its empirical regularities such as the Zipf’s law (Zipf, 1949), the ‘gravity law’ of spatial interaction and the market potential index (Harris, 1954), and with the tradition of studies on cumulative causations, such as the first Lowry model and Pred’s work (1966) on the base multiplier analysis.

Chiara Guglielmetti

27

Despite the efforts made by Isard (1950) to get location and space into mainstream economics, only Krugman’s seminal paper (1991) and the New Economic Geography (Baldwin at al., 2003; Fujita et al., 2001; Fujita and Thisse, 2002) brought core ideas of spatial economics (such as von Thünen’s model, location decisions as the solution of a problem of opposite forces of attraction, and the notion of market potential) to entry into mainstream economics. The point raised by Krugman (1995) and Fujita et al. (2001) is that new tools have been developed which allow core, old and sensible ideas, which were formally intractable, to be mathematically modelled and thus accepted by mainstream economics. In particular, the assumptions of constant returns to scale – and thus of perfect competition – have been relaxed, allowing the mainstream approach to be applied in order to explain agglomeration and specialization patterns of development. In all this, territorial competitiveness plays a crucial role. Indeed, spatial economics hinges on external economies, factor mobility and increasing returns to scale, which lead to a non-perfect competitive market structure, the DixitStiglitz model of monopolistic competition (Dixit-Stiglitz, 1977) being often employed for this purpose. Even though many models have been developed within the NEG, it is possible to single out some key common features in dealing with economy in space. Based on neoclassical micro-level formalization techniques, NEG models are developed within a multiple equilibria framework and assume perfect rationality of firms and households, who maximize their objective functions in response to price signals. The models account for an abstract, uniform space in which the tension between centripetal and centrifugal forces results in the emergence and change of spatial economic structures. Examples of centripetal forces are linkages, thick markets, knowledge spillovers, and pure external economies, while immobile factors, land rent, transportation and trade costs, congestion or other pure diseconomies represent centrifugal forces (Fujita et al., 2001). Externalities and factor mobility provide substantial room for public policy interventions at the sub-national level. However, in Krugman’s perspective (2003), the conversion of theoretical statements into policy recommendations, even within a unifying scientific perspective, is cause for concern. Indeed, Rodrik (Rodrik, 2007, p. 105) and others point to the significant role of ‘random self-discovery attempts, followed by imitative entry’ in the success of regions, which are therefore largely unpredictable. This literature accounts for a critical role of direct government intervention when there are economies of scale and when inputs are needed that are non tradable or require geographical

28

Context and Proximity in Competitiveness and Cohesion

proximity (Rodrik, 1996). In particular, government intervention is needed to overcome information and coordination externalities impeding economic diversification. The importance of a coherent and unified theoretical NEG framework in regional policy design and evaluation is pointed out by Potter (2009), who emphasizes that the models allow the identification of, along with uneven development patterns, unintended, unexpected and interlinked outcomes of policies. A major problem is the fact that, by definition, formal modelling is an abstraction of reality which adopts unrealistic assumptions of agents’ behaviour, which renders difficult its operationalization for policy purposes. Moreover, formalization techniques allow for modelling of only a narrow range of policies from a static perspective, and leave unaccounted unemployed resources. From the 1990s on, the interest of neoclassical economists in economic geography gave rise to a harsh debate, giving fuel to what Boschma and Frenken (2006) appropriately called a true Methodenstreit in the field of economic geography. The polemic contribution by Amin and Thrift, ‘What kind of economic theory for what kind of economic geography’, published in Antipode in 2000, catalysed a deep and diffuse methodological rethinking, which became a sort of manifesto (Martin and Sunley, 2001) for economic geographers to go ‘out of the long shadow of [mainstream] economics’ in order to rely on heterodox, context based ‘economic knowledge’. Another distinction is needed between the analysis of the location of economic activity and the detection of geographical determinants of economic development. The emphasis on ‘the role of endogenous and policy factors’ at the expenses of ‘exogenous factors such as geography or even population’ is highlighted by Nordhaus (2006), who stresses that ‘although natural resources (particularly land and mineral) have been featured in some studies, climate, soil, tropical disease, and similar “unchanging” factors have typically been omitted from modern economic growth analysis’ (p. 3510). However, upgrades in methodology – such as the possibility of gathering data on economic activity at a higher resolution – allow the creation of datasets with higher potentials as far as the analysis of geographic attributes’ impact on the economy is concerned.6 Scholars are divided with regard to the significance of geography as a determinant of development. There is, on the one side, a distinguished body of literature that contends the direct influence of geography (Diamond, 1997; Gallup et al., 1998; Hibbs and Olsson, 2004; Sachs, 2003), and, on the other side, a widespread agreement on the indirect

Chiara Guglielmetti

29

impact of geography mainly via institutions (Engemann and Sokoloff, 1994; Rodrik, Subramanian and Trebbi, 2004). 1.3.2 History as a determinant of development patterns There is a growing body of literature that aims at explaining to what extent and through which channels historic events influence long-term growth and development patterns, accounting for multiple equilibria. Seminal work has been developed by Acemoglu, Johnson and Robinson (2001, 2002), Engermann and Sokoloff (1997, 2002), and La Porta, Lopez-de-Silanes, Shleifer and Vishny (1997, 1998, 1999). This joins a broader stream of literature that accounts for the crucial role of institutions as a determinant of aggregate income (Easterly and Levine, 2003; Hall and Jones, 1999; Rodrik, Subramanian and Trebbi, 2004). Both share the focus on colonial history to achieve econometric identification, while differing in their analysis of the most relevant features of the colonial experience and the causal mechanisms at work (Nunn, 2008). The work of La Porta et al. (1997, 1998), starting from the assumption that the legal origin of former colonies is exogenous to the characteristics of the colonized country, assesses the causal effect of different legal rules for investor protections on financial development. It is argued that common law tradition outweighs civil law in what concerns the protection of investors.7 In a further branch of literature, Acemoglu et al. (2001) examine the effect of colonial rules on domestic institutions, which in turn affect current income levels. In the colonies where European settlers had been more affected by deadly diseases there were very little permanent settlements, and, as a consequence, rent seeking institutions were established instead of ‘good’ institutions. This has had an impact, according to Acemoglu et al. (2001), on current development trajectories of these territories. It remains difficult to fully explain the ways through which history and institutions impact on economic development and, most of all, the direction of causality (Nunn, 2008). Nevertheless the theoretical debate has exerted a strong and direct influence upon policy design giving way to a wave of so-called secondgeneration institutional reforms in order to overcome the limits of a narrow focus upon stabilization, liberalization and privatization policies. Yet the impact of history on institutions is understood by the bulk of this literature as a set of a-contextualized empirical regularities that can be employed to identify one-size-fits-all development strategies. From our standpoint, this is particularly relevant as far as business environment regulations are concerned. The work developed in Djankov et al. (2002, 2003, 2007, 2008a, 2008b, 2008c, 2008d), is at the basis of the

30

Context and Proximity in Competitiveness and Cohesion

theoretical framework of the World Bank’s most influential indicator – Doing Business – which prescribes a set of rules-of-thumb reforms for a more business friendly environment. The inappropriateness of this is argued by a growing body of literature, which points out the strong need of empirical studies that assess the interplay between entrepreneurs, policy, institutions and context,8 instead of taking for granted the mono-directional relation between entrepreneurship loosely and broadly defined and development (Baumol et al., 2009; Shane, 2008; Guglielmetti, 2010).

1.4 Conclusions Opportunities and constraints for territories and firms to develop keep changing in an era of global competitiveness. If there are general principles to ignite and sustain local development – such as macroeconomic stability, reliance on the market and integration into the world economy, diversification of the economy, rule of law, social cohesion, and political stability – the ways in which they are implemented need to take into account localized and context specific features. Institutional, economic, social, historical and cultural legacies and developments can function as incentives and constraints for local capacities to cope with and benefit from global dynamics. In this context, local competitiveness emerged as a sort of ‘umbrella concept’ of the way local economies deal, or fail to deal with, both opportunities and constraints stemming from the increasing openness of economies. Addressed by competing paradigms which deal with economy in space rather than by dominant orthodoxy, the notion of local competitiveness remains a disputed issue in the literature. Moreover, public policy tends to anticipate conceptual understanding and empirical analysis, contributing, in this way, to the nebulous nature of the theoretical framework. What is needed is, on the one hand, a clear distinction between the competitiveness of firms, of local economies, and of national systems and, on the other, a greater attention by research and policy on local contexts. The former is too often neglected by theoretical analysis and public policy. Local economies do not compete like single firms. They are systems with societal aims as well. Yet, there is no trickle-down effect between growth of firms and social cohesion, well-being and cultural and human capital, which are both drivers of economic development and outcomes to be pursued. The latter brings with it the following three key issues, as discussed in this chapter. First, there is a potential trade-off between national growth and

Chiara Guglielmetti

31

spatial equity (see Chapter 2). Second, competitiveness is by definition a relative and dynamic concept and, third, combined and counterintuitive effects of agglomeration and dispersion forces should be considered by public policy not only in dynamics internal to local economies, but also across different localities. This is a challenge, given that there is no common ‘local’ unit of analysis.

Notes 1. In this chapter territories are referred to as distinct local economies and the terms regional, local and territorial competitiveness are employed interchangeably. 2. It is worth noting the Italian debate concerning development in Southern Italy and the role of regional policies (Saraceno, 1980, 1992). 3. On cohesion policy in the European Union, see Guglielmetti (2009). 4. In this chapter the term ‘mainstream’ is purposefully employed instead of the term ‘neoclassical’, following Colander’s criticism of the identification of modern mainstream economics with neoclassical economics (Colander, 2000). 5. Marshall pointed out the importance of local external economies both for their intrinsic importance and as a paradigmatic example of the broader notion of external economies. 6. The G-ECON database (Nordhaus, 2006) is an interesting example of this methodological advancement. It organizes and employs data with a resolution of 1° latitude by 1° longitude. Focusing on the Gross Cell Product, the methodology aims at estimating the geographical intensity of economic activity rather than on the personal intensity of economic activity. 7. Important fields of research include the correlation between legal origin and: labour market regulation (Botero et al., 2004), comparative advantage (Nunn, 2007), contract enforcement (Acemoglu and Johnson, 2004; Djankov, 2003, 2008c), economic growth (Mahoney, 2001); regulation of entry of start-up firms (Djankov et al., 2002); independence of the judiciary and accountability of the government to the law (La Porta et al., 2001); strategies of social control of business, military conscription (Mulligan and Shleifer, 2005a, 2005b), private credit (Djankov et al., 2007); taxes (Djankov at al., 2008d); control of self-dealing (Djankov et al., 2008b) regulation of security issuance through security laws (La Porta et al., 2006). See also Berkowitz and Clay (2005, 2006), Grier (1999) and Bertocchi and Canova (2002). 8. Disentangling, for example, the correlation between economic growth and start-up rates.

References Acemoglu, D., S. Johnson and J. A. Robinson (2001) ‘The Colonial Origins of Comparative Development: An Empirical Investigation’, American Economic Review, 91, 1369–401. Acemoglu, D., S. Johnson and J. A. (2004), ‘Unbundling Institutions’, Journal of Political Economy, 113, 949–95.

32

Context and Proximity in Competitiveness and Cohesion

Albert, R., A. L. Barabasi (2002) ‘Statistical Mechanics of Complex Networks’, Reviews of Modern Physics, 74(1), 47–97. Amin, A. and N. Thrift (2000) ‘What Kind of Economic Theory for What Kind of Economic Geography?’ Antipode, 32(1), 4–9. Andersson, C., K. Frenken and A. Hellervik (2006) ‘A Complex Network Approach to Urban Growth’, Environment and Planning A 38(10), 1941–64. Andersson, C., A. Hellervik, K. Lindgren, A. Hagson, J. Tornberg (2003) ‘Urban Economy as a Scale-Free Network’, Physical Review E, 68 (3 Part 2), 036124. Arthur, W. B. (1987) ‘Urban Systems and Historical Path Dependence’ in J. H. Ausubel and R. Herman (eds) Cities and Their Vital Systems (Washington, DC: National Academy Press), pp. 85–97. Arthur, W. B. (1989) ‘Competing Technologies, Increasing Returns, and Lock-In by Historical Events’, The Economic Journal, 99, 116–31. Arthur, W. B. (1990) ‘Silicon Valley Locational Clusters: When do Increasing Returns Imply Monopoly?’ Mathematical Social Science, 19, 235–51. Aydalot, P. (ed.) (1986) Milieux Innovateurs en Europe (Paris: Presses Universitaires de France). Aydalot, P. and D. Keeble (eds) (1988) High Technology Industries and Innovative Environments: The European Experience (London: Routledge). Bagnasco, A. (1977) Tre Itale (Bologna: Il Mulino). Baldwin, R. E., R. Forslid, P. Martin, G. Ottaviano (2003) Economic Geography and Public Policy (Princeton: Princeton University Press). Barabasi, A. L., R. Albert (1999) ‘Emergence of Scaling in Random Networks’, Science, 286(5439), 509–12. Barrat, A., M. Barthelemy, A. Vespignani (2005) ‘The Effects of Spatial Constraints on the Evolution of Weighted Complex Networks’, Journal of Statistical Mechanics, Art. No. P05003. Baumol, W. J. (2009) ‘Entrepreneurship, Competition and World Trade’ in D. B. Audretsch, R. Litan and R. Strom (eds) Entrepreneurship and Openness: Theory and Evidence (Cheltenham: The Ewing Marion Kauffman Foundation), pp. 13–23. Beccattini, G. (1975) Lo Sviluppo Economico della Toscana (Firenze: Guaraldi). Becattini, G. (1978) ‘The Development of Light Industry in Tuscany: An Interpretation’, Economic Notes, Monte dei Paschi di Siena, 7(2–3), 107–23. Becattini, G. (1987) Mercato e Forze Locali (Bologna: Il Mulino). Becattini, G. (1989) ‘Riflessione sul Distretto Industriale Marshalliano come Concetto Socio-Economico’, Stato e Mercato, 25, 111–28. Becattini, G. (1991) ‘Per una Lettura Sistematica dei Distretti Industriali Marshalliani, paper, University of Florence, Department of Economics. Begg, I. (2002) Urban Competitiveness (Bristol: Policy Press). Bellandi, M. (1986) ‘The Marshallian Industrial District’, Marshallian Studies Series, Department of Economics, University of Florence, 1. Bellandi, M. (1989) ‘Capacità Innovativa diffusa e Distretti Industriali’, Marshallian Studies Series, Department of Economics, University of Florence. Bellandi, M. (1995) Economie di Scala e Organizzazione Industriale (Milan: Franco Angeli). Bellandi, M. and C. Triglia (eds) (1990) ‘Come Cambia un Distretto Industriale: l’Industria Tessile di Prato’, University of Florence, Department of Economics, paper. Berkowitz, D. and K. Clay (2005) ‘American Civil Law Origins: Implications for State Constitutions’, American Law and Economics Review, 7, 62–84.

Chiara Guglielmetti

33

Berkowitz, D. and K. Clay (2006) ‘The Effect of Judicial Independence on Courts: Evidence from the American States’, Journal of Legal Studies, 35, 399–400. Bertocchi, G. and F. Canova (2002) ‘Did Colonization Matter for Growth? An Empirical Exploration into the Historical Causes of Africa’s Underdevelopment’, European Economic Review, 46, 1851–71. Blaug, M. (1997) Economic Theory in Retrospect (Cambridge: Cambridge University Press). Boschma, R. (2004) ‘Competitiveness of Regions from an Evolutionary Perspective’, Regional Studies, 38(9), 1001–14. Boschma, R. (2005a) ‘Editorial: Role of Proximity in Interaction and Performance: Conceptual and Empirical Challenges’, Regional Studies, 39(1), 41–45. Boschma, R. (2005b) ‘Proximity and Innovation: A Critical Assessment’, Regional Studies, 39(1), 61–74. Boschma, R. and K. Frenken (2006), ‘Why is Economic Geography not an Evolutionary Science? Toward an Evolutionary Economic Geography’, Journal of Economic Geography, 6 (3), 273–302. Boschma, R. A., J. G. Lambooy (1999) ‘Evolutionary Economics and Economic Geography’, Journal of Evolutionary Economics, 9, 411–29. Botero, J., S. Djankov, R. La Porta, F. Lopez-de-Silanes and A. Shleifer (2004) ‘The Regulation of Labour’, available at http://www.doingbusiness.org/documents/ labor_June04.pdf, date accessed 7 February 2010. Braczyk, H., P. Cooke and M. Heinderinch (eds) (1998) Regional Innovation Systems (London: University College Press). Brown, G. (2001) ‘The Conditions for High and Stable Growth and Employment’, Economic Journal, 111, 30–44. Brusco, S. (1982) ‘The Emilian Model: Productive Decentralization and Social Integration’, Cambridge Journal of Economics, 6, 167–84. Camagni, R. (1991a) ‘Technological Change, Uncertainty and Innovation Networks: Towards a Dynamic Theory of Economic Space’ in R. Camagni (ed.) Innovation Networks: Spatial Perspectives (London: Belhaven-Pinter), pp. 121–44. Camagni, R. (ed.) (1991b) Innovation Networks: Spatial Perspectives (London: Belhaven-Pinter). Camagni, R. (2002) ‘On the Concept of Territorial Competitiveness: Sound or Misleading?’ Urban Studies, 39(13), 2395–411. Capello, R. (1999) ‘Spatial Transfer of Knowledge in High-Technology Milieux: Learning vs Collective Learning Processes’, Regional Studies, 33, 353–65. Capello, R (2007) Regional Economics (London: Routledge). Castells, M. (1996) The Rise of the Network Society (Oxford: Blackwell). Cellini, R. and A. Soci (2002) ‘Pop Competitiveness’, Banca Nazionale del Lavoro (BNL) Quarterly Review, 55(220), 71–101. Christaller, W. (1933) Central Places in Southern Germany (Jena, Germany: Fischer), English translation 1966 (London: Prentice Hall). Christopherson, S. and M. Storper (1986) ‘The City as Studio; the World as Back Lot: the Impacts of Vertical Disintegration on the Motion Picture Industry’, Society and Space, 4(3), 331–47. Coe, N. M., M. Hess, H. W. C. Yeung, P. Dicken and J. Henderson (2004) ‘“Globalizing” Regional Development: A Global Production Networks Perspective’, Transactions of the Institute of British Geographers 29, 468–84.

34

Context and Proximity in Competitiveness and Cohesion

Colander, D. (2000) ‘The Death of Neoclassical Economics’, Journal of the History of Economic Thought, 22(2), 127–43. Cooke, P. (1996) ‘Reinventing the Region: Firms, Clusters and Networks in Economic Development’ in P. Daniels and W. Lever (eds) The Global Economy in Transition (Harlow: Longman) pp. 310–27. Cooke, P. (2001) ‘Regional Innovation Systems, Clusters, and the Knowledge Economy’, Industrial and Corporate Change, 10(4), 945–74. Cooke, P., M. Gomez Uranga and G. Etxebarria (1997) ‘Regional Innovation Systems: Institutional and Organisational Dimension’, Research Policy, 26, 475–91. Cooke, P. and K. Morgan (1998) The Associative Region (Oxford: Oxford University Press). Council on Competitiveness (2001) US Competitiveness 2001: Strengths, Vulnerabilities and Long-Term Priorities (Washington, DC: Council on Competitiveness). Dei Ottati, G. (1990) ‘Prato: 1944–1963: Reconstruction and Trasformation of a Local System of Production’ in P. Ballini, L. Lotti and M. Rossi (eds) La Toscana nel Secondo Dopoguerra (Milan: Franco Angeli). Dei Ottati, G. (1994) ‘Trust, Interlinking Transactions, and Credit in the Industrial District’, Cambridge Journal of Economics, 18, 529–46. Diamond, J. (1997) Guns, Germs, and Steel (New York: W. W.Norton). Dixit, A. K. and J. E. Stiglitz (1977) ‘Monopolistic Competition and Optimum Product Diversity’ American Economic Review, 67(3), 207–308. Djankov, S., C. Freund and C. S. Pham (2008d) ‘Trading on Time’, available at http://www.doingbusiness.org/Documents/TradingOnTime_APR08.pdf, date accessed 1 March 2010. Djankov, S., T. Ganser, C. McLiesh, R. Ramalho and A. Shleifer (2008a) ‘The Effect of Corporate Taxes on Investment and Entrepreneurship’, draft paper, date accessed 15 March 2009. Djankov, S., O. Hart, C. McLiesh and A. Shleifer (2008c) ‘Debt Enforcement Around the World’, Journal of Political Economy, 116(6), 1105–49. Djankov, S., R. La Porta, F. Lopez-de-Silanes and A. Shleifer (2002) ‘The Regulation of Entry’, Quarterly Journal of Economic, 67, 1–37. Djankov, S., R. La Porta, F. Lopez–de–Silanes and A. Shleifer (2003) ‘Courts’, available at http://www.doingbusiness.org/documents/LexPaperAug211.pdf, date accessed 7 February 2010. Djankov, S., R. La Porta, F. Lopez-de-Silanes and A. Shleifer (2008b) ‘The Law and Economics of Self-Dealing’, Journal of Financial Economics, 88 (3), 430–65. Djankov, S., C. McLiesh and A. Shleifer (2007) ‘Private Credit in 129 Countries’, Journal of Financial Economics, 84, 299–329. Doloreux, D. (2002) ‘What we Should Know about Regional Systems of Innovation’ Technology in Society, 24, 243–63. Doloreux, D. and S. Parto (2005) ‘Regional Innovation Systems: Current Discourse and Unresolved Issues’, Technology in Society, 27(2), 133–53. Dosi, G. (1987) ‘Institutions and Markets in a Dynamic World’, Brighton SPRU Discussion Paper No. 32. Dosi, G. (1988) ‘Sources, Producers, and Microeconomic Effects of Innovation’, Journal of Economic Literature, 25, 1120–71.

Chiara Guglielmetti

35

Dosi, G. and L. Orsenigo (eds) (1985), ‘Order and Change: An Exploration of Markets, Institutions and Technology in Industrial Dynamics’, Brighton SPRU Discussion Paper No. 22. Dosi, G., K. Pavitt and L. Soete, (eds) (1991) The Economics of Technical Change and International Trade (New York: New York University Press). Dosi, G. and R. Salvatore (1995) ‘The Structure of Industrial Production and the Boundaries between Firms and Markets’ in M. Storper and A. J. Scott, (eds) Pathways to Industrialization and Regional Development (London: Routledge), pp. 171–93. DTI, UK Department of Trade and Industry (1998) Our Competitive Future: Building the Knowledge Driven Economy, Competitiveness White Paper (London: Department of Trade and Industry). DTI, UK Department of Trade and Industry (2003a) A Modern Regional Policy for the United Kingdom (London: Department of Trade and Industry). DTI, UK Department of Trade and Industry (2003b) Prosperity for All: The Analysis (London: Department of Trade and Industry). DTI, UK Department of Trade and Industry (2003c) Prosperity for All: The Strategy (London: Department of Trade and Industry). DTI, UK Department of Trade and Industry (2004) Regional Competitiveness & State of the Regions (London: Department of Trade and Industry). Easterly, W. and R. Levine (2003) ‘Tropics, Germs, and Crops: How Endowments Influence Economic Development’, Journal of Monetary Economics, 50(1), 3–39. Edquist, C. (ed.) (1997) Systems of Innovation: Technologies, Institutions and Organisations (London: Pinter). Engerman, S. L. and K. L. Sokoloff (1997) ‘Factor Endowments, Institutions, and Differential Paths of Growth Among New World Economies: A View from Economic Historians of the United States’ in S. Harber (ed.), How Latin America Fell Behind (Stanford: Stanford University Press), pp. 260–304. Engerman, S. L. and K. L. Sokoloff (2002) ‘Factor Endowments, Inequality, and Paths of Development Among New World Economies’, NBER Working Paper 9259, National Bureau of Economic Research. European Commission (1994) Competitiveness and Cohesion: Trends in the Regions. Fifth Periodic Report on the Social and Economic: Situation and Development of the Regions in the Community (Luxembourg: Office for Official Publications of the European Communities). European Commission (1999) Sixth Periodic Report on the Social and Economic Situation and Development of the Regions of the European Union (Luxembourg: Office for Official Publications of the European Communities). European Commission (2001) Second Report on Economic and Social Cohesion (Luxembourg: Office for Official Publications of the European Communities). European Commission (2003) European Competitiveness Report 2003 (Luxembourg: European Commission). European Commission (2004) A New Partnership for Cohesion. Convergence, Competitiveness, Cooperation: Third Report on Economic and Social Cohesion (Luxembourg: Office for Official Publications of the European Communities). European Commission (2007) Growing Regions, Growing Europe: Fourth Report on Economic and Social Cohesion (Luxembourg: Office for Official Publications of the European Communities).

36

Context and Proximity in Competitiveness and Cohesion

Feldman, M. P. (2000) ‘Location and Innovation: The New Economic Geography of Innovation, Spillovers and Agglomeration’ in G. Clark, M. P. Feldman and M. Gertler (eds) The Oxford Handbook of Economic Geography (Oxford: Oxford University Press), pp. 373–94. Fingleton, B. (2000) ‘Spatial Econometrics, Economic Geography, Dynamics and Equilibrium: A “third Way?”’, Environ Planning a, 32, 1481–98. Fingleton, B. (2001) ‘Equilibrium and Economic Growth: Spatial Econometric Models and Simulations’, Regional Science, 41, 117–48. Fingleton, B. (2003) ‘Non-Orthodox Approaches to European Regional Growth Modeling: A Review’ in B. Fingleton, A. Eradin and R. Paci (eds) Regional Economic Growth, SMEs and the Wider Europe (Aldershot: Ashgate), pp. 14–52. Fingleton, B. (2004) ‘Regional Economic Growth and Convergence: Insights from a Spatial Econometric Perspective’ in L. Anselin, R. Florax and S. Rey (eds) Advances in Spatial Econometrics (Berlin: Springer), pp. 397–432. Fingleton, B. and J. S. L. McCombie (1998) ‘Increasing Returns and Economic Growth: Some Evidence for Manufacturing from the European Union Regions’, Oxford Economic Papers, 50, 89–105. Florida, R. (1995) ‘Toward the Learning Region’, Futures 27(5), 527–36. Fothergill, S. (2004), A New Regional Policy for Britain and for Europe? mimeo. Freeman, C. (1995) ‘The “National System of Innovation” in Historical Perspective’, Cambridge Journal of Economics, 19, 5–24. Fujita, M., P. Krugman, A.J. Venables (2001) The Spatial Economy: Cities, Regions and International Trade (Cambridge, MA and London: The MIT Press). Fujita, M., J.-F. Thisse (2002) Economics of Agglomeration (Cambridge: Cambridge University Press). Fratesi, U. (2010) ‘Regional Innovation and Competitiveness in a Dynamic Representation’, Journal of Evolutionary Economics, 20(4), 515–52. Frenken, K. (ed.) (2007) Applied Evolutionary Economics and Economic Geography (Cheltenham: Edward Elgar). Gallup, J. L., J. D. Sachs and A. D Mellinger (1998) ‘Geography and Economic Development’, NBER Working Paper W6849, National Bureau of Economic Research. Glaeser E. L. (2000) ‘The New Economics of Urban and Regional Growth’ in G. Clark, M. P. Feldman and M. Gertler (eds) The Oxford Handbook of Economic Geography (Oxford: Oxford University Press), pp. 83–98. Grier, R. (1999) ‘Colonial Legacies and Economic Growth’, Public Choice, 98, 317–35. Group of Lisbon (1995) Limits to Competition (Cambridge, MA: MIT Press). Guglielmetti, C. (2009) ‘Local Development in a European Union Perspective: Cohesion and Regional Policies in Central and Eastern Europe’ in P. Blokker and B. Dallago, (eds) Regional Diversity and Local Development in the New Member States (Basingstoke, Hampshire: Palgrave Macmillan), pp. 63–98. Guglielmetti, C. (2010) ‘Measuring the Business Environment for Entrepreneurship in Fragile States’, UNU WIDER Working Paper No. 2010/14. Guimerà, R. and L. A. N. Amaral (2004) ‘Modelling the World-Wide Airport Network’, European Physical Journal B, 38(2), 381–5. Hadjimichalis, C. (2006) ‘Non-Economic Factors in Economic Geography and in “New Regionalism”: A Sympathetic Critique’, International Journal of Urban and Regional Research, 30, 690–704.

Chiara Guglielmetti

37

Hall, R. E. and C. I. Jones (1999) ‘Why do Some Countries Produce So Much More Output per Worker than Others’, Quarterly Journal of Economics, 114(1), 83–116. Harris, C. (1954) ‘The Market as a Factor in the Localization of Industry in the United States’, Annals of the Association of American geographers, 64, 315–48. Henderson, J. V. (1974) ‘The Size and Types of Cities’, American Economic Review, 64, 640–56. Hibbs, D. A. Jr. and O. Olsson (2004) ‘Geography, Biogeography, and Why Some Countries are Rich and Others are Poor’, Proceedings of the National Academy of Science of the United States of America, 101(10), pp. 3715–20. Holmes J. (1992) ‘The Organization and Locational Structure of Production Subcontracting’, in M. Scott and A. J. Storper (eds) Pathways to Industrialization and Regional Development (London: Routledge), pp. 80–106. Hoover, E. M. (1948) The Location of Economic Activity (New York: McGraw-Hill). Howells J. (2005) ‘Innovation and Regional Economic Development: A Matter of Perspective’, Research Policy, 34(8), 1220–34. HM Treasury (2000) Productivity in the UK: The Evidence and the Government’s Approach (London: HM Stationery Office). HM Treasury (2001) Productivity in the UK: 3 – The Regional Dimension (London: HM Stationery Office). HM Treasury (2003) Productivity in the UK: 4 – The Local Dimension (London: HM Stationery Office). HM Treasury (2004) Devolving Decision Making: Meeting the Regional Economic Challenge: Increasing Regional and Local Flexibility (London: HM Stationery Office). HM Treasury (2006) Productivity in the UK 6: Progress and new evidence, (London: HM Stationery Office). Isard, W. (1956) Location and Space Economy (Cambridge: MIT Press). Kanbur, R. and A. J. Venables (2005) Spatial Inequality and Development, United Nations University, Policy Brief number 3, 2005, available at http://www.unu. edu/publications/briefs/policy-briefs/2005/spatial-inequality.pdf, date accessed 1 March 2010. Keeble, D. and F. Wilkinson (1999) ‘Collective Learning and Knowledge Development in the Evolution of Regional Clusters of High-Technology SMEs in Europe’, Regional Studies, 33, 295–304. Keeble, D. and F. Wilkinson (2000) High Technology Clusters, Networking and Collective Learning in Europe (Aldershot: Ashgate). Kenny, C. and D. Williams (2001) ‘What do we Know about Economic Growth? Or, Why Don’t we Know Very Much’, World Development, 29(2), 1–22. Kitson, M., R. Martin and P. Tyler (2004) ‘Regional Competitiveness: An Elusive yet Key Concept?’ Regional Studies, 38(9), 991–9. Klepper, S. (1996) ‘Entry, Exit, Growth and Innovation over the Product Life Cycle’, American Economic Review, 86, 562–83. Klepper, S. (2002a) ‘The Evolution of the US Automobile Industry and Detroit as its Capital’, paper presented at 9th Congress of the International Schumpeter Society, Gainesville, FL, 27–30 March. Klepper, S. (2002b) ‘The Capabilities of New Firms and the Evolution of the US Automobile Industry’, Industrial and Corporate Change, 11(4), 645–66. Krugman, P. (1991) ‘Increasing Returns and Economic Geography’, The Journal of Political Economy, 99(3), 483–99.

38

Context and Proximity in Competitiveness and Cohesion

Krugman, P. (1995) Development, Geography, and Economic Theory (Cambridge, MA: The MIT Press). Krugman, P. (1996) ‘Making Sense of the Competitiveness Debate’, Oxford Review of Economic Policy, 12(3), 17–25. Krugman, P. (2003) ‘Second Winds for Industrial Regions?’ The Allander Series: Growth on the Periphery, also published in D. Coyle, W. Alexander and B. Ashcroft (eds) (2005), New Wealth for Old Nations: Scotland’s Economic Prospects (Princeton, NJ: Princeton University Press), pp. 35–47. La Porta, R., F. Lopez-de-Silanes, C. Pop-Eleches and A. Shleifer (2001) Guarantees of Freedom, manuscript, Harvard University. La Porta, R., F. Lopez-de-Silanes, A. Shleifer (2006) ‘What Works in Securities Laws?’ Journal of Finance 61, 1–33. La Porta, R., F. Lopez-de-Silanes, A. Shleifer and R. Vishny (1997) ‘Legal Determinants of External Finance’, Journal of Finance, 52, 1131–50. La Porta, R., F. Lopez-de-Silanes, A. Shleifer and R. Vishny (1998) ‘Law and Finance’, Journal of Political Economy, 106, 1113–55. La Porta, R., F. Lopez-de-Silanes, A. Shleifer, and R. W. Vishny (1999) ‘The Quality of Government’, Journal of Law, Economics, and Organization, 15, 222–79. Lawson, T. (1997) Economics and Reality (London: Routledge). Lawson, T. (2006) ‘The Nature of Heterodox Economics’, Cambridge Journal of Economics, 30(4), 483–505. Leborgne, D. and A. Lipietz (1990) ‘Fallacies and Open Issues of Post-Fordism’, Centre pour la Recherche E´ conomique et ses Applications (CEPREMAP) Working Paper (Couverture Orange) 9009, Paris. Lipietz, A. (1977) Le capital et son espace (Maspero: Paris). Lösch, A. (1940) The Economics of Location (Jena, Germany: Fischer), English translation 1954 (New Haven, CT: Yale University Press). Lundvall, B-A. (ed.) (1992) National Systems of Innovation (London: Pinter). Maillat, D., O. Crévoisier and B. Lecoq, eds (1990) ‘Innovation and Territorial Dynamism’, paper for the workshop ‘Flexible Specialisation in Europe’, Zurich, 25–26 October. Mahoney, P. (2001) ‘The Common Law and Economic Growth: Hayek Might be Right’, The Journal of Legal Studies, 30, 503–25. Maillat M., M. Quévit and L. Senn (eds) (1993) Milieux Innovateurs et Réseaux d’Innovation: Un Défi pour le Développment Régional (Neuchâtel: EDES). Markusen, A. (1983) ‘Regions and Regionalism’, in F. Moulaert and P. Willson (eds), Regional Analysis and the New International Division of Labor (Boston, MA: Kluwer Nijhoff), pp. 33–56. Markusen, A. (1986) Profit Cycles, Oligopoly, and Regional Development (Cambridge, MA: MIT Press). Markusen, A. R., P. Hall, S. Campbell and S. Deitrick (eds) (1991) The Rise of the Gunbelt: The Military Remapping of Industrial America (New York: Oxford University Press). Markusen A. R., P. Hall and A. Glasmeier (eds) (1986) High Tech America: The What, How, Where and Why of the Sunrise Industries (Boston: Allen and Unwin). Marshall, A. (1920) Principles of Economics (London: Macmillan, 8th edn). Martin, R. and P. Sunley (2001) ‘Rethinking the “Economic” in Economic Geography: Broadening Our Vision or Losing Our Focus?’ Antipode, 33(2), 148–61.

Chiara Guglielmetti

39

Massey, D. (1984) Spatial Divisions of Labour: Social Structures and the Geography of Production (London: Macmillan). McCombie, J. L. S. and M. Roberts (2007) ‘Returns to Scale and Regional Growth: The Static-Dynamic Verdoorn Law Paradox Revisited’, Journal of Regional Science, 47(2), 179–208. Meardon, S. J. (2001) ‘Modelling Agglomeration and Dispersion in City and Country: Gunnar Myrdal, François Perroux, and the New Economic Geography’, American Journal of Economics and Sociology 60(1), 25–57. Myrdal, G. (1957) Economic Theory and Underdeveloped Regions (London: Duckworth). Moulaert, F. (1987) ‘An Institutional Revisit of the Storper–Walker Theory of Labour’, International Journal of Urban and Regional Research, 11, 309–30. Moulaert, F. and A. Mehmood (2010) ‘Analysing Regional Development and Policy: A Structural-Realist Approach’, Regional Studies, 44(1), 103–18. Moulaert, F., E. Swyngedouw and P. Wilson (1988) ‘The Geography of Fordist and Post-Fordist Accumulation and Regulation’, papers of the Regional Science Association 64, 11–23. Mulligan, C. B. and A. Shleifer (2005a) ‘Conscription as Regulation’, American Law and Economics Review, 7, 85–111. Mulligan, C. B. and A. Shleifer, (2005b) ‘The Extent of the Market and the Supply of Regulation’, Quarterly Journal of Economics, 120, 1445–73. Nelson, R. (ed.) (1993) National Innovation Systems: A Comparative Analysis (New York: Oxford University Press). Nelson, R. and S. Winter (1982) An Evolutionary Theory of Economic Change (Cambridge: Belknap). Nordhaus, W. D. (2006) ‘Geography and Macroeconomics: New Data and New Findings’, Proceedings of the National Academy of Science of the United States of America, 103(10), pp. 3510–17. Nunn, N. (2007a), ‘Historical Legacies: A Model Linking Africa’s Past to its Current Underdevelopment’, Journal of Development Economics, 83, 157–75. Nunn, N. (2007b), ‘Relationship-Specificity, Incomplete Contracts, and the Pattern of Trade’, Quarterly Journal of Economics, 122, 569–600. Nunn, N. (2008) ‘The Importance of History for Economic Development’, NBER Working Paper 14899, National Bureau of Economic Research. O’Mahony, M. and B. Van Ark (eds) (2003) EU Productivity and Competitiveness: An Industry Perspective: Can Europe Resume the Catching-up Process? (Luxembourg: European Commission). Peck, J. and A. Tickell (1992) ‘Local Modes of Social Regulation? Regulation Theory, Thatcherism and Uneven Development’, Geoforum 23, 347–64. Penrose, E. (1959) The Theory of the Growth of the Firm (Oxford: Blackwell). Perrin, J. C. (1993) ‘Pour une Révision de la Science Régionale:l’Approche en Temes de Milieu’, Centre d’Economie Régionale, University of Aix.Marseille, Aix-en-Provence, 148(3). Perroux, F. (1950a) ‘Les Espaces Economiques’, Economie Appliquée, 1(1), 223–44. Perroux, F. (1950b) ‘Economic Space: Theory and Applications’, Quarterly Journal of Economics, 64(1), 89–104. Perroux, F. (1955) ‘Note sur les Poles de Croissance’, Economie Appliquée, 1(2), 302–20. Piore, M. and C. Sabel (1984) The Second Industrial Divide (New York: Basic Books).

40

Context and Proximity in Competitiveness and Cohesion

Pitelis, C., R. Sugden and J. R. Wilson (2006) ‘Introduction’ in C. Pitelis, R. Sugdden and J. R. Wilson (eds) Clusters and Globalizations: The Development of Urban and Regional Economies (Northampton, MA: Edward Elgar). Porter, M. (1998a) ‘Location, Clusters and the New Economics of Competition’, Business Economics, 33(1), 7–17. Porter, M. (1998b) On Competition (Boston, MA: Harvard Business School Press). Porter, M. (1990) The Competitive Advantage of Nations (New York: The Free Press). Porter, M. (2000) ‘Location, Competition, and Economic Development: Local Clusters in a Global Economy’, Economic Development Quarterly, 14, 15–34. Porter, M. (2001a) Cluster of Innovation: Regional Foundations of US Competitiveness (Washington, DC: Council on Competitiveness). Porter, M. (2001b) ‘Regions and the New Economics of Competition’ in A. Scott (ed.) Global City-Regions: Trends, Theory, Policies (New York: Oxford University Press), pp. 139–57. Porter, M. (2003) ‘The Economic Performance of Regions’, Regional Studies, 37(6), 549–78. Potter, J. (2009) ‘Evaluating Regional Competitiveness Policies: Insights from the New Economic Geography’, Regional Studies, 43(9), 1225–36. Pred, A. (1966) The Spatial Dynamics of US: Urban Industrial Growth (Cambridge, MA: MIT Press). Redding, S. and A. J. Venables (2001) ‘Economic Geography and International Inequality’, CEP Discussion Paper 495, London School of Economics. Redding, S. and A. J. Venables (2004) ‘Economic Geography and International Inequality’, Journal of International Economics 62 (1), 53–82. Regional Studies (2003) Volume 37(6&7). Regional Studies (2004) Special Issue 38(9). Regional Studies (2006) Special Issue 40(2). Rodrik, D. (1996) ‘Coordination Failures and Government Policy: a Model with Application to East Asia and Eastern Europe’, Journal of International Economics, 40(1–2), 1–22. Rodrik, D. (2007) One Economics Many Recipes (Princeton, NJ: Princeton University Press). Rodrik, D., A. Subramanian and F. Trebbi (2004), ‘Institutions Rule: The Primacy of Institutions over Geography and Integration in Economic Development’, Journal of Economic Growth, 9(2), 131–65. Russo, M. (1986) ‘Technical Change and the Industrial District: The Role of Interfirm Relations in the Growth and Transformation of Ceramic Tile Production in Italy’, Research Policy, 14, 329–43. Sachs, J. D. (2003) ‘Institutions Don’t Rule: Direct Effects of Geography on per Capita Income’, NBER Working Paper 9490, National Bureau of Economic Research. Sapir, A., P. Aghion, G. Bertola, M. Hellwig, J. Pisani-Ferry, D. Rosati, J. Viñals and H. Wallace (2004) An Agenda for a Growing Europe: Sapir Report (Oxford: Oxford University Press). Saraceno, P. (1980) La questione meridionale nella ricostruzione post bellica, 1943– 1950 (Milano: Giuffrè). Saraceno, P. (1992) Studi sulla questione meridionale (Bologna: Il Mulino).

Chiara Guglielmetti

41

Saxenian, A. (1988) ‘Regional Networks and the Resurgence of Silicon Valley’, Berkeley, Institute of Urban and Regional Development Working Paper n. 508. Saxenian, A. (1991) ‘Contrasting Patterns of Business Organization in Silicon Valley’, Berkeley, Institute of Urban and Regional Development Working Paper n. 535. Saxenian, A. (1994) Regional Advantage: Culture and Competition in Silicon Valley and Route 128 (Cambridge, MA: Harvard University Press). Scott, A. J. (1988a) Metropolis: From the Division of Labor to Urban Form (Berkeley: University of California Press). Scott, A. J. (1988b) New Industrial Spaces (London: Pion). Scott, A. J. (1990) ‘The Aircraft Industry in Southern California, the Early Years’, University of California Los Angeles: Papers in Economic and Human Geography 2. Scott, A. J. (2001) (ed.) Global City-Regions: Trends, Theory, Policy (Oxford: Oxford University Press). Scott, A. J. and M. Storper (eds) (1986) Production, Work, Territory (London: Allen and Unwin). Scott, A. J. and M. Storper, (eds) (1987) ‘High Technology Industry and Regional Development: A Theoretical Critique and Reconstruction’, International Social Science Journal, 112, 215–32. Scott, A. J. and M. Storper (eds) (1991) ‘Regional Development Reconsidered’ in H. Ernste and V. Meier (eds), Regional Development and Contemporary Industrial Response: Expanding Flexible Specialisation (London: Belhaven), 3–24. Shane, S. A. (2008) The Illusions of Entrepreneurship: The Costly Myths that Entrepreneurs, Investors, and Policy Makers Live by (New Haven and London: Yale University Press). Schmoller, F. G. (1884) ‘Das Merkantilsystem in seiner historischen Bedeutung: Städtische, territoriale und staatliche Wirtschafts-politik’, Jahrbuch für Gesetzgebung, Verwaltung und Volkswirtschaft im Deutschen Reich, 8, 15–61. Schmoller, F. G. (1905) Principes d’Economie Politique (Paris: V. Giard & E. Brière). Sforzi, F. (1990) ‘The Quantitative Importance of Marshallian Industrial Districts in the Italian Economy’ in F. Pyke, G. Becattini and W. Sengenberger (eds) Industrial Districts and Interfirm Cooperation in Italy (Geneva: International institute of Labor Studies), pp. 75–107. Solinas, G. (1982) ‘Labor Market Segmentation and Workers’ Careers: The Case of the Italian Knitwear Industry’, Cambridge Journal of Economics, 6, 331–52. Storper, M. (1989) ‘The Transition to Flexible Specialization in the US Firm Industry: External Economies, the Division of Labor, and the Crossing of Industrial Divides’, Cambridge Journal of Economics, 13, 273–305. Storper, M. (1991) ‘Flexibility, Hierarchy and Regional Development: the Changing Structures of Production Systems and their Forms of Governance in the 1990s’, Research Policy, 21, 407–22. Storper, M. (1992), ‘The Limits to Globalization: Technology Districts and International Trade’, Economic Geography, 68, 60–93. Storper, M. (1995) ‘The Resurgence of Regional Economies, Ten Years Later’, European Urban and Regional Studies, 2(3), 191–221. Storper, M. (1997a) ‘Territories, Flows, and Hierarchies in the Global Economy’ in K. R. Cox (ed.) Spaces of Globalization: Reassenting the Power of the Local (New York, London: The Guilford press), pp. 19–42.

42

Context and Proximity in Competitiveness and Cohesion

Storper, M. (1997b) The Regional World: Territorial Development in a Global Economy (New York, NY: The Guilford Press). Storper, M. and S. Christopherson (eds) (1987) ‘Flexible Specialization and Regional Industrial Agglomerations’, Annals of the Association of American Geographers, 77. Storper, M. and R. Salas (eds) (1992) ‘The Division of Labor and Industrial Diversity: Flexibility and Mass Production in the French Automobile Industry’, International Review of Applied Economics, 6(1), 1–37. Storper, M. and A. Scott (1989) ‘The Geographical Foundations and Social Regulation of Flexible Production Complexes’ in J. Wolch and M. Dear (eds), The Power of Geography; How Territory Shapes Social Life (London: Unwin Hyman), pp. 21–40. Storper, M. and A. J. Scott (eds) (1990) ‘Work Organization and Local Labor Markets in an Era of Flexible Production’, International Labour Review, 129(5), 573–91. Storper, M. and R. Walker (1983) ‘The Theory of Labor and the Theory of Location’, International Journal of Urban and Regional Research, 7, 1–44. Sylos Labini, P. (1966) Problemi dell’economia siciliana (Milano: Feltrinelli). Sylos Labini, P. (1970) Problemi dello sviluppo economico (Roma-Bari: Laterza). Sylos Labini, P. (1981) ‘Technological Change under Contemporary Conditions: An Economist’s View’, Economic papers, Department of Economics, University of Sidney, August. Sylos Labini, P. (1983a) Forze dello sviluppo e del declino (Roma-Bari: Laterza), (1984) The Forces of Economic Growth and Decline (Cambridge, MA: MIT Press). Sylos Labini, P. (1983b) Il sottosviluppo e l’economia contemporanea (Roma-Bari: Laterza). Sylos Labini, P. (1990) ‘ Economia e storia’, Economia Politica, 1, 13–32. Triglia, C. (1985) ‘La Regolamentazione Localistica: Economia e Politica nell’Aree di Piccola Imprese’, Stato e Mercato, 14, 181–228. Triglia, C. (1986) ‘Small Firm Development and Political Subcultures in Italy’, European Sociological Review, 2, 161–75. Triglia, C. (1990) ‘Italian Industrial Districts: Neither Myth nor Interlude’, paper for the conference ‘Industrial Districts and Local Economic Regeneration’, Geneva, 18–19 October. Venables, A. J. (2005) ‘Spatial Disparities in Developing Countries: Cities, Regions, and International Trade’, Journal of Economic Geography, 5(1) 3–22. Von Thünen, J. H. (1826) Der Isolierte Staat in Beziehung auf Landschaft und Nationalkonomie (Hamburg), English translation by C. M. Wartenberg (1966) von Thünen’s Isolated State (Oxford: Pergamon Press). Weber, A. (1909) Urben den Standort der Industrien (Tübingen, Germany: J. C. B. Mohr). World Bank (2009) Reshaping Economic Geography: World Development Report (Washington, DC: The World Bank). Zipf, G. (1949) Human Behavior and the Principle of Least Effort (New York: Addison-Wesley).

Part I Territories, Development and Competitiveness

This page intentionally left blank

2 Globalization and Local Economic Growth in South Africa Wim Naudé, Waldo Krugell and Marianne Matthee

2.1 Introduction The relationship between globalization1 and economic development is a topical and controversial one. Many economists see the benefits of globalization outweighing its disadvantages, and ascribe the rise in living standards, especially in Asia to the openness of trade brought on by globalization. Dissenting voices however, point to globalization as a contributing force to global inequalities and for locking poor countries into disadvantageous positions relative to richer countries (see for instance the summary in Wade, 2004). Following the financial crisis of 2008, many are arguing that financial integration and openness has gone too far, and that it is in the interest of developing countries to delay or roll back financial openness (for example, Obstfeld, 2008). What is clear from these various positions in the literature is that globalization can be a double-edged sword. It can bring benefits in terms of development, but it can also expose the weakness of an economy and it could contribute to increased inequality. Perhaps nowhere else is this double-edged sword more pertinent than in the case of local economic development. On the one hand, globalization can bring huge benefits to localities by providing access to a global market for its goods and services and by providing access to foreign capital to exploit its location’s advantages.2 But on the other hand, openness to global markets can threaten local economic activity that previously thrived in a closed environment, with this threat being particularly real due to the high mobility of production factors within a particular country. The possible outcome is therefore greater within-country inequality. Even as countrylevel economic growth and productivity increases, some localities will thrive and others decline. 45

46

Globalization and Local Economic Growth in South Africa

The questions are whether this tension between national efficiency and growth and sub-national inequality and equity is an inevitable outcome of globalization, and whether and how national and sub-national policies towards local economic development should attempt to address these. Certainly much of the existing empirical literature tends to find increased spatial inequality as countries’ global economic integration and trade openness increases. The World Bank (2009: xxi) perhaps summarizes the current mainstream thinking on these tensions the best by stating that economic growth will be unbalanced. To try to spread out economic activity is to discourage it. But development can still be inclusive, in that even people who start their lives far away from economic opportunity can benefit from the growing concentration of wealth in a few places. The way to get both the benefits of uneven growth and inclusive development is through economic integration. The World Bank (2009) argues that economic integration entails policies and interventions to deal simultaneously with urbanization, territorial (regional) development and regional integration, pointing out that the optimal mix of such policies and interventions will differ among countries depending inter alia on their stage of development and geography. A requirement for identifying such a mix of policies and interventions in a particular country is that its policy makers should be able to grasp how its growth relates (and depends on) the spatial distribution of economic activity, and how the latter is shaped by policies, institutions and geography. In short, successful local economic development requires policymakers to be able to identify lagging sub-national regions and the factors driving their divergence or convergence. In this chapter we apply this thinking to the case of South Africa.3 We analyse the country’s profile of sub-national inequality, and estimate the degree of convergence or divergence that has taken place in per capita incomes since the country’s re-integration into the world economy following the transition to democracy in 1994. Having identified the determinants of convergence or divergence, we then empirically analyse the impact of greater openness and exports on local economic growth rates. We take care to consider both institutional and geographical determinants of local economic growth, and to consider policies and interventions to increase economic integration in a manner which may promote both (uneven) growth and inclusive development.

Wim Naudé, Waldo Krugell and Marianne Matthee 47

Following the World Bank’s (2009) distinction between economic integration policies in the urbanization, territorial development and regional economic dimensions, we attempt to identify the key features of the challenge of local economic development in South Africa from each of these three perspectives. As such, this chapter is a case study of the experience and options of local economic development in a Sub-Saharan African (SSA) country following its embrace of globalization. Given the current lack of such studies from SSA, it attempts to fill a vacuum by adding to the growing number of studies in the literature, which has dealt with spatial and regional inequalities in other developing and transition countries such as Brazil, China, Russia, among others. In section 2.2 we explain why South Africa is an interesting case to study in this regard. In particular, we mention the country’s efforts at global integration since 1994, and describe its patterns and deep causes of spatial disparity. The remainder of the chapter aims at broadening our understanding of the dynamics of these spatial disparities from the territorial development, urbanization and regional integration (trade) perspectives. These perspectives are respectively taken up in sections 2.3, 2.4 and 2.5. Section 2.6 concludes.

2.2 Globalization and spatial inequality in South Africa 2.2.1 From isolation to globalization 1994 was a watershed year for South Africa. It was the year in which the first democratic elections took place after the ending of apartheid. It was also the year marking the end of the country’s international isolation, and is the year in which the new government committed itself to steering the country towards integration with the global community. The country’s commitment to globalization is clear in its extensive trade liberalization, fiscal conservatism (the country recently had a budget surplus), its Constitutionally independent Central Bank committed to inflation targeting, substantial deregulation of the telecommunications and information technology (IT) sectors and the conclusion of a number of free trade agreements (see also Coetzee et al., 1997; Naudé and Coetzee, 2004). As documented by Naudé and Gries (2009), one outcome of South Africa’s transition from isolation to globalization has been an increased openness of the economy, with the country increasingly benefiting from this to expand its exports. Between 1996 and 2000 South Africa’s total

48

Globalization and Local Economic Growth in South Africa

exports increased on average by 6.7 per cent per annum. Manufactured exports increased at an even faster rate, of 9.2 per cent per annum over this period. As a result, the share of manufacturing in total exports increased from 67.5 per cent in 1996 to 73 per cent in 2000. Economic growth also accelerated, and although the country did not achieve the targeted growth rates, which the government aimed at in its economic growth and development strategies (first the ‘GEAR’ and then the ‘ASGISA’), growth picked up after 1994. With the exception of 1998, the year of the Asian Crisis, growth remained positive at historically high rates until the fourth quarter of 2008 (when the economy contracted in the aftermath of the US financial crisis). Du Plessis and Smit (2007) confirm that since 1994 total factor productivity increased, which they argue was due to the increased openness of the economy. 2.2.2 From spatial inequality to spatial inequality Our interest in this chapter is on how local economic growth in South Africa unfolded within this period of globalization. As greater openness, more opportunities for exporting and greater international trade are the key features of this period. One of our key concerns is about the ability of different localities to have benefited from such opportunities. Before exploring this though, it is necessary to paint a picture of the drivers of local economic growth and spatial inequality before 1994. The deep determinants of spatial economic development in South Africa are its first-nature geography, that is to say its basic geographic features which include its long coastline along both the Atlantic and Indian Oceans, its harbours, climatic conditions which favour the eastern seaboard, and the location of precious metals and minerals. Figure 2.1 shows the outline of South Africa and its 354 magisterial districts (which is the unit of analysis in this paper – see (section 2.3) below for a description of these districts and the sources of data) and indicates the major urban agglomerations. Until the mid 1900s economic activity in South Africa was heavily concentrated along the coast, and in particular in three coastal cities: Cape Town, Port Elizabeth (now part of the Nelson Mandela Metropole) and Durban (now part of the Ethekwini Metropole). The major inland agglomeration by 1800 was the town of Kimberley, a world diamond producing location. By the mid 1800s, the inland agglomeration of economic activity had shifted northward to the Johannesburg (JHB) area due to the discovery of gold. For much of the twentieth century, South Africa’s economy

Wim Naudé, Waldo Krugell and Marianne Matthee 49

Figure 2.1 Basic outline of South Africa and urban agglomerations Source: Compiled for the authors by Giscoe (Pty) Ltd.

and the spatial distribution of economic activity was dominated by the exploitation of gold, and for much of the century the fastest growing localities in the country were around the inland agglomeration of Johannesburg and the administrative capital, Pretoria (now part of the City of Tshwane Metro). The infrastructure needs of the gold mining industry (in particular its need for electricity, equipment and transport infrastructure) provided a stimulus to the development of manufacturing around the gold mining industry. Even today the manufacturing sector in South Africa is largely based around the Johannesburg-Pretoria agglomeration, and is dominated by the metals and equipment sectors. The formal introduction of apartheid policies in the 1950s reinforced the above spatial patterns of development, but in a manner which enforced inequalities on racial lines. Thus the ‘grand apartheid’ policy to create homelands for the country’s majority African population enforced the spatial inequalities between the metropolitan and rural areas by attempting to confine the African population for political purposes to homelands. These were located in lagging rural areas, often

50

Globalization and Local Economic Growth in South Africa

areas with weak agricultural potential. And within towns and cities outside of the homelands, the ‘Group Areas Act’ was legislated to allow for the spatial separation of cities on racial grounds. Understanding spatial inequality and local economic growth in South Africa, and promoting inclusive growth through integration within cities, territorial development and regional linkages as discussed in the introduction requires therefore an understanding of this apartheid legacy. In effect, it added a further layer of inequality on top of the spatial inequality due to the country’s first-nature geography. The racially motivated inequalities worsened spatial inequalities and territorial development, in particular local economic development, as it resulted in a spatial economy characterized by inefficient land use, excessive transport costs, and under-investment in transport infrastructure, telecommunications and electric power. It also resulted in segmented labour and consumption markets and created artificial internal barriers to trade (Naudé and Krugell, 2003b). Today, South Africa is characterized by important spatial inequalities. In 2006 only 20 regions out of 354 produced approximately 61 per cent of output, 50 regions produced approximately 80 per cent of the country’s output and the top 100 regions produced 90 per cent of GDP (Krugell, Koekemoer and Allison, 2005: 3). On the face of it, the country’s globalization may not have improved spatial inequalities. Indeed, it would appear that local economic growth between different localities has been quite uneven over the past decade. Thus over the period 1996 to 2004 only 60 regions grew at rates faster than three per cent per annum. Of those, only 14 areas recorded growth in per capita GDP (Gross Domestic Product) in excess of five per cent per annum. At the same time, 81 regions grew by less than one per cent per annum and in 26 regions GDP per capita fell (Krugell et al., 2005: 3). The group of fast growers includes Johannesburg, Kempton Park, Boksburg, Randburg, Pretoria and Durban. Sasolburg and Rustenburg were also fast growers along with smaller places such as Montagu, Mossel Bay, Wellington and George. The high-growth cities and towns are a mix of large, urbanized centres with a literate population and large share of exports in the economy, as well as smaller towns. Johannesburg, Pretoria and Durban are examples of large cities that have grown fast over the period. There, the population is more urbanized and educated and exports make up a substantial share of economic activity (Krugell et al., 2005: 3). There are also smaller places like Mossel Bay, Wellington and Montagu that fall in this league. Rustenburg and Phalaborwa were also fast growers

Wim Naudé, Waldo Krugell and Marianne Matthee 51

with significant export shares, but are less urbanized, with resource extraction making up a significant part of the economy. Smaller places like Waterberg, Potgietersrus, Laingsburg, Humansdorp, Knysna, Witrivier, Nigel, Postmasburg, Riversdal and Warmbad also managed high average growth rates (Krugell et al., 2005: 3). Krugell et al. (2005: 4) documented that amongst the slow growers, the worst performing places are Welkom, Virginia, Westonaria, Klerksdorp, Wodehouse, Kuils River, Mitchell’s Plain, Hlabisa and Mtunzini. These include areas dependent on gold mining that have contracted significantly such as Welkom, Klerksdorp and Westonaria. There are also localities close to the major metropolitan centres that have grown poorly, for example, Mitchell’s Plain and Kuils River near Cape Town. The greater share of the towns and cities are however on average small, more rural than urban, with low levels of human capital and insignificant export shares. It would thus appear that not all localities were able to benefit equally from the openness and growth that the economy experienced post 1994. These statistics suggest that the challenge of local economic development remains significant. Local governments (municipalities) in particular, are grappling with the challenges of economic development, for which they are constitutionally responsible. Indeed, as described by Naudé (2004) and Jansen van Rensburg and Naudé (2007), following its new Constitution the country embarked on an extensive restructuring of the system of local government, and the concept ‘developmental local government’ was introduced as a guiding principle. A key concern for local governments remains how they can benefit from the country’s greater openness, and how they can contribute to creating conditions which will facilitate inclusive growth, even if that growth is spatially unbalanced. This requires an understanding of the determinants of convergence in per capita incomes across localities. We explore these determinants in the next section.

2.3 Territorial development: Gaps and determinants Despite almost a decade of good growth and rising exports, the basic patterns of spatial inequality in South Africa remain. Only a proportion of localities achieved significant economic growth rates. In this section we investigate the determinants of local economic growth rates. We draw on Naudé and Krugell (2003b, 2006) and Bosker and Krugell (2008). Although the focus is on economic growth and per capita income we recognize that economic growth is but one measure

52

Globalization and Local Economic Growth in South Africa

of territorial development. Other aspects, such as quality of life and vulnerability on a local level in South Africa is dealt with elsewhere, for instance in Rossouw and Naudé (2008), Naudé, McGillivray and Rossouw (2009) and Naudé, Rossouw and Krugell (2009). 2.3.1 Data and locations Adequate and reliable data for sub-national economic analysis remain elusive in all but the most advanced countries. In developing countries, such data are very hard to come by, and for African countries in particular, almost non-existent. South Africa is therefore a valuable exception in that consistent socio-economic data are available on a sub-national level at least from 1996 to the present (we will rely on data here which mainly cover the period 1996 to 2004). However, as can be expected, these data are subject to severe shortcomings, which must be acknowledged upfront before discussing the results from studies based on them. The basic data that are used by most of the papers which we will draw on in the remainder of this paper come from a system of integrated databases known as the Regional Economic Explorer (REX). The REX database is complied by Global Insight Southern Africa and draws together many different sources of sub-national economic information from Statistics South Africa (such as census, household and labour force surveys), government departments, development agencies and Regional Services Councils. A discussion of the database and its construction is contained in Cameron (2005). The main weakness of the REX data is that in the process of reconciling data from many different sources across the spatial dimension, it is inevitable to make assumptions and imputations. The dataset is therefore far from perfect, but nevertheless unique in a developing country context. The data from the REX are available for the level of magisterial district, of which there were 354 in South Africa until December 2000. Figure 2.1 depicted the demarcation of the country into 354 magisterial districts. After December 2000 the magisterial districts’ functions were amalgamated into 284 local municipalities (see Naudé, 2001, 2003; Jansen van Rensburg and Naudé, 2007). However, the REX continues to report data corresponding to the prior demarcation, for various reasons, most importantly that the previous demarcation is what was used in both the 1996 and 2001 censuses in South Africa. It may also be argued that the demarcation into 354 districts gives a finer level of spatial disaggregation, which is useful when issues of spatial inequality are to be studied.

Wim Naudé, Waldo Krugell and Marianne Matthee 53

2.3.2 Spatial divergence in South Africa: Are the gaps growing? What is the extent of spatial inequalities and their changes over time as implied from these data? There are various methods to measure whether per capita income between places is converging or diverging, each corresponding to a slightly different concept of convergence. These methods have been developed in the economic growth literature which was, following the seminal contribution by Solow (1956), interested in determining the speed of possible convergence in per capita incomes between lagging and leading countries in terms of per capita income. Four of the most widely used methods are to test for (i) beta convergence (ii) sigma convergence, and to do (iii) Markov chain and (iv) kernel density analyses. We will briefly describe these techniques and their results in the following sub-sections. Beta-convergence Beta convergence is also known as ‘conditional convergence’, and it is tested for by regressing growth rates in per capita income (y) on initial levels of per capita income and a set of control variables (X), as in equation (1) below (see, for example, Barro and Sala-i-Martin, 1991; Mankiw, Romer and Weil, 1992). Δyit = xit − β yit + εit

(1)

Traditionally the coefficient on initial levels of per capita income is denoted by a ‘beta’ (β); if regression estimates can establish that ‘beta’ is significant and negative (β < 0) it would imply that there is betaconvergence. Beta-convergence means that per capita incomes would converge among regions in the sample conditional on the controlling variables. The size of the beta coefficient gives an indication of the speed of convergence. The early literature found rates of convergence at around two per cent per year. Temple (1999: 134), however, notes that recent estimates have varied between zero and 30 per cent a year, and that the consensus that is emerging is one of uncertainty. Naudé and Krugell (2003b) and Naudé and Krugell (2006) both test for beta convergence among South African magisterial districts. Their main finding is that there is indeed evidence of beta convergence in South Africa, but that it is slow. Convergence is conditional on education levels (that is, human capital), initial public capital stock (which they argue could reflect local institutional strength), the share of

54

Globalization and Local Economic Growth in South Africa

exports (trade), and distance from Johannesburg (which proxies for access to markets and transport costs). Sigma convergence ‘Beta’ convergence indicates that poorer magisterial districts are converging on average to the richer ones. It says little about whether these magisterial districts have actually caught up or are falling behind others in terms of levels of per capita income. To determine this, one could evaluate the dispersion of income per capita across magisterial districts over time. A reduction in this dispersion is known as sigma convergence (σ-convergence). Here the focus is on the evolution of the cross-sectional income distribution – its shape and the movement of the distribution over time (Barro and Sala-i-Martin, 1992: 383). All other things being equal, ‘beta’ convergence may eventually lead to sigma convergence. Naudé and Krugell (2006) investigate σ-convergence in the case of South Africa’s magisterial districts by calculating the coefficient of variation of income per capita, or the standard deviation of the log of income per capita, across the magisterial districts over the period 1998 to 2002. They find that the standard deviation of the log of income per capita decreased somewhat between 1998 and 1999, but then increased again. We extend these calculations by calculating the changes in the standard deviation of per capita income and population across cities and towns between 1990 and 2000 (using data from the PIMSS). These results, for the years 1990, 1996 and 2000 for which data on 354 magisterial districts in South Africa are available, are shown in Table 2.1. From Table 2.1 it can be seen that there may be evidence of sigma convergence among South African cities and towns. The standard deviation of the log of real per capita income for all cities and towns declined from

Table 2.1 Sigma convergence in South Africa 1990–2000 Year

Standard deviation of log of real per capita income: All districts

Standard deviation of log of real per capita income: Richest 20% districts

Standard deviation of log of real per capita income: Poorest 20% of districts

Standard deviation of log of real GGP: All districts

1990 1996 2000

0.6147 0.5258 0.5466

0.3229 0.2944 0.3153

0.2379 0.1063 0.1082

1.52 1.51 1.55

Source: PIMSS, 2001.

Wim Naudé, Waldo Krugell and Marianne Matthee 55

0.6147 in 1990 to 0.5258 in 1996, after which it increased again slightly to 0.5466 in 2000. This amounts to an almost 13 per cent decline in the standard deviation over a ten-year period. The slight increases in divergence after 1996 coincide with the period of the country’s globalization efforts. The results are consistent with the view that globalization would favour the larger urban areas where economies of scale and agglomeration advantages can be more readily obtained. The Bartlett test shows these changes to be significant at the five per cent level. The results in Table 2.1 also show that the convergence was much stronger among the 20 per cent poorest magisterial districts between 1990 and 2000 (a 50 per cent decrease in dispersion of per capita incomes) while there is not really strong evidence of sigma convergence amongst the richest 20 per cent of cities and towns. This could suggest an overall reduction in the dispersion of per capita incomes over the longer term. Kernel density analysis4 The studies into the dynamics of spatial disparities in South Africa using conditional and sigma convergence cited above could thus find no hard evidence that the smaller, poorer places in South Africa have been growing faster than the larger, better-off places. At best, regression results indicate slow beta convergence conditional on the initial capital stock in the magisterial district, human capital, the openness of the economy and the magisterial district’s distance from Johannesburg (the major agglomeration). The growth regression results do not, however, provide information about the shape of the distribution of income across localities, or how it has evolved over the years. To analyse the shape of the distribution of income across localities and its evolution, requires a distribution dynamics approach as proposed by Quah (1996). This involves estimating kernels of magisterial district incomes in different time periods so that their shapes and intertemporal dynamics can be studied. A kernel estimator of a set of observations is an estimated distribution function from which the observations are likely to have been drawn. In this case the observations will be per capita GDP at magisterial district level. The interpretation of the kernel estimators is that they provide information about the mass of the distribution of per capita GDP. Based on the growth experience of the magisterial districts, they show how likely it is that per capita GDP was below a certain level in a particular year (Aziz and Duenwald, 2001). Figure 2.2 is taken from Krugell et al. (2005). Figure 2.2 depicts the kernels of the magisterial district incomes in 1996, 2000 and 2004.

56

Globalization and Local Economic Growth in South Africa

0.08 1996

0.07

2000

2004

0.06 0.05 0.04 0.03 0.02 0.01 0 0

5

10

15

20

25

30

35

Figure 2.2 Density of per capita GDP (1996, 2000, 2004) Source: Krugell et al., 2005: 7.

It shows, for 1996, an almost twin-peaked distribution with a higher density of magisterial districts with per capita GDP between R5200 and R9800 per annum (respectively US $535 and $1009 at 2009 exchange rates). The 2000 and 2004 distributions indicate that that mass subsequently diminished. The figure shows that the 2004 distribution lies further to the left with more places having lower per capita GDP. Krugell et al. (2005) calculate, based on these data, that in 1996, 50 per cent of the mass of the income distributions was below R9500 per capita. In other words, the unconditional probability that a magisterial district’s per capita GDP was less than R9500 per annum, was approximately 50 per cent. In 2004 this probability increased slightly to 51 per cent, implying no evidence of convergence. As such these results are consistent with the beta and sigma convergence results reported in the previous sections. Markov chain analysis Markov chain analysis complements the previous analyses by analysing the dynamics of the spatial income distribution in terms of its intradistributional dynamics. This allows a description of the evolution of spatial incomes over a particular period (see for example, Quah, 1993a, 1993b, 1996a, 1996b). Bosker and Krugell (2008) applied Markov chain analysis to South Africa’s magisterial districts. They assigned each district to one of a

Wim Naudé, Waldo Krugell and Marianne Matthee 57

pre-specified number of groups based on its relative GDP per capita level. Using the symbol ft to denote the vector of the resulting discretized distribution at period t and making the assumption that the distribution follows a homogenous, stationary, first order Markov chain process, they depict the evolution of the income distribution as follows: ft + x = M ft

(2)

Where M is the so-called x-period transition matrix that maps the distribution at time t into period t ⫹ x. Each element of the transition matrix, mij, denotes the probability of a region having a GDP per capita that leads it to be located in income group i of the discretized distribution at period t, to make the move to income group j in period t ⫹ x. From the transition matrix it is possible to calculate whether there is a tendency for convergence or divergence in per capita incomes among South African magisterial districts. The estimated transition probability matrix allows one to calculate a steady state income. This so-called ergodic distribution can be calculated by noting that the following has to hold in a steady state: if f ∞ is the steady state distribution it has to hold that multiplying this distribution by the transition matrix, M, gives f ∞ back, that is: Mf ∞ = f ∞

(3)

Rewriting this as ( I − M )f ∞ = 0 , shows immediately that f ∞ is the eigenvector of the transition matrix M associated with the eigenvalue of 1. A caveat to note is that the income distribution will only converge if the second largest eigenvalue of the estimated transition matrix is smaller than one. In the South African case, Bosker and Krugell (2008) found that the second largest eigenvalue of M equals 0.988 and thus the income distribution will converge to a steady state and can be calculated. When this steady state distribution was calculated, Bosker and Krugell (2008) found that if the income distribution continues to evolve as it did between 1996 and 2004, this will result in an income distribution where 98 per cent of the regions earn less than 0.36 times the national level of GDP per capita and only two per cent of the regions more than that, suggesting a heavily diverging income distribution. The upshot of this finding is that if the spatial (or ‘territorial’) income dynamics remain as they have been over the last number of years, South Africa is likely to experience heavily diverging income levels in many of

58

Globalization and Local Economic Growth in South Africa

its localities, resulting in a (continued) highly unequal distribution of income across the country. From the estimated transition probabilities Bosker and Krugell (2008) also calculated several interesting mobility indices. These include indices describing the degree of mobility in the process of moving towards the steady state and indices describing the degree of mobility once the steady state is reached. They established that the indices describing the mobility towards the steady state indicate that while the movement towards the steady state takes quite some time (a half-life of 58 years) the degree of mobility of regions within the distribution is quite low. This suggests that there is some time for policymakers to turn the tide, but the problems facing the poorest regions could be quite substantial to overcome. They furthermore found that the indices describing the mobility in the steady state corroborate the finding of low intra-distributional mobility. In particular these suggest that there is only a one per cent chance that a particular district will shift to a different income group once the steady state is reached. Also in the steady state, the magisterial districts that are relatively rich (poor) remain rich (poor) indicating that the high degree of regional per capita income inequality is likely to remain with very few districts being able to reverse their fortune.

2.4 Cities and spatial inequalities 2.4.1 Why cities are important to unlock inclusive growth in South Africa The studies surveyed in the previous section consistently found no evidence of absolute convergence across South Africa’s territorial space between per capita incomes of magisterial districts. Indeed, the persistence and even widening of income gaps was predicted from use of a Markov Chain. One of the crucial mechanisms in this regard is to be played by cities/urban agglomerations. Cities are widely seen as enhancing growth through higher productivity and attainment of better living standards – although the costs of cities in terms of congestion, squalor and environmental degradation have also been noted. 2.4.2 Profile and challenges facing South African cities There are a number of reasons why cities may be important for economic development in South Africa. For one, Naudé and Krugell (2003b) found that cities were growing faster on average than smaller

Wim Naudé, Waldo Krugell and Marianne Matthee 59

places, and that proximity to South Africa’s largest urban agglomeration (Johannesburg) was positively associated with higher economic growth rates. They also found an enhanced role for human capital to play in cities, which echoes the argument of Glaeser (1997) that a city’s density speeds up the rate of interaction between people, with the result that, since people learn through their interactions, human capital accumulation is faster (Glaeser, 1997). There were 19 cities or large urban areas in the country that produced over 70 per cent of South Africa’s GDP in 2001. Naudé and Krugell (2003b) find that these cities are the country’s ‘engines of growth’. Indeed, urbanization is associated in South Africa, as in most of the rest of the world, with rises in per capita incomes and declines in fertility rates (Henderson 2000). In South Africa, for instance, the total average annual income in rural areas in 2000 was R18,506 compared to R51,107 in urban areas. Given that South Africa is indeed experiencing high and rapid urbanization,5 the challenge facing policy makers and city planners is to manage urbanization in such a way that it continues to provide these developmental benefits. This poses a challenge for the South African government. Although cities are expected to contribute towards inclusive development, the country’s cities are characterized by uneven development, inefficient industries and declining quality of life in many instances. These constraints may in effect limit the extent to which the country can benefit from globalization as it would hamper cities’ international competitiveness. Under apartheid the functioning of South Africa’s cities were distorted through restrictions on the mobility of labour, on the use of capital, through different administrative and legal systems in different parts of the country, through wage and capital subsidies according to location, and through distortions to transport costs. These have resulted in, among others, higher living costs for the urban poor, particularly in terms of time and travel distances to work. Because of this, the urban poor remain particularly vulnerable to the potential destructive impact of globalization, such as the shocks of trade liberalization and the shedding of ‘old economy’ jobs. Even though recent estimates are difficult to come by, the 1996 Census already indicated that over 2.1 million urban residents in South Africa are estimated to be poor, that is, earning less than the then poverty line of R 1500 per month. Given the high rates of urbanization this number is likely to be much higher at present. Urban poverty may also be exacerbated by backlogs in housing provision (Pillay and Naudé, 2006) and the provision of basic services. Furthermore, migration to

60

Globalization and Local Economic Growth in South Africa

South African cities seems to be no longer opportunity driven (or driven by the need for economies of scale), but survival driven, contributing to large unemployment in urban areas and greater dependency in rural areas (Schlemmer and Lovell, 2000: 3). While urban areas and cities in particular, provide the most substantial tax base, city governments are under increasing financial pressure (Jansen van Rensburg and Naudé, 2008). The ability of South Africa’s cities to meet these challenges may depend on the extent to which these cities succeed in generating economic growth through providing the static and dynamic economies of scale (urbanization and localization economies). These are traditionally the justification for the existence of cities, and for encouraging urbanization. Localization economies refer to the benefits a firm receives from being with other firms in the same industry and is said to give rise to internal economies of scale. Urbanization economies refer to the benefits of overall scale and diversity and is said to give rise to external economies of scale (Henderson et al., 1995: 1068). Apart from these static externalities there are also two types of dynamic externalities, namely Jacobs externalities and so-called Marshall-Arrow-Romer (MAR) externalities, the latter due to knowledge sharing, learning and imitation in a particular area (Glaeser et al., 1992). In the endogenous growth literature, cities are important for economic growth precisely because they provide these dynamic information externalities that are important for innovation (as per Romer, 1986; Lucas, 1988). Two major issues which impact on urbanization and localization economies in South Africa are the sizes of its cities (given their production mix) and the functioning of their labour markets. In the latter regard, the re-integration of South African cities following the abolition of apartheid may be a prerequisite for enabling cities to becoming competitive, job-creating platforms for the country to achieve inclusive growth in a global context. The following two sections report briefly on what our research has found in this regard.

2.4.3 Size and functions of South African cities Naudé and Krugell (2003a) investigate the question of whether South African cities are yet of optimal size, and Naudé and Krugell (2005) study the specialization and diversification of its cities. This section draws on these two studies to argue that there may be scope for growth in South African cities, but that not all cities may be equally able to create jobs or grow equally fast.

Wim Naudé, Waldo Krugell and Marianne Matthee 61

In many developing countries cities often tend to be over-sized (see for example, Henderson, 2000). This may be due to the absence of large-scale land developers, a lack of strong land markets and contract enforcement, weak local fiscal autonomy and political institutions that encourage over-concentration (Ades and Glaeser, 1995; Henderson, 1988). However, a priori, South Africa might have entered its period of globalization in 1994 with under-sized, rather than over-sized cities. This is because the country’s cities have been shaped by decades of apartheid. Apartheid-planning created, as is well-documented, a spatial economy characterized by inefficient land use, excessive transport costs, under-investment in transport infrastructure, telecommunications and electricity; it also resulted in segmented labour and consumption markets, and created artificial internal barriers to trade. All of these might have contributed towards sub-optimal city sizes in South Africa. Naudé and Krugell (2003a) argue that it might be important to confirm or reject the hypothesis that South Africa’s cities are too small since the policy implications for generating efficient future economic growth is very different than would be the case if South Africa’s cities were over-sized. Sub-optimal city size would suggest that the most efficient route to further long-term economic growth would be to encourage current cities to grow through urbanization. On the other hand, if South African cities were already of optimal size, or over-sized, policy should assist new metropolitan areas to develop. The implications for city planning are thus very different under these two possibilities.6 Naudé and Krugell (2003a) show that the country’s cities tend overall to be ‘small’, with six ‘large’ cities and no ‘mega’ city. The 40 largest cities in South Africa all have populations of 250,000 or more, but apart from Greater Johannesburg (including the ‘Ekurhuleni’ municipality – see the map in Figure 2.1), less than five million. They show that about 80 per cent of South African localities have less than 250,000 inhabitants. Indeed the median7 municipality in South Africa in 2001 (the year of the last census) had a population of 87,000 people. To investigate whether there is scope for growth, Naudé and Krugell (2003a) calculated the rank-size distribution of cities for South Africa. The rank-size distribution of cities throughout the world follows a law that states that the number of cities with a population larger than S is approximately proportional to S-q (Gabaix, 1999; Knudsen, 2001). In other words, rank times population size is approximately the same constant for all cities. If q is equal to or close to 1 it is also known as ‘Zipf’s Law’ (Zipf, 1949).

62

Globalization and Local Economic Growth in South Africa

Naudé and Krugell (2003a) estimated q, and found this to be = 0.75 in the South African case. Fujita et al. (1999:216) report a coefficient of 1.004 for 130 large USA cities. Thus, whilst the rank-size rule applies to South Africa (it explains 98 per cent of the variance in city sizes) Zipf’s Law does not hold for South Africa. What are the implications of q = 0.75 for evaluating the sizes of South Africa’s cities? According to Brakman, Garretsen and Van Marrewijk (2001) if q < 1, then a more even distribution of city sizes results than if Zipf’s Law holds, and in the limiting case where q = 0 all cities would be of the same size. From this we may conclude that South Africa’s cities tend to be more evenly spread. Gabaix (1999) shows that Zipf’s Law would hold if cities were characterized by either constant returns to scale or by external economies of scale where positive and negative externalities cancel out. This could be interpreted as where the agglomeration forces and congestion (dispersion) forces cancel out (see also Brakman et al., 2001). Brakman, Garretsen, van Marrewijk and van den Berg (1999) support this notion and calculate q for the Netherlands for the periods 1600, 1900 and 1990, and note that ‘industrialization lead to an increase in q’. By 1600 the value for q was much lower than 1 (0.55) and it subsequently rose as city sizes increased. The implication is thus that South Africa’s cities are too small and that these cities are still predominantly offering urbanization economies rather than localization economies (see also Henderson et al., 1995). This however, would be a broad generalization about the roles of South African cities. There might be important differences between the extent to which different cities in South Africa offer largely urbanization or localization economies. There is clearly a need for further research in this area. The different cities in South Africa all play an almost unique role in the national economy. Both specialized as well as diversified cities are needed. Specialization is important, since it is a pervasive source of agglomeration and scale economies. Diversified cities are seen as the ‘nurseries’ for new firms and products. This is important for strategies to grow the urban economy, as it indicates that small business support, deregulation of the informal sector, and skills-development support for the self-employed, should especially target the larger, diversified urban economies of South Africa. 2.4.4 Integration and labour markets in South African cities8 Given urbanization trends in South Africa, and the need for perhaps bigger, more competitive cities offering urbanization and localization economies,

Wim Naudé, Waldo Krugell and Marianne Matthee 63

city development and management should be concerned about tackling the legacies of apartheid. We remarked in the previous section that optimizing on urbanization and localization economies would require cities’ labour markets to function well. Without creating sufficient jobs, South African cities stand the danger of becoming reservoirs of unemployment and poverty. However, in the way that apartheid has skewed the spatial economies of cities themselves, if its legacy is not removed, it may jeopardize overall inclusive spatial development in the entire country. One such legacy to be addressed is that of residential segregation. Under apartheid patterns, politically enforced residence has created racially segregated cities (Horn, 2002). Since the abolition of apartheid in the mid 1990s, there has been a significant, although relatively slow decline in overall residential segregation (Christopher, 2001). The implication is that differences in spatial access to jobs may result in different rates of unemployment among differently affected population groups, that is there may be a ‘mismatch’ of the unemployed with job opportunities. Naudé (2008) argues that this might be one explanation for the higher unemployment rate among black South Africans, in that their residences are insufficiently ‘matched’ with the places where most new jobs are being created, due to the spatial layout of cities during apartheid. This spatial mismatch results in higher unemployment for those at a further distance from job opportunities as it creates job search costs and information problems. In South Africa this may be significant due to a lack of employer-sponsored transportation, weak public transportation and high costs of private transport. Lau and Chiu (2003) illustrated the importance of good public transport infrastructure to overcome spatial mismatches in a city labour market by using data on commuting times and unemployment in Hong Kong. Their results imply that compact city size together with good public transport may limit the potential of spatial mismatches in labour markets. Currently South African metropolitan cities are characterized by the opposites: sprawling cities with weak public transportation. Such a spatial mismatch implies a mismatch between where a population group resides and where jobs are being created. Naudé (2008) compares the population distribution with patterns of employment creation in South African cities. Table 2.2 shows employment by place of work within a 10km radius of a city centre in 1996 and 2001 for South Africa’s six metropolitan cities, as well as the ratio of the growth in central city employment to the growth in total city employment (the higher this ratio the more jobs have been created in the central city areas relative to the suburbs).

64

Globalization and Local Economic Growth in South Africa

Table 2.2 Employment creation in South Africa’s cities, 1996 and 2001 Metropolitan city

City of Cape Town Nelson Mandela Metro Ethekwini Metro Ekurhuleni Metro City of Johannesburg City of Tshwane (Pretoria)

Employment by place of work in 1996 (%) in central city

Employment by place of work in 2001 (%) in central city

Ratio of central city employment growth to total employment growth

55.8

53.7

−1.5

66.2

66.0

−1.05

43.6 26.9 51.2

43.6 27.4 52.1

−1.04 2.1 1.22

65.5

66.7

2.3

Source: Naudé, 2008.

The message of Table 2.2 is that the inner city areas of cities in South Africa are important providers of employment. For instance, 65 per cent of all employment opportunities in Tshwane (Pretoria) are located within a 10km radius of the city centre. This is lowest (26 per cent) for Ekurhuleni due to its unique structure, comprising in effect nine urban centres. The table also shows the extent to which job creation has been relatively faster in the inner city areas than in the suburbs. Thus in the case of Tshwane (Pretoria), inner city employment growth has been twice as fast as the city average, while in Cape Town it has been 1.5 times slower than the city average. This is suggestive of employment suburbanization (whereby jobs move towards the suburbs) in Cape Town, Nelson Mandela Metro and Ethekwini (Durban) but not in the other three cities. Naudé (2008) further compared the proportion of the black population who has since the end of apartheid gained access to live in or near the inner city areas (where job creation is highest and fastest on average) and indeed finds that the proportion of the black population in central city areas has increased precisely in those cities where central city employment growth has been highest: Tshwane, Johannesburg and Ekurhuleni. However, he finds that the proportions of the black population who reside in these inner city areas are still relatively small, at about 20.1 per cent in the case of Johannesburg and 15.8 per cent in the case of Tshwane (Pretoria). Naudé (2008) concludes that this

Wim Naudé, Waldo Krugell and Marianne Matthee 65

evidence may be consistent with the case of the higher skilled black population moving to where employment proportion and growth is fastest (for example, central areas of Tshwane and Johannesburg and suburbs of Cape Town) but the lower skilled remaining relatively remote in suburbs, which in most cases have seen little suburbanization of employment opportunities. As such, following the abolition of apartheid, highly skilled blacks would have moved closer to central areas in the cases noted. One implication is that residential segregation would have declined in those cities – and this is, indeed, what Naudé (2008) finds. Another implication is that less skilled blacks would be subject to a spatial mismatch in city labour markets, and that distance from where job opportunities are being created would be a determinant in their rates of unemployment. Naudé (2008) also finds evidence for this, namely that distance from the city centre generally plays a much more important role in explaining black unemployment in South Africa, even when controlling for education and income levels. In contrast, in the case of white unemployment rates, distance from the city centre is insignificant. One reason why whites do not appear to be subject to a spatial mismatch, even for whites residing far from city centres, may be due to differences in ‘friction of distance’ as experienced currently by the different groups. According to Houston (2005), differential access to transport could contribute to spatial mismatches in labour markets. People dependent on unreliable public transport (such as bus, taxi, train) may be at a disadvantage compared to people having access to private transport by car. He states (p. 422) that ‘the increased mobility brought by car travel has led some authors to dub the commuting problem faced by the urban unemployed as automobile mismatch rather than spatial mismatch’. In South Africa, the white population has traditionally had more access to private cars (due to higher incomes) while the black population is largely reliant on taxis, buses and trains for commuting in the cities. South Africa’s recent National Household Travel Survey (2003) confirms this in finding that only 10 per cent of Africans of 18 years and older in the country possess a driver’s licence compared to 83 per cent of the white population (DOT, 2005: 7). The policy conclusions from these findings are clear: South African cities have the potential to increase per capita incomes and living standards in the country through the process of urbanization and people moving to and from cities. Localities in relative close proximity to cities can benefit from this. However, the findings from the research reported here also suggest that unless urban planners and policymakers address

66

Globalization and Local Economic Growth in South Africa

urban sprawl, suburbanization and the question of compact cities and the provision of better public transport infrastructure and services in cities, the ability of cities to facilitate such more inclusive spatial growth will remain limited.

2.5 Openness, exports and local growth Economic integration is an important way to obtain both uneven spatial growth and inclusive development. This means allowing people across the territory of a country to benefit from cities as growth engines (section 2.3), allowing urbanization and the spatial structure of cities to assist people to raise their living standards (section 2.4), and finally, ‘regional integration’. In this section we will focus in the South African context on the relationship between local development and trade, in accordance with the World Bank’s (2009: xiii) understanding that regional integration refers to the ability of localities to partake in international trade. We will ask how South Africa’s spatial economy depends on international trade, specifically the ability to export into international markets. 2.5.1 Does openness matter for local economic growth?9 There is consensus that exports matter for economic growth – at least on the level of a country. A large research literature deals with the benefits of exporting, which includes knowledge spillovers and knowledge diffusion, greater scope for economies of scale, greater competition and efficiency and the loosening of a country’s foreign exchange constraint. For a recent overview of this literature see Foster (2006). It follows from this literature that exporting may bring the same benefits to localities, so that promotion of exports are often recommended as a local economic development strategy. Recently, within the growing field of new economic geography (NEG) a number of contributions have provided a theoretical basis for the relationship between exports and spatial inequality (Venables, 2005; Gries and Naudé, 2008). So far however, there have only been relatively few studies which provide empirical tests of these ideas. Moreover, it may not just be degree of openness (and extent of exporting) that matters, but also how diversified or specialized a region or locality’s export basket is. In the latter regard there has been a substantial debate on the country level, whether export diversification or specialization is better for economic growth. Empirical studies find both evidence for greater export diversification and greater export specialization being positively associated with

Wim Naudé, Waldo Krugell and Marianne Matthee 67

economic growth on a country level. Naudé et al. (2010) provide a short overview of this literature. On a local level, there have been fewer studies into whether exporting (and openness) matters for growth, and whether export specialization or diversification is better. Naudé, Bosker and Matthee (2010) attempt to address this shortcoming by using export data from 354 magisterial districts of South Africa for 1996 and 2001 (corresponding to the country’s census years) and estimate growth regressions that include measures of openness and export diversification. Openness is simply measured by the share of exports in a magisterial district’s GDP. For export specialization/diversification, Naudé et al. (2010) calculate three indices, namely (index 1) a Herfindahl-index which examines trends in export revenue or specialization of the regions relative to overall South African export specialization, (index 2) a relative specialization index taken from Al-Marhubi (2000) which measures the degree of specialization by the sum of each industry’s absolute deviation of that industry’s share in a district’s total exports from that industry’s share in total South African exports at the national level; and (index 3) a normalized Herfindahl index, measuring a district’s own export concentration. They first show using these measures that exports are spatially very unequally distributed in South Africa. This is consistent with the finding of Naudé and Gries (2009) who report that between 1996 and 2000 about 22 magisterial districts in South Africa were responsible for 85 per cent of the country’s manufacturing exports. In order to determine whether more open places, and places with more diversified or specialized exports performed better in terms of economic growth, Naudé et al. (2009) ran various regressions of economic growth on the degree of openness and the three indices of export diversification/ specialization. They take care to account for the possibility of ‘spatial’ spillover effects on their results. Their results confirm the widely shared expectation that openness is generally good for economic growth, given that openness (as measured by the share of exports in GDP) is positive and significant throughout the regressions. Also, their results show that districts that have a better-educated population, and that have experienced rapid population growth have experienced higher GDP growth over the 1996–2001 period. Again these findings are in accordance with expectations and the earlier results on the determinants of GDP per capita growth reported by Naudé and Krugell (2003b, 2006). Their results also do not suggest that export diversification is significant for local economic growth. On the contrary, the results would

68

Globalization and Local Economic Growth in South Africa

suggest that the more specialized regions compared to the national export portfolio (after controlling for the effect of the other included variables in our regressions) experienced the fastest GDP growth rates. According to Naudé et al. (2010: 17) this can perhaps be explained by the fact that districts that specialized in agriculture and mining achieved better economic performance. Over the period in question commodity prices were high, suggesting that districts that took advantage of this development by specializing in exporting these high-priced commodities subsequently outperformed other regions focused on, for example, manufacturing. The implication from these findings is that openness (and globalization) has generally benefited most of those districts that were in a position, due to the availability of natural resources which were globally in demand, to make use of its opportunities. It would however, have contributed to greater spatial inequalities, and also comes with a risk, given the likely dependence on global commodity prices. 2.5.2 What determines local exports?10 Given that exports (openness) and the specialization of exports in particular goods matters for spatial inequality and local economic growth as was shown in the previous subsection, the final question remains, what can be done to increase exports on a magisterial district level? What are the determinants of district-level exports? Matthee and Naudé (2008), following the estimation strategy of Nicolini (2003) estimated the determinants of magisterial district exports (EXPR) in South Africa as a function of a geographical component (GeoR), the home market effect (HMR) of each district and specific district features (SER). Nicolini (2003), whose study focused on Europe, measured the home market effect by using the GDP per region corrected by the geographical surface area of the region (GDP per km²) in order to account for the size of the local market. She found that the home market effect explains the export intensity of the regions. The geographical component captures transport costs. Transport costs were proxied by using two different measures, the surface area of a region (that is, the geographic area in km²) and the transport intensity (the local transport infrastructure or network) of each region. She found that the surface area of a region affects the density of exports negatively and concludes that distance matters. Increased transport intensity facilitates trade flows (see also Bougheas et al., 1999). Matthee and Naudé (2008) captured the home-market effect (HMM) by using the GDP per magisterial district, as well as GDP per capita or

Wim Naudé, Waldo Krugell and Marianne Matthee 69

population per magisterial district. They measured the geographical component (using two proxies), namely the distance from each magisterial district to its nearest export hub and the surface area of each magisterial district. The influence of domestic transport costs on regional exports was captured through the implementation of these proxies. Using a variety of estimators (Tobit, RE-Tobit and type II Tobit) they found that the home-market effect (measured by the size of local GDP) and distance (measured as the distance in km to the nearest port) are the significant determinants of local exports. Particularly interesting is their finding that internal distance and thus by implication domestic transport cost, may influence the extent to which different localities in the country can be expected to be successful in exporting. In particular, comparing their findings (from a developing country) to that of Nicolini (2003) (from advanced economies), they found that in the advanced EU context that the home-market effect appears to have a much stronger effect on exports than distance has in the South African case. In Matthee and Naudé’s (2008) case the coefficients on the home-market effect (GDP) ranged between 1.3 and 4.4 and on distance between −0.78 and −1.90. In contrast, Nicolini (2003: 459, 460, 461) found the effect of the home-market effect to be significant but somewhat smaller in overall size and the effect of transport/distance (which she proxied using surface area and transport infrastructure) to be much smaller, with sizes of coefficients ranging between 0.7 and 1.3 for the home-market effect (GDP) and −0.36 and −0.58 for distance (surface area). Although direct comparisons between the results in this research and that of Nicolini (2003) for Europe were made difficult due to different estimation methods and different proxies for distance, the intriguing implication is that distance (and per implication transport costs) is relatively more important for local exports in the developing country context than in the developed country setting. This would mean that investments in transport infrastructure and services should be high on the priority list of local economic development strategies. This could include improving the efficiency of export hubs, and even creating additional export hubs (for example, through dry ports). Another, perhaps more speculative, but warranted policy implication given the discussion, is that openness to trade, if accompanied by declines in international transport costs, may contribute to a greater dispersal, or decentralization, of export manufacturers. This will have beneficial results for more peripheral regions, and may be important for local and regional development strategies in a continent where concerns over spatial inequalities have been raised (Kanbur and Venables, 2003).

70

Globalization and Local Economic Growth in South Africa

2.6 Concluding remarks The aim of this chapter was to give a comprehensive overview of the broad relationship between globalization and local economic growth in South Africa over the period 1994 to 2004, the country’s first decade of democracy and a decade of its re-integration into the global economy. Given the country’s inherited spatial inequalities, induced both by apartheid planning and geography, and the institutional extension of democracy to the local level through decentralization, the country’s entry into the global economy might be a double-edged sword. While it may stimulate economic growth it may also exacerbate spatial inequalities. Accordingly, the chapter reviewed a number of recent studies which dealt with the spatial gaps and determinants of growth on a local level, the economics of South Africa’s cities and the imperatives of making cities more inclusive engines of growth, and finally on the relationship between spatial inequalities and growth and openness to trade. The main findings from this emerging body of research stress the ‘lumpiness’ of economic growth in South Africa, and suggest that spatial inequalities are quite persistent. But this does not preclude more inclusive forms of development. Ways in which to ensure that more people (and localities) can benefit from the spatial growth points in the country include investments in human capital, investments in physical capital such as transport services and infrastructure, and investments in urban planning. Improving the structure, functioning and competitiveness of South Africa’s cities is probably one of the best development strategies in which the people of South Africa can invest.

Notes This chapter is a substantially revised version of a paper that was presented at the International Conference on ‘Apparent Antithesis: Globalization and Local Development’ University of Trento, Trento, Italy, 10 October 2008. We are grateful to the participants at the conference, and in particular Bruno Dallago and Chiara Guglielmetti, for useful comments and suggestions. The usual disclaimer applies. 1. Globalization may be understood for purposes of this chapter, following Epifani (2001:4) as the ‘increasing international division of labour through the exchange of a greater variety of intermediate goods’. 2. As remarked by Helmsing (2001: 3) ‘getting a small share of a large volume of internationally mobile investment may make a big contribution to local employment and income … and may assist in bridging the local-global gap’. 3. This chapter is based on, and summarizes, the empirical results of a number of previous papers by the authors, in particular Bosker and Krugell (2008),

Wim Naudé, Waldo Krugell and Marianne Matthee 71

4. 5.

6. 7. 8. 9. 10.

Krugell and Matthee (2009), Matthee and Naudé (2008), Naudé (2008), Naudé and Krugell (2003; 2006), and Naudé, Bosker and Matthee (2010). This section draws on Krugell et al. (2005). Southern Africa has one of the world’s highest rates of urbanization (United Nations World Urbanization Prospects, 2001). Urbanization in South Africa is expected to reach 70 per cent by 2030 (subject to the impact of HIV/AIDS). The following paragraphs are drawn from Naudé and Krugell (2003a). The average municipal size in 2001 was 178,365 and is twice the size of the median due to the six ‘outlier’ cities with more than 1 million people each. This section draws on Naudé (2008). This section draws on Naudé et al. (2010). This section draws on Matthee and Naudé (2008).

References Ades, A. F. and E. L. Glaeser (1995) ‘Trade and Circuses: Explaining Urban Giants’, Quarterly Journal of Economics, 110: 195–227. Al-Marhubi, F. (2000) ‘Export Diversification and Growth: An Empirical Investigation’, Applied Economics Letters, 7(9): 559–62. Aziz, J. and C. K. Duenwald (2001) ‘China’s Provincial Growth Dynamics’, IMF Working Paper, no. 01/3. Washington. Barro, R. J. and X. Sala-I-Martin (1992) ‘Convergence across States and Regions’, Brookings Papers on Economic Activity, 1: 107–82. Bosker, M. and W. F. Krugell (2008) ‘Regional Income Evolution in South Africa after Apartheid’, Journal of Regional Science, 48 (3): 493–523. Bougheas, S., P. O. Demetriades and E. L. W. Morgenroth (1999) ‘Infrastructure, Transport Costs and Trade’, Journal of International Economics, 47: 169–89. Brakman, S., H. Garretsen and C. Van Marrewijk (2001) An Introduction to Geographical Economics: Trade, Location and Growth (Cambridge: Cambridge University Press). Brakman, S., H. Garretsen, C. Van Marrewijk and S. Van den Berg (1999) ‘The Return of Zipf: Towards a Further Understanding of the Rank-Size Curve’, Journal of Regional Science, 39(1): 183–215. Cameron, M. (2005) ‘Spatial Economic Analysis: On the Need for Sub-National Economic Models and Data in South Africa’, Journal of Development Perspectives, 1(1): 142–63. Christopher, A. J. (2001) ‘Urban Segregation in Post-Apartheid South Africa’, Urban Studies, 38: 449–66. Coetzee, Z. R., K. Gwarada, W. A. Naudé and J. Swanepoel (1997) ‘Currency Depreciation, Trade Liberalisation and Economic Development’, South African Journal of Economics, 65(2): 165–90. Department of Transport (2005) National Freight Logistic Survey, available at http://www.transport.gov.za/library/docs/policy/freightlogistics/index.html, date accessed 12 July 2006. Du Plessis, S. and B. Smit (2007) ‘South Africa’s Growth Revival after 1994’, Journal of African Economies, 16(5): 668–704. Epifani, P. (2001), ‘Globalisation, Peripherality and Regional Unemployment Divergence’, Queen Elizabeth House Development Studies working paper no. 135, University of Oxford.

72

Globalization and Local Economic Growth in South Africa

Foster, N. (2006) ‘Exports, Growth and Threshold Effects in Africa’, Journal of Development Studies, 42 (6): 1056–74. Fujita, M., P. Krugman and A. Venables (1999. The Spatial Economy: Cities, Regions, and International Trade (Cambridge MA: MIT Press). Gabaix, X. (1999) ‘Zipf’s Law for Cities: An Explanation’, Quarterly Journal of Economics, Aug: 739–67. Glaeser, E., J. Scheinkman and A. Shleifer (1995) ‘Economic Growth in a CrossSection of Cities’, Journal of Monetary Economics, 36: 117–43. Glaeser, E. L. (2007) ‘Entrepreneurship and the City’, NBER Working Paper 13551, The National Bureau for Economic Research. Gries, T. and W. A. Naudé (2008) ‘Trade and Endogenous Formation of Regions in a Developing Country’, Review of Development Economics, 12 (2): 248–75. Helmsing, A. H. J. (2001)’ Externalities, Learning and Governance: Perspectives on Local Economic Development’, Development and Change, 32 (2): 277–308. Henderson, J. V. (1988) Urban Development: Theory, Fact and Illusion (Oxford: Oxford University Press). Henderson, J. V. (2000) ‘How Urban Concentration Affects Economic Growth’, Working Paper, Infrastructure and Environment, Development Research Group, World Bank, Washington DC. Henderson, J. V., A. Kuncoro and M. Turner (1995) ‘Industrial development in Cities’, Journal of Political Economy, 103(5): 1067–90. Horn, A. C. (2002) ‘New Perspectives on Urban Segregation and Desegregation in Post-Resolution South Africa’, in Schnell, I. and W. Ostendorf (eds) Studies in Segregation and desegregation (Ashgate: Aldershot) pp. 247–84. Houston, D. (2005) ‘Employability, Skills Mismatch and Spatial Mismatch in Metropolitan Labour Markets’, Urban Studies, 42 (2): 221–43. Jansen van Rensburg, L. and W. A. Naudé (2007) ‘Human Rights and Development: The Case of Local Government Transformation in South Africa’, Public Administration and Development, 27 (5): 393–412. Kanbur, R. and A. J. Venables (2003) Spatial Inequality and Development (Oxford: Oxford University Press). Knudsen, T. (2001) ‘Zipf’s Law for Cities and Beyond: The Case of Denmark’, American Journal of Economics and Sociology, 60 (1): 123–46. Krugell, W. F., G. Koekemoer and J. Allison (2005) ‘Convergence or Divergence of South African Cities and Towns: Evidence from Kernel Density Estimates’, paper presented at the Biennial Conference of the Economic Society of South Africa, Durban, South Africa, 7–9 September. Krugell, W. F. and M. Matthee (2009) ‘Measuring the Export Capability of South African Regions’, Development Southern Africa, 16(4). Lau, J. C. Y. and C. C. H. Chui (2003) ‘Accessibility of Low-Income Workers in Hong Kong’, Cities, 20 (3): 197–204. Lucas, R. E. (1988) ‘On the Mechanics of Economic Development’, Journal of Monetary Economics, 22: 3–42. Mankiw, G., D. Romer and D. Weil (1992) ‘A Contribution to the Empirics of Economic Growth’, Quarterly Journal of Economics, 107(2): 407–37. Matthee, M. and W. A. Naudé (2008) ‘The Determinants of Regional Manufactured Exports from a Developing Country’, International Regional Science Review, 31 (4): 343–58. National Household Travel Survey (2003) Department of Transport, South Africa.

Wim Naudé, Waldo Krugell and Marianne Matthee 73 Naudé, W. A. (2001) ‘South Africa’s Local Government Transformation: An Economic Development Perspective’, University of Leipzig Papers on Africa, Politics and Economics, No. 54. Naudé, W. A. (2003) ‘Local Government Transformation in South Africa: Challenges for Local Economic Development in a Globalizing Economy’, Africa Insight, April. 33(3): 50–6. Naudé, W. A. (2008) ‘Is There a Spatial Mismatch in South Africa’s Metropolitan Labour Market?’ Cities: The International Journal of Urban Policy and Planning, 25 (5): 268–76. Naudé, W. A. and W. F. Krugell (2003a) ‘Are South African Cities too Small?’ Cities: The International Journal of Urban Policy and Planning, March 20 (3): 175–80. Naudé, W. A. and W. F. Krugell (2003b) ‘An Enquiry into Cities and their Role in Sub-National Economic Growth in South Africa’, Journal of African Economies, 12(4): 476–99. Naudé, W. A. (2004) ‘The Effects of Policy, Institutions and Geography on Economic Growth in Africa: An Econometric Study Based on Cross-Section and Panel Data’, Journal of International Development, 16 (6): 821–49. Naudé, W. A. and Z. R. Coetzee (2004) ‘Globalisation and Inequality in South Africa: Modelling the Labour Market Transmission’, Journal of Policy Modeling 26: 911–25. Naudé, W. A. and W. F. Krugell (2005) ‘City Size and Economic Specialization in South Africa’, paper presented at the 4th Global Conference on Business and Economics, St. Hugh’s College, University of Oxford, Oxford, 27 June 2005. Naudé, W. A. and W. F. Krugell (2006) ‘Sub-National Growth Rate Differentials in South Africa: An Econometric Analysis’, Papers in Regional Science, 85: 443–57. Naudé, W. A. (2008) ‘Is There a Spatial Mismatch in South Africa’s Metropolitan Labour Market?’ Cities: The International Journal of Urban Policy and Planning, 25 (5): 268–76. Naudé, W. A., Bosker, M. and Matthee, M. (2010) ‘Export Specialization and Local Economic Growth’, The World Economy, 33(4): 552–72. Naudé, W. A., S. Rossouw and W. F. Krugell (2009) ‘The Non-Monetary Quality of City Life in South Africa’, Habitat International, October 33 (4): 319–26. Naudé, W. A., M. McGillivray and S. Rossouw (2009) ‘Measuring the Vulnerability of Sub-National Regions’, Oxford Development Studies, September 37 (3): 249–76. Naudé, W. A. and T. Gries (2009) ‘Explaining Regional Export Performance in a Developing Country: The Role of Geography and Relative Factor Endowments’, Regional Studies, August 43 (7): 967–79. Nicolini, R. (2003) ‘On the Determinants of Regional Trade Flows’, International Regional Science Review, 26(4): 447–65. Obstfeld, M. (2008) ‘International Finance and Growth in Developing Countries: What have we Learned?’ Commission on Growth and Development, Working Paper no. 34. Pillay, A. M. and W. A. Naudé (2006) ‘Financing Low-Income Housing in South Africa: Borrower Experiences and Perceptions of Banks’, Habitat International, 30 (4): 872–85. PIMSS (2001) Provincial Information Management Support System. CSIR & Department of Provincial and Local Government (www.pimss.net). Quah, D. (1993a) ‘Empirical Cross-Section Dynamics in Economic Growth’, European Economic Review, 37: 426–34.

74

Globalization and Local Economic Growth in South Africa

Quah, D. (1993b) ‘Galton’s Fallacy and Tests of the Convergence Hypothesis’, Scandinavian Journal of Economics, 95: 427–43. Quah, D. (1996a) ‘Empirics for Growth and Convergence’, European Economic Review, 40: 1353–75. Quah, D. (1996b) ‘Regional Convergence Clusters across Europe’, European Economic Review, 40: 951–8. Regional Economic Explorer (REX) (2007) Database compiled by Global Insight Southern Africa (www.globalinsight.co.za). Romer, P. M. (1986) ‘Increasing Returns and Long-Run Growth’, Journal of Political Economy, 94(5): 1002–37. Rossouw, S. and W. A. Naudé (2008) ‘The Sub-National Quality of Life in South Africa’, Social Indicators Research, 86 (3): 433–52. Schlemmer, L. and T. Lovell (2000) ‘Millions of People with Nowhere to Go: The Estimated Distribution of the South African Population 1995–2025’, unpublished paper prepared for the National Spatial Development Perspective, Office of the Presidency, November 2002. Solow, R. (1956) ‘A Contribution to the Theory of Economic Growth’, Quarterly Journal of Economics, 70: 65–94. Temple, J. (1999) ‘The New Growth Evidence’, Journal of Economic Literature, 37: 112–56. United Nations World Urbanization Prospects (2009), available online at http:// esa.un.org/unpp/. Venables, A. J. (2005) ‘Geographical Economics: Notes on Africa’, Journal of Development Perspectives, 1(1): 63–84. Wade, R. H. (2004) ‘Is Globalization Reducing Poverty and Inequality?’ World Development, 32 (4): 567–89. World Bank (2009) Reshaping Economic Geography, World Development Report (Washington, DC: The World Bank). Zipf, G. K. (1949) Human Behavior and the Principle of Least Effort (New York: Addison-Wesley).

3 Provincial Systems of Innovation and Globalization in South Africa Mario Scerri

3.1 Introduction In this chapter, the possible effects of globalization on the spatial economy of South Africa in light of its post-apartheid provincial map are explored. The question that is initially addressed is whether the provinces which have been demarcated in post-apartheid South Africa constitute valid local (sub-national) systems of innovation. Should they do so, the issues of the viability of these systems and the strategies for their development then arise. Where provinces do not constitute systems of innovation, the rationale for their existence would then have to be interrogated. The second related question concerns the effects of globalization on South Africa after apartheid and within the new spatial economic context. Most critics of the effects of globalization (Bauman, 1998) identify the exclusion of sections of the population, especially in developing economies, as introducing a novel and more pernicious form of class division exacerbated by a worsening of the bargaining powers of locally grounded labour unions. In the case of post-apartheid South Africa, this exclusion was doubly reinforced. Apartheid, by the very nature of its logic had excluded the majority of the population from any developmental participation in modernity. Indeed, one can argue that apartheid was by its nature and within the context of the post-war global economy, progressively anti-modern (Scerri, 2009). Within this overall political economic framework, the relegation of virtually all of the black population to the periphery of the economy, both spatially and through job reservation, had already removed the large majority of the labour force from effective engagement with the modern economy. The advent of democracy in 1994 plunged South Africa into a world 75

76

Provincial Systems of Innovation in South Africa

economy where globalization, after the collapse of the Soviet Union, had reached unprecedented spheres of influence. The sudden exposure to international competition thus found an economy with a labour force which was singularly uncompetitive, due to a combination of the erosion of the human capital base under apartheid and the legitimate aspiration of the majority of the population to an improved material quality of life after political liberation. These two related issues form the core argument of this chapter: the convergence of the effects of the post-apartheid provincial map with the sudden immersion of the South African economy in a globalized world. The specific variable that will be examined will be human capital formation, that Janus-faced concept that, in its broad definition, reflects the quality of life of a population as well as the main source of competitive advantage, simultaneously the end and the means of growth and development.

3.2 The system of innovation approach to growth and development The ‘system of innovation’ approach to the analysis of the growth and development process has gained wide credence over the past two decades, among academics as well as policy-makers at both the national and the global levels. Broadly speaking, the term refers to networks of institutions which form the context for innovation (Archibugi and Lundvall, 2002; Nelson, 1993; Nelson and Winter, 1974). However, the definition of the concept is still quite fluid and this can be the cause of a degree of confusion in the debates on its applicability for analytical and prescriptive purposes. Its common usage, especially in innovation surveys such as those developed by the OECD, refers to largely technological innovations and as such constitutes an important expansion of the old R&D surveys to include innovation as the wider object of measurement and analysis. In this respect, the choice of institutions that should be considered as part of the system is a consequence of the breadth of the definition of innovation that is adopted and at the same time a determinant of the analytical and prescriptive implications of the approach. In its narrowest sense, a system of innovation may refer to the web of those formal institutions that directly create the conditions for the development of science, technology and innovation. As such, a national system of innovation is by implication defined as a sector of the economy. This web may be extended to contain other formal institutions which, while not directly concerned

Mario Scerri

77

with science and technology, have an adjacent effect on the intensity and patterns of innovation paths. The inclusion of informal institutions in the form of broadly defined routines and practices further extends the analysis of innovation and widens its scope to an economy wide scale, at least in terms of the contextual set of determinants of innovation, broadly defined to include all novel ways to order economic activity within a certain context. If innovation, broadly defined as all contextually new ways of engaging in economic activities, is dragged from the fringe assigned to it by neoclassical theory to the core of the process of economic growth and development, the study of the determinants of innovation and the consequent innovation policy would take centre stage in the analysis of economic dynamics and in economic planning. From its origins, this approach was anchored to the nation (or multination) state as the defining space of systems of innovation. However, two factors caused an extension of its scope to other demarcation lines in recent times. The first was the modern phenomenon of globalization and the consequent erosion of the power of nation states to command their own economic fortunes. Within a global context of instant and virtually costless transmission of information and the rapid dismantling of barriers to the flow of goods, services, and financial and human capital, the economic relevance of national borders is rapidly, albeit unevenly, being eroded. The increasing effectiveness of economic blocs further reinforces this erosion. The second factor was the assumption of specificity as a non-trivial determinant of economic structures and development paths that is at the core of the system of innovation approach. It is this assumption, more than any other, which marks this approach as the counter discourse to the neoclassical account that assumes an overwhelming degree of universality of explanation across time and space. However, once specificity is introduced, the nation state, a relatively recent political construct, loses some degree of its relevance in the face of the possibility of sub-national (and supra-national) systems of innovation. There is, however, one proviso to the argument for local systems of innovation as a basis of analysis. The sovereign nation state is generally a given and internationally recognized legal entity. Its integrity is only challenged in those relatively rare cases of internal conflict, such as civil war or separatist movements, or in the case of an act of war by another nation state. In contrast, the legal basis for sub-national systems of innovation tends to be less firm and inviolate. Thus, in the case of provinces and municipalities, for example, the legal demarcation lines may be changed relatively easily through internal political processes. This

78

Provincial Systems of Innovation in South Africa

has considerable implications for the analysis of systems of innovation. Generally speaking, the legal delimiters of the modern nation state are powerful enough to fix it as the object of analysis. Using the biological metaphor of the systems of innovation approach we can then assess the ‘health’ of such systems and evaluate their viability in terms of their ability to reproduce, grow and adapt. This does not apply with the same degree of necessity to legally defined sub-national entities and here the issue that arises is whether any particular sub-national legal entity, such as a province, does actually constitute a system of innovation. This has a powerful bearing on the relevance of the approach to the analysis of such entities. In the case of large sub-national entities such as provinces there are three possibilities with regard to their identification as distinct systems of innovation. In the first place, we may find that a particular province has been defined on the foundation of explicit and distinct sets of historically determined specific characteristics, networks and linkages among its various sectors. Alternatively, this foundation may be weak, but there could exist some specific distinguishing characteristics within the provincial borders that offer the opportunity for the development of a distinct and viable provincial system of innovation. Finally, the foundation may be so weak as to offer no feasible chance for the development of a distinct provincial system of innovation. This classification holds distinct implications for the viability of provinces, for their role in the national development process and for policy. In the first case the viability of the provincial system of innovation predates the legal formation of the province and, given adequate provincial administration, there is every chance that the new legal construct acts as a catalyst for the accelerated development of the system. The role of the state here would be primarily an enabling one, largely designed to capitalize on an already viable system for the benefit of that system and the broader national one. In the second case the creation of the province is based on the potential of institutional networks in the specified geographic area to develop into a viable and identifiable system. In this case the role of the state in managing the new entity becomes crucial for the emergence of the viable provincial system. It would entail, inter alia, the establishment of structures and of the right institutional networks in order to establish and entrench the long-term viability of the system, again within the broader systemic context. Finally, there are those provinces which lack the pre-requisites for the development of a viable system of innovation. The creation of such provinces would often be the sole result of political bargaining with little regard to economic constraints and prospects. In this case, the only logical role of the

Mario Scerri

79

provincial government would be to ensure a minimum guaranteed quality of life for its constituency through transfers from the national government. Alternatively, the rationality of its creation in the first place may have to be re-addressed and the possibility of the re-configuration of the provincial map may have to be considered. It is therefore incumbent on the researcher and the policy maker to identify the possibilities of existence for provincial systems of innovation, those specific elements which are necessary for a system to exist, and if possible to provide some indication of threshold levels which determine the ‘coming into being’ of such systems. These elements can be roughly grouped into three broad categories. The first concerns the legality of the sub-national entity. The legal definition of a province has some ‘truth effect’ in that it sets the initial conditions for the existence of a provincial system of innovation, but this has to be qualified by the degree of autonomy of the province, be it legal, institutional or fiscal, vis-à-vis the central or national authority. The next category covers economic relationships and the networks of economic activities within the province. In this case intra-province economic relationships can refer to vertical production relations and to the clustering of enterprises within the same sector. As indicators we can look at input-output matrices and examine the strength of upstream/downstream relationships relative to the national norm. Within this category we can also include the relative weighting of intra-province production chains as compared with the production links with other provinces and with extra-national systems of innovation. This will enable an assessment of the leader/follower role that a specific province plays within the national economic context. The third category comprises resource flows within provinces, between provinces and between provinces and other countries. With regard to resources we need to distinguish between financial capital, human capital and physical capital. The flows of these various types of resources carry different implications with regard to the existence/non-existence and the viability of the sub-national system of innovation. Of these three, the strongest indication would be the net migration of human capital: a positive net immigration indicates the strength of the core capital stock of an innovation system, and the ability of that system to attract such capital. The net flows of the other two types of capital may prove to be ambiguous variables: they simultaneously indicate an attractive environment for investment and a strong source of investment for the rest of the national system of innovation. In this case, these two indicators should be weighted by the ratio of intra-province investment to cross-province investment.

80

Provincial Systems of Innovation in South Africa

Other indicators would reflect the relative size of provinces, their economic base, unemployment rates, educational profile, and the general quality of life conditions as represented by the human development index. These conditions, or rather pre-conditions for the existence of legally defined sub-national systems of innovation should enable an initial assessment of the possibilities of the existence of systems. Of course, there is here a mix of ex ante and ex post facto analysis since, except at the pre-legislative planning stages, these assessments are usually carried out vis-à-vis existing legally defined sub-national units. The overall success of spatial economic delineation is the extent to which performance indicators for the various provinces converge within an overall national growth and development path. Once the levels of viability of the provincial map have been established, we can then proceed to explore the degree to which globalization assists or impedes the convergence of these performance indicators. This is not the type of causality that can easily be empirically tested; rather, its exploration mostly proceeds through argument and some evidence regarding the context.

3.3 Provincial systems of innovation in South Africa From a system of innovation approach the usual determinants of current topographies of local development almost always fall into the two, broad but interlinked, categories of history and policy. In the case of South Africa, it is often convenient to use the pre-democracy and postapartheid periods as the identification of the point of rupture in the analysis of economic history and the evolution of economic systems. However, this may be analytically misleading since a radical change in the nature of the state does not necessarily imply an equally radical change in the nature of economic relations. The blueprint of apartheid, the economic feasibility study for ‘separate development’, came out in the report of the Tomlinson commission.1 In spite of the subsequent evidence of the wide inaccuracy of the projections of the demographic trends on which its recommendations had been based, the methodology of this report was fundamentally to determine the economic map of the country thereafter. This study worked backward from the basic requirement of apartheid that the black section of the population should as far as possible be removed from the designated central areas of white dominance. The policy of bantustans, as self-sufficient homelands, was to be the foundation stone of this programme. True to the doctrine of ‘separate development’ as

Mario Scerri

81

articulated under Verwoerd, the bantustans were created along ethnic lines2 and were meant to be economically viable in order to establish their legitimacy. However, the major constraint, and an insurmountable one at that, to the fulfilment of this policy was the area of land required for allocation to the rural black population as compared to existing allocations and the impoverished state of these areas. On paper, the solution to this constraint required that the estimated minimum income requisite for the sustainability of a rural family had to be adjusted downwards and that structural changes in production and distribution should be recommended in order to raise income from agricultural land in order to make the figures of the attainable tally with the requirements of the envisaged programme of separate development. In the case of the industrial nucleus of the Vaal triangle3, where the dependence of the industrial hub of the country on permanent pools of black labour, excluded the possibility of establishing a ‘homeland’, black residential areas spatially separated from the urban centres were established. ‘White’ South Africa was divided into four provinces – the Transvaal, the Orange Free State, Natal and the Cape Province – and influx control and pass laws rendered black South Africans foreigners in their own country. These four provinces, unlike the bantustans, had well-established economies that had evolved on the basis of sets of comparative advantage which transformed into competitive advantage on the basis of streams of investment over time. Influx control was the name given to measures used to regulate the inflow of black Africans into South Africa’s urban areas during the pre-apartheid and apartheid eras. First introduced by the Smuts government, the Native (Black) Urban Areas Act No 21 of 19234 imposed a system of segregation which allowed black Africans access to towns only to serve white labour needs. Domestic workers were allowed to live in town, while the rest of the black labour force would be restricted to finding housing in townships on the outskirts. Legislation in 1937 restricted black African males to a window of 14 days in which to find employment or return to the reserves. Pass Laws5 and other related legislation were the main methods of control. But despite rigorous application of apartheid law, the number of black Africans living in urban areas increased over time with the increasing labour input requirements of industrial growth. Given this heritage, one of the first priorities of the new democratic government was to dismantle the bantustan system and to re-draw the provincial map of South Africa. The result was the post-apartheid administrative topography consisting of nine provinces and 283 district

82

Provincial Systems of Innovation in South Africa

and metropolitan municipal regions. However, a high degree of disparity appeared with the re-drawing of the provincial map. The four ‘white’ provinces that were in place prior to democracy were broken down to various degrees and parts of them were combined in different ways with the ex-bantustans. With one exception. The exception was the amalgamation of Transkei and Ciskei which were combined to become the Eastern Cape. The Orange Free State became the Free State with the absorption of QwaQwa and parts of Bophuthatswana. In the case of the other provinces, the Transvaal was broken up into Gauteng, Limpopo, Mpumalanga and part of North West; the Cape Province was broken up into the Western, Northern and Eastern Cape and part of North West; and Natal was combined with KwaZulu to become KwaZulu-Natal. In the case of the bantustans, the larger part of Bophuthatswana was added into the North West province, with other parts going to the Free State and Mpumalanga. Venda, Gazankulu and Lebowa became part of the Limpopo province. KaNgwane and KwaNdebele, along with a part of Bophuthatswana and the old Eastern Transvaal became part of Mpumalanga. The core of the economy of the first four provinces, Gauteng, the Western Cape, KwaZulu-Natal and the Free State, is that of the heartlands of the four provinces in ‘white’ South Africa under apartheid. These were innovation systems in their own right which had evolved through the colonial, segregationist and apartheid history on the basis of natural resources and strategic location with cumulative and path dependent trajectories of private investment and state support. This could never have been true of the bantustans whose creation essentially served to establish a dumping ground for the rural black population and to render all urban blacks foreigners in their own country. They could never have been viable systems of innovation, by virtue of their ersatz creation, their location, their size and resource pool, and their generally inefficient and often corrupt local administration. The last is perhaps the major lasting constraint on development, an ‘inability to invest’ à la Hirschman (1973). Informal institutional networks, such as patronage systems tend to endure long after political change, and even after the change of guard, and there is every reason to have expected such systems to be strongly self-reproductive. Magubane (1979: 87–90) and Davenport (1987: 383–5) chart the resistance of traditional leaders to the creation of the bantustans and the eventual defeat of such resistance. New patronage systems were installed with the specific goal of lending legitimacy to the apartheid model of ‘separate development’. In this pursuit the apartheid government was generally quite willing

Mario Scerri

83

to exempt them from most of the control mechanisms on administration systems that were the norm for the rest of the country. This was a perfect environment for the development of a culture of corruption and mismanagement that has, in general, tended to survive the demise of apartheid. To a large extent, therefore, the composition of provinces in terms of the old apartheid spatial administrative entities may provide an indication of the development prospects of the various provinces, with those that reproduced the old bantustan configuration least likely to develop a viable system of innovation.

3.4 Performance indicators The tables in this section provide some data that may reflect the levels of performance of the different provinces and the capacity to proceed on to a sustainable path of growth and development. These comparative data also give some indication of the convergence of the economies of the different provinces within the overall national economy. Most of the information provided in this section reflects a high degree of disparity among these provinces in terms of a number of broad indicators of economic performance and capacity. There are also worrying indications regarding convergence. Table 3.1 shows Gross Geographic Product (GGP) per capita. Here we can see that Gauteng offers by far the highest gross measure of the standard of living, with the Western Cape as a distant second at 70 per cent of the Gauteng figure. The GGP per capita for Gauteng is more than seven times that of the Limpopo. The extremity of this geographic distortion between the richest and the poorest provinces may have eased somewhat towards 2004, as the doubling of the contribution of the Limpopo to GDP may indicate. However, this is too tentative a conclusion, given the absence of other data that would allow this interperiod comparison. One of the immediate implications of the figures provided in Table 3.1 is that if incomes per capita are to some extent related to GGP per capita, huge national imbalances in the standard of living of the population appear to exist. Apart from other effects, these imbalances would generate strong flows of internal migration away from the economic peripheries to the centres of economic activity, and indeed this exists, as is shown in Table 3.5 below. Within the current provincial map, the role of the state in this case should be twofold. In the first place, an effective system of inter-provincial transfers should ensure a minimum standard of living across provinces. Secondly, on a longer term perspective, local economic

84

Provincial Systems of Innovation in South Africa Table 3.1 Gross Geographic Product (GGP) for by province % contribution to the GDP

Western Cape Eastern Cape Northern Cape Free State KwaZulu-Natal North West Gauteng Mpumalanga Limpopo South Africa

Per Capita Gross GGP (Rands)

1998

2004

1998

14 8 2 6 15 6 38 8 4 100

14 8 2 5 17 6 33 7 8 100

18,379 6,305 12,132 11,583 9,189 8,532 26,309 14,633 3,745 12,578

Source: Ntsika Enterprise Promotion Agency, The State of Small Business in South Africa 2000; The Gross Geographic Product Per Capita figures were calculated from estimates from OHS 1998.

development initiatives should be pursued to raise the indigenous income generating capacity across the country as much as possible. The possibility of the existence of a provincial system of innovation is strongly related to the degree of diversity of the production structure of a particular province. Table 3.2 below gives some indication of the spread of sectoral diversity in the various provinces. Gauteng stands out as the most diverse economy with mining and quarrying contributing only 1.9 per cent to the industrial output of this resource rich province, and with the manufacturing industries and tertiary industries showing the highest relative contributions to industrial output out of all provinces. It is worth noting that the North West and the Northern Cape, which are the most heavily reliant on the primary sector (platinum mining in the North West and agriculture in the Northern Cape), are also among the poorest provinces. Diversity and economic well-being seem to correlate, regardless of the direction and complexity of the relationship. Table 3.3 provides an indication of the human resource capacity in the various provinces. As such, it offers a preliminary snapshot of the range of development capabilities of the various provinces. Again, the same pattern is repeated with the two richest provinces of Gauteng and the Western Cape having the highest proportions of their population with a tertiary education and a matriculation certificate. The rest of the

Table 3.2 Percentage contribution to industrial output by sector and province (2004) PROVINCE INDUSTRIAL SECTOR

W. Cape

North West

Mpumalanga

Limpopo

KZN

Free State

Gauteng

E.Cape

N.Cape

Primary industries

5.6

30.6

24.2

27.6

6.6

17.3

2.5

2.4

37.8

Mining and quarrying

0.4

27.8

20.0

24.2

1.8

12.1

1.9

0.3

28.8

Secondary industries

26.0

10.7

27.3

8.5

29.2

18.6

27.9

21.7

7.6

Manufacturing

20.9

7.8

20.8

3.9

24.3

14.1

22.9

18.6

3.8

Tertiary industries

68.4

58.6

48.5

63.8

64.2

64.1

69.5

75.9

54.7

Wholesale and retail trade; hotels and restaurants

17.2

12.2

11.4

12.8

13.6

11.4

14.9

14.6

10.8

Transport, storage and communication

10.8

9.1

8.9

9.3

12.9

8.4

9.2

8.8

9.2

Finance, real estate and business services

30.2

15.2

12.7

17.4

17.7

17.6

23.9

21.7

13.3

Community, social and other personal services

5.7

8.6

5.4

5.0

6.1

11.5

4.4

9.9

9.1

10.9

13.5

10.0

19.4

13.3

15.2

17.1

20.9

12.3

General government services Source: StatsSA.

85

86

Table 3.3 Percentage of the population aged 20 years and above by province and educational level, 2001 PROVINCE Education Level

Western Cape

Eastern Cape

Northern Cape

Free State

KZN

North West

Gauteng

Mpumalanga

Limpopo

SA

Tertiary

11.2

6.3

6.1

6.3

6.9

5.9

12.6

5.9

6.8

8.4

Grade 12

22.4

14.1

16.5

17.5

19.8

18.5

28.0

18.2

14.0

20.4

Some Secondary

36.5

29.6

29.9

30.7

28.8

29.0

34.3

26.6

26.1

30.8

Complete Primary

7.9

7.4

8.3

7.8

5.7

6.8

5.5

5.9

5.5

6.4

15.2

19.8

21.0

21.7

16.9

20.0

11.2

15.9

14.1

16.0

5.7

22.8

18.2

16.0

21.9

19.9

8.4

27.5

33.4

17.9

Some Primary None Source: StatsSA.

Mario Scerri

87

provinces lag far behind, in terms of the percentage of the population with no schooling. We can see in this pattern a self-reinforcing vicious cycle of low incomes due to untenable provincial economies which leads to low investment in human capital which, in turn, further inhibits local economic development. There are also implications for the quality and levels of service delivery, since an impoverishment of the human capital base of the poorer provinces also leads to an impoverishment of the municipal and provincial administrative capacity in those provinces. This feeds further into the vicious cycle of impoverishment and the increasing stratification among provinces. We should also note that the matriculation and higher education qualifications data for the various provinces might not be an accurate representation of the actual spread of skills across the various provinces. Internal migration in search of better employment possibilities after the recording of the levels of education may easily distort the actual geographical location of skills. Table 3.4 shows the Human Development Index (HDI) figures for the various provinces, along racial categories. The HDI figures show that Gauteng and the Western Cape offer the best quality of life among all provinces for all racial groupings. It also shows that the degree of variation in HDI is lowest for Whites and Indian/Asians while it is high among Coloureds and Blacks. This is obviously a function of the relative skills levels of the various groupings, with quality of life of Whites, Indians and Asians being significantly less subject to the vagaries of geographical location. The less educated and less skilled Black and Coloured populations are much less mobile and hence more closely linked to the economic fortunes of the provinces that they live in. This is one of the more enduring legacies of apartheid which has not been significantly addressed in the post-apartheid period. It is also, arguably, one of the most serious obstacles to the attainment of a sustainable growth and development path for the country as a whole. Given that the black African and Coloured populations constitute the very large majority of the country’s population these figures show a worrying failure both to address successfully the income distribution patterns of apartheid and also to set up a sound launching pad for the development of the country. Thus, as well as providing a succinct picture of the relative performance of the provinces, Table 3.4 offers an indication of the development potential of the various provinces. The HDI captures a number of the important constituents of broadly defined human capital. From a development perspective it thus serves not only as an indicator of

88

Provincial Systems of Innovation in South Africa

Table 3.4 Human Development Index6 by province and population group, South Africa, 2003 Population group Province Western Cape Eastern Cape Northern Cape Free State Kwa-Zulu Natal North West Gauteng Mpumalanga Limpopo South Africa Standard Deviation

Black

Coloured

Indian/Asian

White

.57 .47 .49 .49 .49 .49 .61 .48 .48 .52 .045

.61 .58 .51 .58 .71 .59 .72 .66 .65 .61 .064

.78 .76 .75 .70 .73 .75 .78 .72 .76 .74 .025

.85 .83 .83 .82 .85 .81 .87 .83 .82 .85 .018

Source: Global Insight, SA 2003.

the objective of the development process, but also as that of the state and performance of its most crucial strategy. The system of innovation approach, through its focus on the specificities of localized development processes, seeks to derive appropriate development strategies in order to optimize human capital development strategies. Here we see that not only is the overall indicator low for the largest portion of the population, but also that it varies widely by province. This provides a worrying picture of the development potential of the various provinces. It is also worth noting that the geographic spread of development achievement indicators and those of development capacity has not been substantially altered in the 14 years since the advent of democracy. This may be, to a large extent, due to the effect of the initial, and strongly neoliberal, economic plan for the new South Africa, which advocated minimal state interference in the restructuring of the economy. This, when combined with a redrawing of provincial borders and the rapid dismantling of the system of subsidies which were offered to business enterprises to locate their operations in bantustans and thus provide the illusion of a workable apartheid economic model, has led to an entrenchment of the real economic differences that were fostered under apartheid. The effects of these provincial disparities on the various populations also result in migration patterns, as indicated in Table 3.5. We may draw

Mario Scerri

89

Table 3.5 Net migration by province for 1996 and 2001 Migration Province Western Cape Eastern Cape Northern Cape Free State Kwa-Zulu Natal North West Gauteng Mpumalanga Limpopo

1996

2001

244,232 −384,892 −29,184 −6,262 −60,715 30,530 351,490 78,040 −223,239

184,999 −254,791 −7,445 −44,259 −75,333 −22,172 403,326 −26,992 −157,333

Source: Statistics South Africa, Population Census 1996 and 2001.

some preliminary indications as to the state of health of the various provinces, apart from the ones discussed above. One of the more telling signs of the state of provincial economies is provided by migration flows across provincial borders. Presumably the majority of such flows would be in response to differentials in incomes and work opportunities. Table 3.5 provides these data for the two years of 1996 and 2001. The migration figures for 2001 show that only the Western Cape and Gauteng recorded net inflows of internal migrants. All the other provinces experienced net outflows. Moreover, only Gauteng showed an increase in its net inflows of migrants between the two years. In terms of ‘people voting with their feet’ these migration patterns generally reflect and reproduce the performance patterns of the various provinces. Gauteng and the Western Cape are the recipients of the outflows of other provinces. If we assume that those who migrate are the more skilled and enterprising, then we are also witnessing a migration of skills which will further impoverish the poorer provinces. The enduring differences in the economic performance and prospects of provinces cast serious doubts regarding the viability of a number of these provincial systems of innovation, and indeed, in the very existence of a number of these systems at the provincial level. As argued earlier, while the principle of sovereignty creates a de facto national system of innovation, there is no such necessary premise for provincial systems. Provincial borders are the outcome of an internal political process and as such are relatively flexible.

90

Provincial Systems of Innovation in South Africa

3.5 Globalization and provincial systems of innovation The debates over the effects of globalization on developing economies have been going on for quite some time. On the one hand, globalization seems to be pushing the world economy towards the ideal neoclassical model with the erosion of barriers to trade, resource mobility and the flow of information, as well as the reduced incidence of transport costs in trading. Indeed, the global volume of trade has increased dramatically, and under the neoclassical assumption of the equalization of returns to factors of production, we would have expected the income gap between developed and developing economies to narrow. This, of course, has not generally happened (Stiglitz, 2003). The counter argument, based on List (2005) and, in a narrower sense, on the PrebischSinger hypothesis, is that the initial stage of development of industrial and institutional structures in different economies prior to the opening up of trade would determine the effects of trade on the development paths of nations. In those instances of trade between industrialized economies and resource based economies the income gap would tend to be reinforced with the advent of free trade. Both of these scenarios are, of course, quite reductionist and there are numerous contextual qualifications that would determine the effects of globalization on specific economies and specific sets of trading partners. One of the more recent lines of enquiry has focused on the effects of globalization on the intra-nation distribution of income and wealth. Here, using the logic of neoclassical analysis, we would assume that the owners of those factors of production which are used intensively in internationally competitive sectors would see their incomes rising while the income of those owners of factors which are mostly employed in hitherto protected import substituting sectors would drop. The starkness of this conclusion would be mitigated somewhat by the introduction of the spread of assets holdings across the population, since such portfolios would introduce a degree of flexibility into the resource ‘fixity’ assumption. Again, the starting point of the analysis is crucial to the discussion of the consequences of globalization. We would assume, ceteris paribus, that the more unequal the initial distribution of income and wealth, the greater is the probability that globalization will have a worsening effect on income and wealth gaps. Given cumulativeness and path dependence over time these rifts would grow as the well endowed would progressively emerge as global citizens, increasingly independent of the local economy while the less endowed become progressively excluded from the globalized economy.

Mario Scerri

91

The seminal factor in this progression is the rate of change of knowledge as the pre-eminent determinant of the growth and development process. Beyond some limit, and in a context where the extra-market provision of basic needs is deficient, wealth and income gaps signal categorical rifts in the access to knowledge; hence the introduction of a cumulative and path dependent development of the distribution of economic options among the population. With sub-national political and economic segmentation a further determinant of differentiation enters the analysis. In the presence of significant and enduring spatial differences in economic performance and capacity, globalization would further increase the rift between those local systems of innovation which are firmly linked to the global system of innovation and those which are progressively being removed from access to global markets. The internal migration patterns among provinces in South Africa are particularly indicative of this phenomenon. They are not only a reflection of the different economic opportunities in the various provinces, but also a dynamic determinant of the changing capacity for growth and development in the different provinces. We can reasonably assume that in general migrants tend to be the more skilled and enterprising component of the unemployed. In conditions of destitution, the ones who stay behind tend to be those who are less economically active. Thus migration patterns from sluggish to the more economically vibrant provinces indicates a shift in technological capabilities, defined as the ability to create, adopt and adapt innovations, which further reinforces the rift in the economic fortunes and prospects of different provinces. Within this context there is again apparent the source of self-reinforcing mechanisms of privilege and deprivation that entrench the deep differences in life opportunities among provinces. One can even argue that it is the very privilege of the liberation from the confines of the local brought about by globalization that further increases the relative exclusion of those sections of the population who are not provided with the key to access at the formative educational phase of their lives. The redress of these gaps depends on the patterns of privilege and deprivation. The fact that there is evident a starkly spatial and legislative dimension to these patterns requires a review of the rationale for current spatial administrative frameworks, with the possibility of a dismantlement of a structure that actually seems to add to the already highly skewed distribution of income, wealth and opportunities in the country as a whole.

92

Provincial Systems of Innovation in South Africa

3.6 When is a province not a system of innovation? This section addresses three related issues. The first is the question of the applicability of the broad version of the concept of sub-national innovation systems to the analysis of the economic performance and prospects of provinces in South Africa. Although the innovation systems approach seems to have been officially adopted in the national strategy for local economic development policy,7 the validity of the concept of provincial systems of innovation is still an open debate which merits further elaboration. Should we accept the concept, the next issue that is raised is the rationale for the existence of particular provinces as specific systems. Once this point is accepted, the next logical step for future research would be to identify the set of criteria that should be applied to identify systems along with the relevant sets of parameters. These may then be used to determine which provinces should remain and which should be merged and amalgamated. This may well prove to be the radical step that is required to address the current wide divergences in local economic development. Finally the effects of globalization on the spatial economy of South Africa are briefly explored. The conclusion is that where sub-national disparities are insignificant we can fruitfully deal with the national system of innovation as the sole object of the analysis of the relationship between the global and the local. If, as is evidently the case in South Africa, intra-regional disparities are significant and self-reinforcing over time, the relationship between the local and the global becomes more complex due to the increased difficulty in defining the local as some homogenous whole. Globalization tends to reinforce even further the rift between the poor and the rich subnational economies. The main policy implication of these arguments is based on the conclusion that the current provincial map of South Africa is fundamentally flawed. Gauteng, the Western Cape and, to a lesser degree, KwaZulu-Natal and the Free State seem to have evolved as distinct provincial systems of innovation through specific histories of institutional evolution in South Africa’s pre-democratic history. On the other hand, where provinces were designed to include former bantustans as the larger part of their territory, the development of resulting sub-national economies tends to be seriously handicapped. In the case of a number of these provinces, there is evidence that the specific provincial system of innovation holds little prospect of developing. Indeed, in a number of cases we may legitimately doubt whether a provincial system of innovation exists at all. In this context a re-drawing of the provincial map becomes imperative.

Mario Scerri

93

Notes 1. See Union of South Africa, Report of the Commission for the Socio-Economic Development of the Bantu Areas within the Union of South Africa (UG 61-1955) (Tomlinson Report), and Union of South Africa, Government Decisions on the Recommendations of the Commission for the Socio-Economic Development of the Bantu Areas within the Union of South Africa (WPF-1956). 2. Ultimately four ‘independent’ bantustans were created along ethnic lines. These were Transkei (Xhosa), declared independent on the 26 October 1976, Bophuthatswana (Tswana), declared independent on the 6 December 1977, Venda (Venda), declared independent on the 13 September 1979, and Ciskei (also Xhosa), declared independent on the 4 December 1981. The other six homelands – Gazankulu (Tsonga [Shangaan]), KaNgwane (Swazi), KwaNdebele (Ndebele), KwaZulu (Zulu), Lebowa (Northern Sotho or Pedi) and QwaQwa (Southern Sotho) – were assigned partial administrative autonomy. 3. Also referred to as the Pretoria, Witwatersrand and Vereeniging (PWV) area. 4. The act essentially removed residence rights for black males, only allowing temporary residence rights for those who could prove employment. The creation of bantustans along ethnic lines eventually allowed the separate citizenship of the black population in the respective bantustans according to language. 5. Blacks were obliged to carry identity documents that contained their residential status and their employment history. 6. The three components of the HDI are (a) longevity measured by life expectancy at birth; (b) educational attainment measured by adult literacy rate (two-thirds weighting) and combined gross enrolment at primary, secondary and tertiary levels, and (c) comfortable lives measured by a GDP Index. The overall HDI value for South Africa dropped from 0.688 in 1996 to 0.59 in 2003. This dramatic drop in this index over a relatively brief period may be largely attributed to the effects of the HIV/AIDS pandemic on overall life expectancy figures. 7. Stimulating and Developing Sustainable Local Economies – National Framework for Local Economic Development in South Africa (2006–2011), Department of Provincial and Local Government (2006).

References Archibugi, D. and B-Å. Lundvall (eds) (2002) The Globalizing Learning Economy (UK: Oxford University Press). Bauman, Z. (1998) Globalization: The Human Consequences (UK: Polity Press). Davenport, T. R. H. (1987) South Africa: A Modern History, 3rd edition (South Africa: Macmillan). Hirschman, A. O. (1973) The Strategy of Economic Development (USA: Yale University Press). List, F. (2005) National System of Political Economy, Vols 1–3 (USA: Cosimo). Magubane, B. M. (1979) The Political Economy of Race and Class in South Africa (USA: Monthly Review Press). Nelson, R. R. (1993) National Innovation Systems: A Comparative Analysis (USA: Oxford University Press).

94

Provincial Systems of Innovation in South Africa

Nelson, R. R. and S. G. Winter (1974) ‘Neoclassical vs. Evolutionary Theories of economic Growth’, The Economic Journal, 84 (336): 886–905. Scerri, M. (2009) The Evolution of the South African System of Innovation since 1916 (UK: Cambridge Scholars Publishing). Stiglitz, J. E. (2003) Globalization and its Discontents (USA: W. W. Norton).

4 Institutional Approach in China’s Local Development: The Cases Studies of Jiangsu and Zhejiang Zhikai Wang

4.1 Introduction In the past 30 years, the emergence of the market economy in China has been characterized by tremendous changes and a significant geographical concentration of economic activities. Two particularly important cases occurred in the Yangtze River Delta. The ‘South Jiangsu Model’ in Jiangsu province and the ‘Wenzhou model’ in Zhejiang province succeeded in developing two different ways of economic development, becoming the most famous examples of local development in China’s economic transformation and market development. As a matter of fact, the institutional transition and systems transplantation that occurred in China is two-fold, and implies the necessity of analysing China’s market development from both a globalization and a localization point of view. China’s successful reform and market development has certainly long been driven by the specific motivation of the Chinese for change. Meanwhile, China has benefited from transplanting the market-oriented economic system from the Western world, as well as from entry into the World Trade Organization (WTO). Yet, the driving force behind China’s motivation for change has undoubtedly been the active local development. This chapter aims to address transition and transplantation in China’s market development mainly from a local development perspective, to study how the two typically different local development models influence each other and extend their influence nationwide. The ‘South Jiangsu Model’ is characterized by Township and Village collective Enterprises (TVEs), while the ‘Wenzhou Model’ by family firms. Both TVEs and family firms are regarded as private sector or non-state owned economy. From a geographical perspective, Zhejiang, 95

96

Institutional Approach in China’s Local Development

which hugs the South of Shanghai, and Jiangsu, which hugs the North of Shanghai, have been shaping China’s most developed heartland: the Yangtze River Delta. Both are leading provinces of market economies in China, but the differences in the respective developmental paths have been significant. Although there have been debates on the two institutional approaches and development models for a considerable length of time, in the two provinces as well as across China, both models have undoubtedly contributed and still contribute to the regional growth of industrial clusters and market development in China. Yet, since the late 1990s the two economic systems have been approaching the same goal and narrowing their path differences, influencing each other through bilateral paths transplantation, that is, learning from each other and employing cooperation in their development. Market transition and systems transplantation between the two models have become critical adaptation mechanisms for local development in the two provinces, as will be discussed in the remainder of the chapter.

4.2 South Jiangsu model The Southern part of Jiangsu has long been the economic centre of China; this region was and is well endowed with resources including good locations, convenient transportation networks, agricultural sector accumulations, and inflows of human resources and technology from China’s industrial or economic capital city, Shanghai. These resource endowments represented substantial comparative advantages for the rural industrialization in the Southern part of Jiangsu during the 1980s, which became one of the most affluent regions in China and registered high levels of economic welfare. From the early stages of reform attention has thus been paid to the South Jiangsu, first defined by Fei Xiaotong1 in 1983 as ‘the South Jiangsu Model’. Ever since, this has become the popular expression for rural development and modernization in China. The ‘South Jiangsu Model’, which concentrated heavily on the development of the TVEs – most of them being collective enterprises at the township and village level – was proclaimed as a new economic and social development model for China in the 1980s and the first half of 1990s. During that period, the development of TVEs was very rapid and strong in, and profitable to, not only South Jiangsu but also other rural parts nationwide. TVEs accounted for more than 60 per cent of the total economy in Jiangsu, which established the ‘South Jiangsu Model’

Zhikai Wang

97

as a developmental banner for rural development to the whole nation.2 The TVEs of the ‘South Jiangsu Model’ had been transplanted almost everywhere in China. This even successfully set the northern part of Zhejiang marching on the developmental road of the township and village collective economy. However, north Jiangsu was not successful in transplanting the ‘South Jiangsu Model’; this is addressed in the latter part of the chapter.

4.3 Wenzhou Model and the Zhejiang phenomenon Unlike the South Jangsu Model – characterize by the rapid development of TVEs in a favorable economic, institutional and political environment – Wenzhou is a region with a population of over 5 million in 1978 and a per capita area of cultivated farmland of only 0.0223 ha. The agricultural sector in Wenzhou was underdeveloped and could barely respond to the needs of the population. Thereby, the agricultural accumulation couldn’t support the industrial sector (Wang, 2006). It is a mountainous area far away from big industrialized cities like Shanghai and Hangzhou, and thus has almost no inflow of industrial technology, human resources and commercial knowledge from big cities’ spill over. During the earlier reforms in 1978–82, while people were debating whether the road to capitalism would require the development of commodity economy and long distance trade, in rural China, family firms with purely private ownership started to develop within the institutional environment which had deemed private sector as illegal economy. Despite the fact that every year from 1982 to 1986 the central committee of CPC issued the No. 1 document in order to stimulate rural economic development, national institutions were still crucial for the development of the purely private sector during the 1980s. In spite of the constraints of the national institutional environment, Wenzhou was an exception at that time. The ‘Wenzhou Model’ based on family firms with purely private ownership was born in the South East part of Zhejiang, on the periphery, without local resources endowments but kept growing under the ‘critical protection’ of the local governments.3 In the 1980s, the non-public ownership industrial economy’s output value amounted to nearly 50 per cent of the total in Wenzhou (if we consider as well those private sectors, which were only in name collective property rights economies, the percentage would be even higher). The strong growth of the private sector in Wenzhou influenced the neighbouring regions; Taizhou was the first neighbouring region that started to transplant the ‘Wenzhou Model’ for massive

98

Institutional Approach in China’s Local Development

development of family firms. In the 1990s, the ‘Wenzhou Model’ constantly extended its influence over the whole Zhejiang province; and eventually the status of the Zhejiang phenomenon of private sector development, which was driven by the institutional transition of implementing clarity of property rights, was fundamentally laid down in Zhejiang province.

4.4 Chinese market transition driven by the two development models From the beginning, there were divergences in the development of the ‘South Jiangsu Model’ and ‘Wenzhou Model’. Wenzhou created the option for market transition by developing privately owned economies, including individual producers and private enterprises. South Jiangsu facilitated Chinese market transition based on its strong development of the TVEs. As for the institutional transition of the two models, the ‘Wenzhou Model’ was and is inseparable from the clarity of property rights, people’s pragmatic sense, the utilitarianism and entrepreneurial spirit, which have long been formed by the ‘Yongjia school of thought’. The ‘South Jiangsu Model’ was inseparable from initial local official motivation for economic development in the earlier period of China’s implementation of reform and open door policy, in addition to good endowments of location, previous economic accumulation, technology and information influences from Shanghai, and so on. Thus, the market transition in the two provinces manifested different characteristics. 4.4.1 The clusters of family firms concentration in Wenzhou and the expansion of ‘Small Items and Big Markets’ in Zhejiang In the South Eastern part of Zhejiang, in Wenzhou Municipality, the boom of family plants rapidly stimulated rural industrialization and urbanization, and consequently high economic growth. Duly in April 1985, when the number of householders of family firms in the industrial sector amounted to 133,000 in Wenzhou, a large number of farmers stepped onto the ‘wealthy lives’ road and became the visible more than ‘ten thousand yuan income householders’ at that time. Fei Xiaotong summarized the ‘Wenzhou model’ as ‘small commodities, big market’. ‘Small items, big markets’ refers to those commodities with a small scale of production, limited technology content and lower cost of transportation; daily consumer goods and durables being the main items of small merchandise. This is a good definition of Wenzhou’s production structure and commodity circulation: it is a high condensation

Zhikai Wang

99

of rural industrialization attained by the thousands upon thousands of family firms which have been relying on specialized markets.4 Huge family firms geographically concentrated in clusters here and there in Wenzhou have locally shaped the economic structure of the ‘small items and big market’. In the 1980s, Chinese urban and rural areas were extremely short of daily consumer goods and durables. At that time, China was a profitable market for the rural family firms’ industrial development in Wenzhou. It was more or less as if the family firms benefited from the producers’ monopoly market. Thus, in this phase, there was a process of localized specialization which led to the clustering of industries in Wenzhou and the whole Zhejiang Province (Zhao, 1999). Industrial clusters emerged through the expansion of family firms via blood and family relationships (Zhu, 2002). This was and is the expansion of the Zhejiang phenomenon of the ‘Wenzhou Model’ with the leading development of family-based industries along the path of ‘small items and big markets’; the industrial clusters expansion from single family-based industrial plants to many thousands of family-based industrial plants, and then from one village with one commodity, to one town with a production system (Wang, 2008). This has successfully shaped and strengthened the advantages of institutional mechanisms for the private sector in Zhejiang. 4.4.2 TVEs dominant development of rural industrialization and urbanization in Jiangsu In Jiangsu, the ‘South Jiangsu Model’ officially refers to the local development with TVEs in the Suzhou administrative region, Wuxi administrative region and Changzhou administrative region. As aforementioned, during the 1980s and the first half of the 1990s, the ‘South Jiangsu Model’ was the rural development miracle created by township governments governed TVEs. In the South Jiangsu region, each city, county and township government, and village officials, created a multitude of Township and Village Enterprises. This development model turned peasants into industrial workers with no need to leave their native areas. Rural residents in South Jiangsu were workers as well as peasants during that rapid development period; the way toward rural industrialization was cultivated in the southern part of Jiangsu by the TVEs and as a result farmers were becoming wealthy. TVEs generated revenues for each county, township and village government by investing more in infrastructure constructions and producing more public goods for the local people’s economic welfare: this was to be of benefit to rural urbanization and to further development of TVEs.

100

Institutional Approach in China’s Local Development

The final result of the TVEs’ rapid development was the overall enhancement of the economic power and the improvement of ruralurban infrastructure in South Jiangsu. Once farmers enhanced their economic strength, they started to have strong motivations to move into cities and town centres, and many of them did move and live in cities. This led to the wave of dismantling counties and the re-birth of cities in Suzhou, Wuxi and Changzhou territories.5 Jiangyin county, Zhangjiagang county, Wuxian county, Changshu county, Yixin county, Wujin county and others were all renamed as cities. The level of urbanization increased significantly in South Jiangsu, which became the place of most rapid urbanization in China at that time. This kind of TVEs dominant rural industrialization and urbanization did help the concentration of factors of production within towns and villages. Consequently, capital accumulation has since further accelerated in TVEs and led to their incredibly strong development. By the end of the 1980s, the TVEs accounted for more than 60 per cent of the total GDP in the whole Jiangsu province. 4.4.3 North Jiangsu was unsuccessful in transplanting the ‘South Jiangsu Model’ for TVE development Undoubtedly, the ‘South Jiangsu Model’ with TVE development had a strong influence in China in the 1980s. At that time, even the northeast part of Zhejiang including Hangzhou territory, Jiaxing territory and Huzhou territory were following TVE development. In the Hang-Jia-Hu region transplantation of TVE from the South Jiangsu model has been pursued, with good economic performance in the whole integrated Hangzhou-Jiaxing-Huzhou region.6 After failing in transplanting the ‘South Jiangsu Model’, North Jiangsu started to explore and practise the ‘Gengcui model’, whose name derives from the town of Gengcui, located in the rural part of Huaiyin Municipal Level City administrative territory, which was running on ‘four wheels’. One of these four wheels referred to the privately-owned economy, but this path of more localized development failed to achieve successful development. More recently, the leader of a municipality in North Jiangsu proposed to develop a kind of ‘courtyard economy’ (that is, family business firms) in rural areas, which then could be a way for North Jiangsu to reduce dependency on the ‘South Jiangsu Model’. This could be deemed a systems transplantation, and it was hoped that this would have similar effects to the ‘Wenzhou Model’ for local and regional development in North Jiangsu (Wang, 2007). However, because the ‘South Jiangsu Model’ and the collective economy had long been highly regarded as

Zhikai Wang

101

the socialist banner by the Jiangsu provincial leaders of that time, this institutional innovation of demand-induced transformation or systems transplantation,7 which could possibly relieve North Jiangsu of dependency on the ‘South Jiangsu Model’, was unable to achieve successful development under the existing regime. This also led to North Jiangsu losing its chance to gain the pre-emptive institutional advantages of the private sector development during that key historical period of China’s market transition.

4.5 Differing paths of market transition of the two development models During the 1980s and the first half of the 1990s, both the private sector development of the ‘Wenzhou Model’ (Zhejiang Phenomenon), and the ‘South Jiangsu Model’ contributed to the institutional innovations in the process of China’s market transition; both have been the successful development models of China’s economic development and participated in the industrial division of the global economy; both have laid the foundation of labour-intensive industrial development for local industrialization and rural urbanization in China. The key difference in the developmental environment between the two models was that the Chinese central government and local governments supported the ‘South Jiangsu Model’ and provided guidance for its development during that period; and led to it being transplanted and imitated nationwide. Yet, the ‘Wenzhou Model’, due to political constraints imposed on its nationwide development at that time, did not gain an equivalent expansion scale even though it had been growing and expanding very rapidly and rather well in the Southern part of Zhejiang, including Wenzhou and Taizhou. 4.5.1 Industrial mix of and differences in clusters of the two models Due to the different initial conditions and environmental endowments, the two areas followed different paths. Because of the lack of resources and without opportunities to gain assistance from nearby large industrialized cities for its economic and institutional transition, the Southern part of Zhejiang chose the road of economic clustering in developing its labour intensive family-based industries as well as specific markets so as to produce ‘small merchandise’ and achieve easier market penetration. By contrast, in the Southern part of Jiangsu the TVEs had achieved a ‘critical mass’ from the collective accumulation which had

102

Institutional Approach in China’s Local Development

built up significant assets since the late 1970s. Thus the southern part of Jiangsu continued on its original path of development of the collective ownership economy with TVEs, and chose some capital and technology intensive industries besides labour intensive ones for its regional industrialization. In short, depending on its historical legacy and influenced by Shanghai’s industrial information, technology and knowledge of management, South Jiangsu had generated a favourable environment for industrial stimuli, which was aided by a shortage of goods plus an economic credit expansion in the mid-1980s throughout the nation. This led to rapid industrialization in the southern part of Jiangsu. As a result, differences between the industrial clusters of the privately owned economy, between the southern part of Jiangsu and the southern part of Zhejiang remains. The privately owned economy was and is concentrated in the construction industry and manufacturing sector industries in Wenzhou, Taizhou and even the whole Zhejiang province: mainly the labour-intensive industries such as stationary, textiles, clothing, socks, foodstuff, metal signs, plastic, general machinery manufacturing, and so on; and traditional industries in the tertiary industries such as commerce, catering, transport, social services. Meanwhile, the private sector development in South Jiangsu was and is mainly focused on some labour-intensive and capital-intensive industries, technologyintensive industries, including the construction material industries, the mechanical industry and the manufacturing of heavy machinery equipment. Table 4.1 provides details of a comparison of the two development models. 4.5.2 Divergence in institutional transition of the two development models Undoubtedly, market development was and is the fundamental force in facilitating economic transformation and industrial development. In the 1980s and 1990s, specialized markets and industrial clusters, as well as TVEs, were the main private sector development in Zhejiang and Jiangsu. However, as aforementioned, the structures of the private sector vary from Zhejiang to Jiangsu within the Yangtze River Delta region. Thus, there are manifest differences in the market-building process and in market mechanisms between Jiangsu and Zhejiang provinces, which led to disparities in cluster development in the two provinces. The law for clusters in specialized markets in Zhejiang The private sector clusters initially grew from family-based industries in Wenzhou and Taizhou in Zhejiang Province; meanwhile markets

Table 4.1 Views of development in the ‘Wenzhou Model’ and the ‘South Jiangsu Model’ South Jiangsu Model

Southeast part of Zhejiang, Wenzhou as representative, and Taizhou included

South part of Jiangsu, including Suzhou, Wuxi and Changzhou

Local resources endowments

Traditionally a place with poor agricultural sector, more mountain area but less cultivated farmland, less primitive accumulation from agriculture, no initial foundation for the development of industries and commerce.

Traditionally a place with good agricultural sector, abundant fish and rice, merchants gathered around this area, plenty of accumulation from agriculture which laid a good basis for the development of industries and commerce.

Political environment

Being deemed an illegal economy the development of the private sector had very limited scope in 1980s, but then it was encouraged towards development, and has since been protected from the start of the 21st century.

Being supported and guided in its development by governments from the beginning led to it being transplanted and imitated by other regions throughout China. However, its transition took off in the late 1990s.

Location

A periphery area of Zhejiang province, it used to have poor transportation infrastructure; being far away from industrial and commercial metropolis cities like Shanghai, and being isolated from outside of Zhejiang, allowed no positive influence of industrial information, technology and knowledge from big cities.

A very good location between Nanjing and Shanghai, the Shanghai to Nanjing railway route and express ways run through Suzhou, Wuxi and Changzhou; long influenced and driven by industrial information, technology and knowledge from Shanghai.

Historical legacy

Less influence from the previous State planned economy, with less investment from the State or Zhejiang Province, thus with less restrictions for private sector development since China implemented the reform and opening policy.

Strongly influenced by the State planned economy, with more investment in this area from the State and Province. Private sector development with private ownership was seriously restricted, instead TVEs were strongly encouraged.

Perspectives

Depending on the family-based plants, with private ownership or private property rights, means the clarity of property rights. Focused on labour intensive industries like constructing, manufacturing industries, traditional tertiary industries, merchants, restaurants, logistic and social service.

Depending on township and village collective enterprises, with collective ownership, no clarity of property rights. Focused on capital and labour intensive industries, like constructing material, chemical industries, heavy equipment manufacturing industries.

Note: This table quoted from author’s previous publications (Wang, 2007, p. 102 and Wang, 2008, p. 27).

103

Wenzhou Model Original place of success

104

Institutional Approach in China’s Local Development

provisions were initially the result of private actions, although there were later responses of local public collective actions.8 Undoubtedly, there were and are natural links between clusters of family-firms and specialized markets in Zhejiang. ‘Small merchandise and big market’ characterized the ‘Wenzhou Model’; specific markets and industrial collaboration formed the basis of this mix. Specialized markets stimulate or have led to the development of industrial clusters into so-called economic blocks (agglomerative economies) with a concentration of specialized manufacturing. Market building in Zhejiang improves economic resources allocation. Each market has created its own industries based on its specific resources; each specialized market together with localized industrial clusters rely on each other for local development. Normally, if a rural family-based industrial plant wanted to expand its production size, the first step would be to deepen its specific production and enhance the division of labour. Market development could then provide platforms for lower transaction costs for a more specialized industrial division. The development of well functioning markets allows family firms to reduce transaction costs in selling their products, avoiding the costly and inefficient development of self-sales networks. Thereby, it is critical to improve the quality of industrial collaboration and division of labour, and hence to support private firms in increasing economic efficiency. This is the law for clusters in specialized markets, explained by Coase in his Transaction Cost Theory in 1937.

Ineffective market mechanisms for cluster stimuli in Jiangsu As a result of long being strongly influenced by the ‘South Jiangsu Model’, Jiangsu lagged behind Zhejiang in the process of market building. However, once alerted by Zhejiang’s miracle development of specialized markets and industrial clusters, Jiangsu began to catching up from the earlier 1990s. On the whole, building new markets and the extension of markets progressed hand in hand throughout Jiangsu, from South to North, from 1993 onwards. From 1993 to 1997, the commodity markets, what we also call specialized markets, developed rapidly. Factors of production markets (real estate, technology, financial, human resources, labour and auction markets) also increased in development. All of these market-building efforts improved the environment for local economic development. The specialized markets did to some extent help Jiangsu’s regional economy to be better connected with the national economy, and they have become the third driving force for

Zhikai Wang

105

development of Jiangsu’s local and regional economy; in addition to the existing driving forces of TVEs and export-oriented economy9 based on FDI in Jiangsu. However, compared with Zhejiang, Jiangsu was lagging far behind in effecting market mechanisms; and Jiangsu was in even larger contrast with Zhejiang in matching market-building processes together with effecting market mechanisms. The specialized markets in Jiangsu did not fully play their roles in providing platforms for lower transaction costs, and were unable to play their roles in rationally allocating resources and increasing the mobility of factors of production. Geographically, both Jiangsu and Zhejiang are on the east coastal area of China; generally speaking, their location and the environmental conditions of economic development are quite similar. Both provinces have been ranked in the leading position of China’s institutional innovation, thus it is worth considering why Jiangsu lagged far behind Zhejiang in market building, particularly in effecting market mechanisms.

Main disparities in the connection of markets and industries The market plays important roles in enhancing commodities circulation, meeting consumer demands, increasing employment, and improving people’s living standards. In fact, the roles of the market in rationally allocating resources, leading to mobility of factors of production, stimulating industrial clubbing and industrial restructuring, are the most essential and important for effectiveness (Yang and Huang, 1993). Certainly, it was easy for Jiangsu to learn the form of market building from Zhejiang. However, it was not simple for Jiangsu to get the essence of Zhejiang’s market building with its close links between specialized markets and industrial clusters (Wang, 1998). Additionally, unlike booming family firms in Zhejiang in the 1990s, Jiangsu had been vigorously developing its export-oriented economy. While the TVEs were still the important force for its local and regional economic development in the rural areas, two economic driving forces in Jiangsu were more likely to establish their in-home sales networks instead of depending on specialized markets for goods transaction. Thus, there were no natural links between specialized markets and industrial complex, including industrial parks, industrial clusters and industrial agglomerations in Jiangsu, no sufficient small industrial plants based on households (family firms) in specialized markets. Finally, market building in Jiangsu was unable to stick to the point of providing a lower cost transaction platform for small items transaction.

106

Institutional Approach in China’s Local Development

Particularly at that time, people in Jiangsu still did not trust the purely privately owned economy or individual enterprises (family firms). On this premise, it was understandable for the specialized markets to be short of supplies of small items from the manufacturing sector in Jiangsu. Thus, it is no wonder that quite a few specialized markets in Jiangsu gradually became Zhejiang’s distance branch markets along with the extended influence of Zhejiang’s specialized markets (Wang 1998; Zheng, 2003). The divergence here in the development of the two models was that the market mechanisms failed to stimulate the boom of local family-based economy in Jiangsu. That is why, comparatively, the economic activities and vitality of local development started to decline in Jiangsu while on the contrary, day by day, Zhejiang showed its great and sustained economic vitality.

4.6 Convergence: Bilateral systems transplantation in the new development trend of the two models Compared with the private enterprises with purely private ownership in Zhejiang, TVEs somehow neglected the market rule in resources allocation. So far, TVEs in South Jiangsu were increasingly revealing similar shortcomings10 such as those of state-owned enterprises in the earlier 1990s. Economic efficiency was declining and growth was relatively weak. Meanwhile, the evolution of specific markets and that of industrial clusters were not well interrelated or matched with each other in Jiangsu. By 1996, the income growth rate of aggregate sales income of TVEs had declined to below 10 per cent in south Jiangsu; the profits of TVEs in Suzhou and Changzhou (two main municipal level cities in South Jiangsu) started to show negative growth rates (Wang, 2005). However, in Zhejiang, with the economic development of the ‘Wenzhou model’, economic vitality has been increasingly apparent and shows tremendously stronger growth than that of Jiangsu. The Zhejiang phenomenon of the private sector in clusters with clarity of property rights had finally achieved a nationwide effect of institutional transition and transplantation in China (Sheng and Zheng 2004). This led directly to the reforming of the TVEs in South Jiangsu in the 1990s, and since that time the southern part of Jiangsu has also undertaken the development of an export oriented economy. With the change in Jiangsu, after the start of the new century, Zhejiang, including Wenzhou, began to pay more attention to the installation of a collective public force and the provision of public goods for a further and better development of the local economy; as well as starting to pay

Zhikai Wang

107

more attention to FDI inflows by investing in infrastructure and building industrial parks. 4.6.1 Export oriented economy and the FDI inflows in Jiangsu and Zhejiang What is well worth attention here is the export-oriented economy based on FDI inflows. Compared with the southern part of Jiangsu; the inflow of FDI in Zhejiang has long been lower than that of Jiangsu. Even in Hangzhou and Ningbo, the two most modern city regions in Zhejiang, FDI inflows were and are far less than that of Suzhou and Wuxi, let alone the inflows of FDI in other city regions in Zhejiang. In 1999, the contracted inflow of FDI in Hangzhou was 0.567 billion US$ and the real inflow of FDI was 0.42 billion US$, while in Suzhou the contracted FDI was 3.56 billion US$ and the real inflow FDI was 2.85 billion US$ (see Table 4.2). After the start of the new century, the FDI inflows in cities in the Yangtze River Delta keep increasing, and the southern part of Jiangsu still shows the strongest inflows of FDI, while the northeast part of Zhejiang is catching up with Jiangsu in FDI inflows. In 2005, eight cities within Jiangsu along the Yangtze River achieved real FDI inflows of 12.8 billion US$, which was almost 50 per cent of the total FDI inflows in the Yangtze River Delta. While the seven cities along the Hangzhou harbour region achieved real FDI inflows of 7.02 billion US$ which was about 26.5 per cent of the total FDI inflows in this region. Although Taizhou and Wenzhou achieved great progress in attracting FDI inflows in 2005, there were however still only 0.357 billion US$ FDI inflows in Wenzhou, and 0.338 billion US$ in Taizhou (see Table 4.3). Disparities of FDI inflows between Jiangsu and Zhejiang manifested the fact that the export-oriented economy in Zhejiang was and is lagging behind than that of Jiangsu. And figures in the Tables 4.2 and 4.3 show that Jiangsu has more potential for further development in the globalizing world, at least from the aspect of FDI inflows. Table 4.2 FDI inflows in selected cities in the provinces of Jiangsu and Zhejiang, 1999 (figures in billion US$)

Contracted FDI Real FDI

Suzhou

Wuxi

Changzhou

Ningbo

Hangzhou

3.568 2.856

1.001 1.00

0.902 0.625

0.657 0.52

0.567 0.420

Source: Data selected from Jiangsu statistic annual report 2000, Hangzhou statistic annual report 2000 and Ningbo statistic annual report 2000.

108

Institutional Approach in China’s Local Development

Table 4.3 FDI inflows in selected cities of the Yangtze River Delta, 2005 (figures in billion US$)

Real FDI Percentages of total FDI inflows in two provinces

Suzhou

Wuxi

Hangzhou

Ningbo

Wenzhou

Taizhou

5.116

2.07

1.71

2.311

0.357

0.338

8 cities along the Yangtze River in Jiangsu achieved nearly 50% of the total FDI inflows in the Yangtze River Delta 7 cities along the Hangzhou harbour in Zhejiang achieved 26.5% of the total FDI inflows in the Yangtze River Delta

Source: Data collected and recalculated from annual statistic report 2005 of related cities in the Yangtze River Delta

4.6.2 Reform of the TVEs and re-establishment of collective force in the two models The private sector development in the eastern coastal area where institutional pre-emptive advantages in market development exist, show that the private sector developments in Jiangsu and Zhejiang have been approaching the same goal and narrowing their path differences. Both the ‘South Jiangsu Model’ and the ‘Wenzhou Model’ learn from each other to amend their deficiencies. The clarity of property rights was introduced in the TVEs for systems reform in Jiangsu at the end of 1990s. Local governments in South Jiangsu reformed the property rights system, at the same time pursuing complementary reforms of industrial organization, income distribution, labour and social security rights. The aim was to regain the strong economic power of the region (Li, 1998). Meanwhile, Wenzhou started to re-install the local political collective force and economy so as to improve local infrastructures and standardize institutional infrastructures, and impose effective regulations on market development. Governments at different levels in Zhejiang, together with entrepreneurs, started to invest in public goods and to provide more public goods for the economic welfare of local residents as well as encouraging FDI inflows. Particularly, after China’s entry into the WTO, both Jiangsu and Zhejiang provinces have had to participate in the world division of industries from the aspect of worldwide mobility dynamics in this globalizing era. The Yangtze River Delta, particularly the two provinces, will undoubtedly play the leading role in China’s new development trend and market transition. From this sense, it seems crucial that Jiangsu and Zhejiang strengthen bilateral cooperation; both provinces

Zhikai Wang

109

should contribute to the further development of the Yangtze River Delta integration. Jiangsu needs to learn the market advantages of the privately owned economy from Zhejiang, and Zhejiang needs to learn collective economic power and to pay attention to public goods provision from Jiangsu: cooperation and convergence is the correct choice of the two development models. 4.6.3 Cooperation in the new development trend of the two models The southern part of Jiangsu is a strong export-oriented economy and has more potential for further development in the globalizing world. However, we should also be aware that the southern part of Jiangsu has been overly reliant on foreign capital for its regional development. This is a potential worry for the long-term development of the Jiangsu economy because of the possibility that foreign capital may sooner or later drain away.11 However, if most foreign capital investment industrial chains could be localized within the competition and cooperation by participation of local private enterprises, then the so-called latent crisis will be resolved. Even though the private sector in Jiangsu is not powerful enough to merge huge foreign capital economies, the developed private sector in Zhejiang and huge privately owned capital among Zhejiang’s population could make South Jiangsu take heart. On the one hand, the successful development of the private sector in Zhejiang has set up a good model for South Jiangsu to accelerate its development of the privately owned economy, encouraging local primary and secondary private capital owners to make investments and run businesses as well as to establish industries in Jiangsu (Chen, 2001). On the other hand, it is critical that Zhejiang’s private enterprises move into the southern and northern part of Jiangsu to collaborate with foreign capital in South Jiangsu, thereby accelerating the localization of foreign-funded industrial chains.12 The private capital flows from Zhejiang into the Southern part of Jiangsu represents a good opportunity for private firms in Zhejiang to improve their business performance and organization.

4.7 Concluding remarks The development evolution of the ‘South Jiangsu model’ and the ‘Wenzhou model’ is the bilateral systems transplantation in the development of the two models in Jiangsu and Zhejiang. A convergent model of regional economic development has been pursued in the Yangtze River

110

Institutional Approach in China’s Local Development

Delta. Only in this way could the private sector successfully coordinate the harmonious urban-rural development within Jiangsu and Zhejiang, allowing the two to achieve common development goals. Finally, as the driving force of China’s market transition, the private sector development in the Yangtze River Delta has the capabilities to create an integrated, coordinated environment for conciliating regional development within an international competitive environment. Only in this way, can Jiangsu and Zhejiang continuously contribute to China’s institutional transition and development.

Notes 1. Fei Xiaotong visited Suzhou, Wuxi, Changzhou in May 1983 while doing research in towns and villages in South Jiangsu. At that time he started to call the development of rural industrialization in the southern part of Jiangsu Sunan Moshi (‘South Jiangsu Model’), and then the term Sunan Moshi first appeared in his paper ‘Small Towns: Re-Investigation’ published in Xinhua Daily on 2 May 1984, p. 4. 2. Yang Furong, ‘The Challenges Facing the South Jiangsu Model’ (Sunan moshi mianlin de tiaozhan), The Weishi Magazine (Weishi Zazhi), 7, 1994, pp. 21–4. 3. Local governments including the Wenzhou municipal government and Wenzhou local townships and villages governments: they kept playing games with the provincial and central governments in order to protect the good development of the local private sector under the nationwide institutional constraints during that period. For example, local governments protected family firms by offering them the name of TVEs (Red Cap) but in reality those TVEs were private ownership enterprises. Similar government activities happened quite often, particularly during the earlier period of reform in 1978–82, and almost throughout the 1980s. 4. See Fei Xiaotong (1986) ‘Wenzhou Tour’ (Wenzhou Xing), Liaowang, issues 20–2. 5. This was an innovation of rural industrialization and urbanization in South Jiangsu in the 1980s and the first half of the 1990s. 6. Though lately the economic development of transplanting the South Jiangsu Model in Hangzhou-Jiaxing-Huzhou region has encountered similar difficulties to that of South Jiangsu. Fortunately, northeast Zhejiang quickly introduced the law of clarity of property rights from the Wenzhou Model. 7. Professor Jin Xiangrong has done comparative studies on government mandatory institutional transition and demand-induced institutional transition by local public (Jin Xiangrong, 2000). 8. This is to say that the private sector grows spontaneously at the beginning: whether family firms or clusters, countryside open markets or later specialized markets. They all spontaneously appear and develop in the initial local culture of business. But specialized markets as infrastructures are also

Zhikai Wang

9.

10.

11.

12.

111

public goods; private forces are normally unable to provide for this kind of public goods services, thus local public collective actions are essential support for provision of specialized markets. The export-oriented economy has been the extremely strong driving force for regional economic development and growth particularly in South Jiangsu since China implemented the Pudong opening policy in 1992. From then on, South Jiangsu established a number of industrial parks for inviting FDIs based on its strong collective economic force in public goods provision like infrastructure construction. The ‘South Jiangsu Model’ has since shifted its attention from TVEs to an export-oriented economy. For example, no separation of TVEs from township and village level officials, no separation of management rights from ownership rights, and no clarity of property rights. These shortcomings, which were similar to that of the state owned enterprises, discouraged TVEs managers and workers to work hard. It would certainly be dangerous for South Jiangsu to rely heavily on an export-oriented economy in the long term; if FDIs are unable to be localized in Jiangsu, the potential worries of an FDI drain out will always be there. Even if FDIs do not withdraw from South Jiangsu, however, FDIs contribute less to local residents’ economic welfare. That is why per capita income is much lower in South Jiangsu when compared with that of Zhejiang. See ‘Yangtze River Delta: from processing plants to world manufacturing base’, in China’s third side commodities circulation net: http://www.3rd56. com/wwwroot/list.

References Chen, H. (2001) ‘Economic Development and Innovation of the South Jiangsu Model’ (Sunan jingji fazhan yu sunan moshi chuangxin), Journal of Jiangsu Reform (Jiangsu Gaige), 12: 10–3. Coase, R. H. (1937) ‘The Nature of the Firm’, Economica, 4: 386–405. Fei, X. (1984) ‘Small Towns: Re-Investigation’ (Xiao Chengzhen: Zai Tansuo), Xinhua Daily (Xinhua Ribao), 2 May 1984, p. 4. Fei, X. (1986) ‘Wenzhou Tour’ (Wenzhou Xing), Liaowang, issues 20–2. Jin, X. (2000) ‘Multiple Modes of Institutional Transition and Progress of Stepby-Step Reform’ (Duozhong Zhidu Bianqian Fangshi Bingcun he Jianjin Zhuanhuan de Gaige Daolu), Journal of Zhejiang University (Humanity and Social Science edition), 30 (4): 138–45. Li, X. (1998) ‘Reform of Property Rights of TVEs in South Jiangsu’ (Sunan xiangzhen qiye chanquan gaige), Group Economic Research (Jituan Jingji Yanjiu), No. 4. Sheng, S. and Y. Zheng (2004) Zhejiang Phenomenon: Industrial Clusters and Regional Economic Development (Zhejiang xianxiang: chanye jiqun yu quyu jingji fazhan), (Beijing: Qinghua University Press) pp. 65–73. Statistics Bureau of Jiangsu Province (2000) ‘Statistical Bulletin of National Economic and Social Development of Jiangsu Province 2000’, Statistics Bureau of Jiangsu Province.

112

Institutional Approach in China’s Local Development

Statistics Bureau of Hangzhou (2000) ‘Statistical Bulletin of National Economic and Social Development of Hangzhou 2000’, Statistics Bureau of Hangzhou. Statistics Bureau of Ningbo (2000) ‘Statistical Bulletin of National Economic and Social Development of Ningbo 2000’, Statistics Bureau of Ningbo. Statistics Bureau of Jiangsu Province (2005) ‘Statistical Bulletin of National Economic and Social Development of Jiangsu Province 2005’, Statistics Bureau of Jiangsu Province. Statistics Bureau of Zhejiang Province (2005) ‘Statistical Bulletin of National Economic and Social Development of Zhejiang Province 2005’, Statistics Bureau of Zhejiang Province. Statistics Bureau of Hangzhou (2005) ‘Statistical Bulletin of National Economic and Social Development of Hangzhou 2005’, Statistics Bureau of Hangzhou. Statistics Bureau of Ningbo (2005) ‘Statistical Bulletin of National Economic and Social Development of Ningbo 2005’, Statistics Bureau of Ningbo. Statistics Bureau of Wenzhou (2005) ‘Statistical Bulletin of National Economic and Social Development of Wenzhou 2005’, Statistics Bureau of Wenzhou. Statistics Bureau of Taizhou (2005) ‘Statistical Bulletin of National Economic and Social Development of Taizhou 2005’, Statistics Bureau of Taizhou. Statistics Bureau of Suzhou (2005) ‘Statistical Bulletin of National Economic and Social Development of Suzhou 2005’, Statistics Bureau of Suzhou. Statistics Bureau of Wuxi (2005) ‘Statistical Bulletin of National Economic and Social Development of Wuxi 2005’, Statistics Bureau of Wuxi. Wang, Z. (1998) ‘Market Building, Resources Allocation and Regional Economic Development’ (Shichang Jianshe, Ziyuan Peizhi yu Quyu Jingji Fazhan), Macroeconomic Working Paper, 9(4), The Development and Reform Commission of Jiangsu Provincial Government. Wang, Z. (2005) ‘The Private Sector Development and the Evolution of Industrial Clusters’ (Minying JIngji Fazhan yu Chanye Jiqun Yanjin), Journal of Chinese Non-Governmental Enterprises (Zhongguo Minying Qiye) 2 (6): 31–8. Wang, Z. (2006) ‘The Growth of China’s Private Sector: A Case Study of Zhejiang Province’, China & World Economy, 14 (3): 109–20. Wang, Z. (2008) The Private Sector and China’s Market Development (Oxford: Chandos Publishing), pp. 19–20. Yang, F. (1994) ‘The Challenges Facing the Sunan Model’ (Sunan moshi mianlin de tiaozhan), The Weishi Magazine (Weishi Zazhi), 7: 21–4. Yang, X. and Y. Huang (1993) Specialization and Economic Organization (Chinese edition 1999) (Beijing: Economic Science Press), pp. 195–201. Zhao, W. (1999) ‘Wenzhou Power’ (Wenzhou liliang), Economics Highlights (Jingjixue xiaoxi bao), 26 November. Zheng, Y. (2003) Explaining the Leading Markets Province: Studying Zhejiang’s Specialized Markets (Jiedu shichang dasheng: Zhejiang zhuanye shichang yanjiu) (Hangzhou: Zhejiang University Press). Zhu, K. (2002) ‘Industrial Cluster and its Evolution in Wenzhou’ (Wenzhou Chanye Qunluo jiqi Yanjin), in Shi J., X. Jin, W. Zhao and W. Luo (eds) Institutional Transformation and Economic Development: Study on Wenzhou Model (Zhudu bianqian yu jingji fazhan: Wenzhou moshi yanjiu) (Hangzhou: Zhejiang University Press) pp. 113–24.

5 Cluster Development in Hungary: Searching for a ‘Critical Mass’ of Business via Cluster Mapping Miklós Szanyi, Ichiro Iwasaki, Péter Csizmadia, Miklós Illésy, and Csaba Makó

5.1 Introduction1 Industry clusters (ICs) have attracted much attention in the recent past. Besides the ever-growing academic interest, ICs have become primary targets of development policy. Various documents of the European Commission (EC) have expressed strong confidence in ICs as exceptionally suitable drivers of economic growth, innovation, and competitiveness (EC, 2003, 2008a, 2008b). National governments and EC-supported policies were designed to promote the process of clustering and the establishment of cluster organizations. Another important string of literature and policy practice is foreign direct investment (FDI) attraction and the development of local linkages (for example, supplier networks) of foreign investment enterprises (FIEs). Both structures, ICs and widespread supplier networks, have common features. Most importantly, both need a sufficient number of potential collaborators. Both can be developed most successfully in regions where economic activity is vivid and enterprising and cooperation has traditions. It is therefore of special interest to learn what should and could be the relationship between the two cooperation systems, what are their common features, and what are the differences. Agglomeration of economic activity is a phenomenon that is as old as human history. Centres of active and vibrant economic development and welfare have attracted various businesses for centuries. As early as the work of Marshall (1890), there has been an awareness of the importance of geographical proximity in determining the location of industrial activity. Marshall argued that clusters develop as a consequence of three factors: (a) the presence of a skilled local labour market; (b) key inputs from suppliers; and (c) rapid know-how transfer between firms, 113

114

Cluster Development in Hungary

leading to technological spillover. Hence, regional concentration is not a new phenomenon. What is then new in clusters? The industrial clustering work by Michael Porter (1990, 1998, 2003) is regarded as seminal. He emphasized that firm competitiveness was determined by multiple factors only partly endogenous to the company. In his ‘diamond model,’ four sets of interrelated forces are introduced to explain industrial dynamics and competitiveness. These are associated with factor input conditions, sophisticated local demand conditions, related and supported industries, and firm structure, strategy, and rivalry. A core notion arose around his model, stressing that a collaborative, mutually supportive group of actors could enhance regional competitiveness in global markets and, thus, create growth and other benefits. In addition, the significance of face-to-face contacts and personal demonstration, exchange of experience, and role of geographical proximity for knowledge transfers and innovation has been explored and emphasized. Another string of related economic thought elaborated on knowledge creation and innovation as a social process engaging individuals who exchange tacit and explicit knowledge. Trust-based relationships and social capital may, thus, be important for enabling horizontal cooperation between individuals within and across firms and institutions (Pouder and St. John, 1996; Saxenian, 1994). ICs are spatial concentrations of business and related institutions with activity specialization and active cooperation linkages among cluster members.2 IC activity may be facilitated by cluster organizations (cluster initiatives). Nevertheless, the latter are institutions rather than an economic phenomenon, and we make a clear distinction between them. The essence of ICs is member cooperation, and the main benefits that they obtain stem from joint actions. For the study of cluster emergence and their further development, the Hungarian experience has potential to be taken as the best laboratory case in the context of transition economies. It is well known that Hungary has been a leader among Central European states in terms of the total accumulated FDI inflows during the early 1990s. This vast influx of foreign capital formed a mega economic sector of FIEs within the country (Iwasaki, 2007). As discussed later, there is considerable room for the development of production networks between incoming multinational enterprises (MNEs) and local companies (Acs et al., 2007). Nevertheless, it is also true that the business activity of FIEs has taken greater root in local communities, and their alliance with indigenous companies, especially in manufacturing and service industries, has achieved larger scale and depth through parts supply and outsourcing than before. This

Szanyi, Iwasaki, Csizmadia, Illésy, and Makó 115

recent progress is empirically supported by our studies, which confirmed the positive and statistically significant FDI spillover effects on the productivity and export propensity of domestic firms for the early 2000s (Iwasaki et al., 2009; 2010). As a result, newly emerged clusters of FDIled businesses can now be observed in many regions, which gives us the opportunity to examine the determinants of cluster development and its possible impact on the national and regional economy in Hungary. We can approach ICs on different levels. Since the co-location of business in close geographical proximity is an organic development, we can focus on a real economic clustering process, that is, how spatial concentrations of certain activities evolve or show up at a given time of observation. This is important, since benefits of close cooperation among firms are expected to arise when cooperating agents exceed a certain number, the ‘critical mass’.3 We can make observations using statistical analysis of activities on the local level. Such an extensive ‘cluster mapping’ exercise was first carried out in the US by Michael Porter’s team at Harvard Business School. Since then, several similar calculations were made using Porter’s original method. In this chapter, we review previous mapping exercises and report our own results for Hungary. The remainder of this chapter is organized as follows: in the next section, we briefly summarize the existing literature on the relationship between supplier networks and cluster development in Hungary. The second section deals with measuring the regional density of economic activity using Michael Porter’s measurement idea, the cluster mapping methodology. In this section, we introduce the results of previous mapping exercises as well as our own research results, which were based on a modified measurement method that expanded the number of measures and refined the database in geographic terms. In the third section, we perform cluster mapping using the census-type data of Hungarian firms. The concluding remarks follow.

5.2 Supplier networks and cluster development in Hungary ICs are flexible production platforms with some kind of activity specialization. Cluster operation can be targeted directly to consumer markets but also to supplies of specific intermediate products. In some cases, ICs are organized as an alliance of equal parties (that is to say, firms with similar size and importance). In other cases, an organization is more satellite-like, and there is one or there are several large companies that determine cluster activities according to their input demands.

116

Cluster Development in Hungary

In this latter case, cluster participants and activities are organized in order to enhance the competitiveness of the whole value chain, at the top of which there usually are western large-scale MNEs. It is important to emphasize that FIE-centred ICs may work properly only on the basis of mutual benefits. Cluster cooperation, which is largely sponsored by the FIE, must bring benefits for suppliers in terms of technological up-grading, market access, and sometimes even financial support. The benefits of FIEs may range from access to less expensive and flexible local supplies to a better labour force pool and technology assistance. The essence of ICs is the mutually beneficial cooperation of various economic actors. Hence, true ICs expand beyond the mere FIE supplier networks. They include non-business participants, and their activity goes beyond the technical organization of supplies. Most common is the technology and knowledge transfer to facilitate the technical and managerial capabilities of small suppliers. There is also financial support to undertake necessary investments. However, in this type of cooperation, there is relatively little emphasis on innovation and technological cooperation, at least for the time being. MNEs are desired participants of ICs (Sölvell et al., 2003). They may support cluster development in several ways. They may be important players in the innovation process of ICs. They were always regarded as primary sources of technology to the host transition economy. Whenever their local involvement increases, interfaces of technological spillovers also widen. Hence, ICs may serve as good platforms of knowledge transfer between FIEs and local actors. The concept of dynamic clusters4 emphasizes innovative cooperation among partners rather than one-way transfers of knowledge. It is not self-evident that FIE strategies exceed the technical minimum of knowledge transfer towards suppliers. Their links to local universities or research laboratories also depend on many factors that are independent from cluster policies (Sass and Szanyi, 2004). Related to knowledge generation is training and education. This is also based on cooperation of heterogeneous partners, including MNEs. We believe that, at least for the time being, emerging market economies do not offer strong conditions for knowledge-based dynamic clusters or innovation systems that could provide strategic innovation inputs for MNEs, though many of them possess strong innovation communities that could potentially serve as a knowledge-generating network with international importance. Thus, it is highly likely that the interest of MNEs in developing deep cooperation networks with cluster participation is weaker in emerging market economies, including Hungary, than in developed countries. Nevertheless, similarly to

Szanyi, Iwasaki, Csizmadia, Illésy, and Makó 117

conditions for developing supplier networks, cluster participation is plausible and desirable, although the likelihood and modes of participation may greatly vary. In the next section, we compare the conditions of supplier network development with those of cluster establishment from the angle of MNEs. This comparison will also highlight possible ways of organizing ICs based on existing supplier networks of MNEs. In general, we expect that factors increasing the likelihood of supplier network development also increase the propensity for cluster involvement. However, the two phenomena are not identical, and, in some cases, interests may differ substantially. Therefore, it is necessary to consider these determinants from a cluster viewpoint. These are: spatial concentration, specialization, heterogeneity of actors, simultaneous competition and cooperation, critical mass, and typical cluster activities. As far as the geographic concentration is concerned, we can immediately see that, in Hungary, the main areas for FDI are identical with those of intensive cluster development. It is mainly in the capital city and the Central and Western Transdanubia regions that both clusters and FDIs accumulate.5 In fact, investments started to settle in important agglomerations already in the 1990s, while cluster development (meaning formal cluster initiatives) started only after 2000. Causal relations are rather unclear, hence these regions used to be rather developed industrial centres prior to the transition period, and their production potentials significantly contributed to FDI attraction. Later, this attraction potential was further strengthened by the MNEs themselves. Leading original equipment manufacturers (OEMs) attracted their traditional suppliers to invest in the same region in order to ensure easy and smooth cooperation. This FDI pattern itself contributed, to a large extent, to the creation of sufficient pools of specialized firms within close vicinity. OEMs also exercised a strong pulling effect on local suppliers. While many of them had their premises in these historic industrial districts, new firms also settled in them. This process was strengthened by some policy measures as well. For over a decade or so, special industrial zones enjoyed privileges in the form of tax and customs relief provided that they exported their output in its entirety. Tax-free zones became hubs for greenfield investments that also incorporated many Hungarian suppliers (Antalóczy and Sass, 2001; Sass, 2003). Much of the export-oriented greenfield investment was carried out in the tax-free zones; however, it is also worth noting that some 100 such zones were created in Hungary, since regulations for the establishment were rather easy to meet. Therefore, the likely pattern of spatial concentration was one OEM and its traditional first tier suppliers,

118

Cluster Development in Hungary

completed by local second and third tier supplier companies. Only on rare occasions did OEMs with a similar final product settle in the same hub. They separated themselves from their competitors and seemed to prefer separating their supplier network as well (Szalavetz, 2001). Consequently, significant concentrations of specialized firms were created in Hungary’s more developed areas. These networks consisted of technologically dependent suppliers of the value chain of single OEMs. The types of cooperation also contributed to the smooth functioning of the chain. Technology and knowledge transfer were provided by the OEMs and other major firms to Hungarian smaller suppliers in the areas to the extent it was necessary to improve their supply capabilities. This knowledge transfer and, generally speaking, all cooperation links were vertical: the OEM was in the centre, and other firms depended on them as satellites. Not only did OEMs avoid contacting other OEMs of their branch, but the horizontal linkages of suppliers were also curtailed (or at least not promoted), that is, both contacts to other MNEs and linkages among suppliers (for example, in the case of Electrolux).6 There is some evidence that MNEs liked sporadic suppliers because they could bargain for lower prices when dealing with separate, individual companies (Szanyi, 2008a). Summing up, FDI created hot spots for potential cluster development, but MNEs were not really interested in creating cooperation and communication platforms among supplier firms, which would be an essential cluster function. We must emphasize the role of the tax-free zones in the spatial development of industrial districts in the first phase of the transition period. The advantageous regulation was, however, lifted while Hungary was joining the European Union (EU), since it was not regarded as compatible with competition rules. In addition, in this period, there was another pattern of FDI in Hungary, which was more connected with the privatization process and was regarded as more likely leading to the development of supplier networks. From the point of view of the development of horizontal linkages, and the possibility of becoming suppliers of several firms, (various OEMs) there is anecdotal evidence proving that cooperation linkages were more frequent in this second FDI pattern. Hence, the development of local cooperation linkages around these OEMs can be more likely than in the case of greenfield investments. Another aspect of cluster development is the heterogeneity of members. It is rather clear that supplier networks around MNEs serve primarily the business interests of the integrating company. Anything beyond this interest must be initiated by other parties. The day-to-day interest of MNEs is simple: they must run their production facilities

Szanyi, Iwasaki, Csizmadia, Illésy, and Makó 119

smoothly and effectively since many of them are seeking efficiency. They need reliable business partners in the value chain. However, basically, and especially in the early years of their investments, they do not care much about the broader background. Many MNEs regard investment projects as one-off deals that last until favourable conditions prevail, but they do not intend to get involved in supporting the longer-term provision of the conditions. Therefore, institutions of the broader production background (education, infrastructure, and local development) remain outside the focus of their attention. As a result of this, the early-phase local production networks usually lack diversity, which would be an important feature of ICs. This situation is changing with the age and development of investment projects. There is much empirical evidence that shows how even greenfield investments changed their nature and behaviour (Szalavetz, 2005; Szanyi, 2003; Hunya, 2001). This is because it is in their own efficiency-seeking interest to tap cheap opportunities throughout the whole value chain. Therefore, they expand their activity from the final assembly of imported parts to increasing the local component supply to increasing local participation in corporate functions (from accounting through logistics and even to R&D). This expansion of affiliate activity in global corporate networks is in line with the current wave of concentrating on core competences and outsourcing/off shoring much of the activities (Sass, 2008). The higher the number of activities that are carried out locally, the more likely business and cooperation links are developed in various directions, exceeding the simple technological cooperation of suppliers. Whenever there is more room for contacts among heterogeneous market actors, the potential also increases for organizing these contacts and actors in some formal ways. The clustering process may also get started from the bottom. Recent experiences with labour shortage in some industrial bases in Hungary opened up new frontiers of cooperation with MNEs. National Instruments in Debrecen, Siemens in Budapest, Nokia in Szeged, and Audi in Gyo˝r are just a few examples of MNEs participating in shaping and also financing education programmes in universities. Of course, they do this because they need a high quality labour supply in the future. Another welcome development pattern is the increasing participation of MNEs in financing and participation in R&D projects in Hungary. Some of the leading investors in Hungary established R&D laboratories in the country. This also substantially increased the clustering potentials of some cities in which a sufficient educational and innovation background was present. MNEs realize that they may

120

Cluster Development in Hungary

also benefit from cluster cooperation in Hungary and become active members of ICs. Concerning the coexistence of cooperation and competition, Hungarian ICs may play a positive role. MNE supplier networks always supported intensive competition among local firms. The degree of cooperation was insufficient; however, it was clearly demonstrated that local firms benefited when they improved their abilities in joint actions rather than individually. ICs may play an important role in organizing various programmes for the development of participating SMEs. This is also in the interest of the MNEs heading the value chain. Other forms of cooperation, most importantly, technology and knowledge transfer, possibly even generation, are also plausible in supplier-based ICs, especially if cluster members can change their way of thinking regarding vertical flows but recognize that there is also room for joint horizontal actions. The empirical evidence indicates that this is the most difficult task for cluster managers since many of the potential cluster members are competitors and compete for contracts of the top OEMs or first tier foreign suppliers. Promoting MNE interest in cluster cooperation is sometimes not much more difficult than building trust among competing local suppliers. As far as the critical mass of ICs is concerned, there is very little information on this issue in Hungary. Empirical surveys have indicated that formal cluster organizations do not set such targets (Szanyi, 2008a). Many are in their early stage of development; thus, the question is not yet relevant for them. Nevertheless, we can draw some general conclusions using guidelines available in the literature (Sölvell, 2003; ECOTEC, 2003; CLOE, 2006). Achieving a critical mass is important for three reasons. One is stability, which protects against potential dropouts of large, dominating firms; the second is a financially self-sustaining cluster and new entry attraction; and the third is achieving a critical mass of information flow and activity, which is a kind of density of cluster actions that provides the desired synergies. MNE supplier networks alone have little opportunity to achieve these goals. The membership of competing OEMs is not likely. However, there may be ICs that are not initiated and dominated by OEMs but are established by other parties, building on suppliers to MNEs. In this case, the initial favourable condition of the supplier network is utilized; namely, there is a pool of potential cluster members. Drawing on this pool, a cluster can be organized with or without the participation of the MNE itself. The case of the oldest and largest Hungarian cluster, the Pannon Automotive Cluster (PANAC), is a good example of this. However, even this cluster could not develop activities away from a simple supplier network support

Szanyi, Iwasaki, Csizmadia, Illésy, and Makó 121

for many years. It took time and a setback in the cluster activity until cluster management realized that proper cluster functioning cannot be solely based on supplier network development programmes (Grosz, 2006). Representing the cluster’s own interests as a separate organization is crucial and cannot be subordinated to one company’s business interests. In addition, professional cluster management needs to be employed as well so that regular cluster functions are developed. As reported above, there is little information available on the actual concentration of economic activity or the achievement of critical mass in Hungary. In the remaining part of this chapter, we try to fill the information gap concerning existing critical mass of firms and economic activity in Hungary using large-scale firm-level data.

5.3 A new Hungarian cluster mapping In this section, we perform a new cluster mapping exercise based on annual census-type data of Hungarian firms. The data were compiled from financial statements associated with tax reporting submitted to the National Tax Authority in Hungary by legal entities performing accounting and tax procedures by double-entry bookkeeping. The data contain basic information for each sample firm, including its geographical location, the NACE 4-digit codes, annual average number of employees, total turnovers, and other financial indices. First, we describe our empirical methodology followed by the results. 5.3.1 Methodology The cluster-mapping procedure tries to identify spatial locations where the representation of certain industries or economic activities is higher than average, that is, where they seem to concentrate. The logic is simple. In these places, there must be some kind of competitive advantage that is perceived by economic actors, and they tend to co-locate. There are three types of industries that have different reasons to co-locate. A large number of manufacturing branches as well as service providers, typically personal services, are located right at their markets. The dispersion of such industries is roughly even in all regions. Per capita measures, for example, are very close to each other in the various geographic regions of a country. Natural resource-based industries, on the other hand, tend to concentrate mainly at the location of the valuable asset. These industries may serve the global market, but they do not have much locational choice. The third group of activities is the most important one. These are industries that concentrate at locations; hence, they choose among

122

Cluster Development in Hungary

many potential sites. These industries are regarded as traded cluster industries. In the case of the US economy, their proportional share in employment was close to one third, but they recorded higher than average wages, productivity, and innovation (Ketels and Sölvell, 2005). We employ the 1998 and 2005 datasets to conduct mapping of ICs in Hungary using Porter’s measurement method, which was described in the previous section. When transforming the industry categories of the database to the one that was defined in the HBS cluster mapping project, we could separate 37 out of the original 38 traded cluster activities.7 Out of the three measures that were used by Ketels and Sölvell (2005), we used only one, namely, the specialization quotient. The design of the locational quotient is similar to Bela Balassa’s RCA measure (revealed comparative advantage). It expresses the relative weight of one single sector in a region to the total weight of the region compared to either the national economy or a larger geographical area. The calculation is conducted using the following formula: e ij LQ ij =

Ei ej E

=

sij xj

, (1)

where eij is the number of employees in area j in branch i, ej is the total number of employees in area j, Ei is the number of employees in branch i in the whole country (spatial unit of comparison), and E the is total number of employees in the whole country (spatial unit of comparison). Hence, sij denotes the share of area j in total employment of branch i, and xj denotes the share of area j in total employment. We found that the statistical content of the other two measures was quite similar. We also found the other two measures to be strongly biased by the absolute differences between firms, branches, and spatial units. Relative concentration is at the heart of the clustering process, and this requires relative measures. Comparisons that are based on the use of absolute values are, therefore, less applicable, since they reflect size biases. Our calculations are new and more precise in two aspects as compared to previous larger-scale calculations (Ketels and Sölvell, 2005; Europe Cluster Observatory, 2003). We could disaggregate our database in spatial terms from NUTS-2 level (regions) to NUTS-3 level (comitats).8 This is important because, on a regional level, important concentrations can be neglected due to differences in terms of varying significance levels of the different economic activities. However, a finer spatial focus also allows for the observation of activity concentrations that do not follow

Szanyi, Iwasaki, Csizmadia, Illésy, and Makó 123

the artificial boundaries of the regions. Previous cluster mapping studies were calculated with NUTS-2-level employment data. Using solely employment data also allows serious bias in the calculations in favour of labour-intensive activities. The other novelty of our calculation method was the usage of various measures of economic activity, not just employment data. We used employment (number of employed persons), number of enterprises, value added, and cumulated investment data (investments of the 1998–2005 period). Thus, the final product of the calculations was four measures for each traded cluster branch in each NUTS-3-level spatial unit for the year 2005 and three for the year 1998, since, for the starting year no cumulated investment figure was available. 5.3.2 Results The total number of calculation results was 740 (20 spatial units, 37 branches) for each of the four measures. For an easier overview and better analysis, we followed the evaluation method found in Ketels and Sölvell (2005). We gave one point for all branch-comitat pairs that belonged, in terms of the given measure, to the upper 15 per cent of the calculation values. Thus, every branch-comitat pair could receive a maximum of four points (three points in 1998).9 We considered those pairs in which at least two measures proved to be significant (they belonged to the highest 15 per cent and, therefore, received two points). We also calculated the Gini coefficients. This measure helps us determine whether activity concentration is caused by one or a few large companies or a number of medium-sized or several small firms. This is a very important aspect, since we want to measure the pool of potential cooperators, and, therefore, the actual size structure is highly relevant for us. The Gini-coefficient was calculated from employment figures. Values over 0.9 reflect a very uneven structure. If the number of firms (observations) is high (100 or more), then values as high as 0.7–0.8 already indicate that a number of medium-sized firms should also be present. Thus, cooperative structures, such as clusters or supplier networks, would have a sufficiently broad pool to serve as a base. We could spot significant concentration in 22 of the 37 traded cluster branches for the year 2005. In the remaining 15 traded cluster branches, no branch-comitat pairs received at least two points. The results are summarized in Table 5.1. It is noteworthy that no services-centred cluster was captured by our calculations, although there is much anecdotal evidence of the existence of even formal cluster organizations based on various service activities (financial services, education, and entertainment). Of course,

124

Table 5.1 Results of cluster mapping in Hungary using the 2005 census data Sector

Counties

Number of firms

Gini coefficient

Qualification

Note

Automotive

Gyo˝r. Komárom

29; 17

0.81; 0.77

yes

one centre

Leather products

Vas. Baranya. Szolnok. Szabolcs

6; 17; 6; 3

0.66; 0.65; 0.58; 0.66

?

two centres, spatially disperse

Footwear

Vas. Baranya. Tolna. Bács-Kiskun. Szolnok. Szabolcs

10; 15; 15; 19; 14; 27

0.64; 0.70; 0.56; 0.54; 0.73; 0.67

?

two centres, few firms

Processed food

Bács-Kiskun. Csongrád. Békés.

262; 135; 141; 201

0.78; 0.85; 0.79; 0.79

yes

two centres

Building fixtures. Equipment and services

Veszprém. Komárom. Nógrád

238; 319; 119

0.82; 0.76; 0.68

yes

one centre

Furniture

Zala. Vas. Gyo˝r. Békés

170; 124; 186; 117

0.71; 0.78; 0.81; 0.73

yes

two centres

Metal manufacturing

Fejér. Nógrád

179; 49

0.91; 0.75

yes

two centres

Motor driven products

Zala. Szolnok

62; 63

0.80; 0.86

yes

two centres

Biopharmaceuticals

Hajdu

6

0.82

?

one centre, few firms

Communications equipment Aerospace

Nógrád. Heves. Szolnok

18; 30; 36

0.79; 0.89; 0.89

yes

one centre

Heves

3

0.57

?

one centre, few firms

Agricultural products

Veszprém. Baranya. Bács-Kiskun. Borsod

61; 59; 141; 93

0.81; 0.73; 0.65; 0.76

?

three centres, dispersed activities

Plastics

Bács-Kiskun. Borsod

106; 74

0.78; 0.87

yes

two centres

Analytical instruments

Pest

87

0.77

yes

one centre

Medical devices

Hajdu

57

0.83

yes

one centre

Publishing and printing

Komárom

16

0.73

?

Apparel Sporting. Recreational and children’s goods

Vas. Békés. Hajdu Baranya. Nógrád

40; 54; 115 17; 6

0.76; 0.68; 0.89 0.61; 0.75

yes

one centre, dispersed activities two centres

?

one centre, few firms

Information technology

Veszprém. Komárom. Baranya. Pest

13; 25; 23; 127

0.77; 0.91; 0.94; 0.92

?

quickly changing spatial location

Construction materials

Veszprém. Békés

12; 10

0.84; 0.63

no

one centre, dispersed location

Chemical products

Vas. Borsod

5; 18

0.70; 0.70

no

one centre, dispersed location

Lighting and electrical equipment

Tolna

6

0.62

no

dispersed location, few firms

Source: Authors’ estimation.

125

126

Cluster Development in Hungary

it is possible that this failure is related to the shortcomings of the measurement method. However, the absolute lack of indication in the whole country may also mean that either these ICs operate in an inappropriate environment (too few related companies) or may be very young organizations that are not yet measurable statistically. In the case of the capital city, Budapest, a further option is also likely. This city is simply too big and its business activity is too heterogeneous and does not allow statistically outstanding concentrations. The overall size – namely the denominator of their LQ – limits the relative importance of sectors that would otherwise be sufficiently large. Due to this measurement problem, Budapest and Pest County did not show significant concentrations at all. Since, however, we could also provide the total number of firms in the given branch, high values of this data may still deliver the necessary information on spatial concentration. As is seen in Table 5.1 and also on the amended maps shown as Figures 5.1 and 5.2, in many cases, we included several comitats together to form a potential cluster. This idea stems from the logic that the spatial dispersion of clusters should not necessarily follow administrative boundaries. The lower spatial observation level (NUTS-3) allows us to localize the potential spread of ICs in neighbouring comitats better. We treated the comitat-branch pair, which showed a significant concentration on the 15 per cent level as gravity centres, and added the neighbouring comitats, which showed concentration on a level of at least 33 per cent. In some branches, we could identify two and, in some cases, even three centres, the nucleus of potential cluster formations.10 These examples are presented on the amended cluster maps. The last two columns of the table provide an evaluation of the branch-comitat pairs concerning the likelihood that they may become real ICs. Our objections were placed in the last column, and they included wide spatial dispersion and a shortage of companies. Fifteen concentrations are found to be strong enough to form ICs. In many cases, cluster organizations already work in these centres. In fourteen other cases, we inserted a question mark, indicating that either a strong concentration was not supported by a sufficiently high number of potential cooperating firms or the relatively strong comitats were not in each other’s immediate neighbourhood. That would have limited the frequent personal contacts of cluster members, which would also be an important aspect of successful cluster operations. In a few cases, we found that the original traded cluster categorization is not perfectly suitable for the Hungarian economy. For example, in the case of the branch agricultural products, Porter’s original category

127

Figures 5.1–5.2 Potential clusters in the processed food, apparel, automotive, and communications equipment industries in Hungary, 2005

128

Cluster Development in Hungary

included all types of farm products, such as crops and animal products. It also included equipment repair and other services. This is highly relevant for large and complex American farms, but it does not really apply to much smaller, more specialized Hungarian producers. In this case, another category could have reflected more precisely those activities along which Hungarian agricultural producers could potentially cooperate.

5.4 Concluding remarks From a summary of the lessons of our cluster-mapping exercise for Hungary, we draw some important conclusions. It is necessary to show that most spatial concentrations (potential clusters) are located in areas where similar industrial activity had been carried out before the transition. This means that, despite the tremendous structural changes of the two decades of transition, some basic characteristics of spatial and activity structure of the Hungarian economy remained in place. This is important evidence that supports an important aspect of the IC-related literature, namely, that there is strong path-dependency in economic development. Path-dependency also means, however, that cluster policies should not be treated as a means of a new capitalist industrialization. The main aim of clustering is to develop further traditional regional strength in order to gain regional competitiveness. We do not want to deny the possibility of creating new structures in the long run. Indeed, in the case of the automotive industry and ICT production, development in Hungary by far exceeded previous levels. In these cases, the existing capacities and expertise played a relatively small role. However, such examples seem to be more the exception than the rule. Another noteworthy result of the survey follows from the previous argument. We found ample evidence of the existence of activity concentrations in branches and regions that have strong FIE influence, such as the automotive and ICT sectors. There is much empirical evidence that shows the impact of important supplier networks.11 Strengthening the clustering process in such vertically integrated networks would require the support for horizontal linkages among cluster members. However, we also found branches in which FIE involvement was much weaker. We can conclude, therefore, that cluster development in such regions and branches in which there is no FIE dominance is also possible. However, the structure and functions of these clusters may be very different. They have stronger horizontal and less vertical cooperation. In addition, their power relations are different.12 In this second

Szanyi, Iwasaki, Csizmadia, Illésy, and Makó 129

type of cluster, the main activity is rather small-business and regional development. This variation of cluster types calls for more refined and not uniform solutions in cluster development policy.

Appendix

Map 5.1 Regional administration units of Hungary: Comitats (NUTS-3)

Map 5.2 Regional administration units of Hungary: Regions (NUTS-2)

130

Cluster Development in Hungary

Notes 1. This chapter presents one of the research results of a Hungarian-Japanese joint project titled ‘Multinationals and Local Resources’ launched by the Institute of Economic Research, Hitotsubashi University, the Institute of Sociology, Hungarian Academy of Sciences (HAS), and the Institute of World Economics, HAS. The research was financially supported by a grant-in-aid for scientific research from the Ministry of Education and Sciences in Japan (No. 19402023), the Nomura Foundation for Academic Promotion, the Tokyo Maritime Kagami Memorial Foundation, and IBM Hungary. We thank Jim Treadway for his editorial assistance. 2. Michael Porter’s original definition for clusters is as follows: ‘Clusters are geographic concentrations of interconnected companies, specialized suppliers and service providers, firms in related industries, and associated institutions (for example universities, standards agencies, and trade associations) in particular fields that compete but also co-operate’ (Porter, 1990, p. 199). The main aim of this cooperation is enhancing the competitiveness of regions and actors in the region. 3. One main precondition of a successful cluster operation is the presence of a fairly large and diverse pool of economic agents specializing in similar or supportive activities. The sufficiently large specialized local economic activity is crucial for knowledge generation and transfer, for the internal stability of cluster organizations, for the visibility of clusters, and for the self-sustaining development of cluster activities. For more general descriptions and various interpretations of the cluster concept, see Porter (1998), Sölvell et al. (2003), ICEG (2007), Sölvell (2008), EC (2008b), and Szanyi (2008b). 4. Sölvell et al. (2003) ran the first major questionnaire-based empirical survey on cluster organizations worldwide. Using the survey results, they described a typical or best-practice cluster type: the most common appearance of clusters. Because of the overrepresentation of clusters from developed market economies, this model, which they called a dynamic cluster, basically reflected those characteristics, cooperation forms, and structures that were found to be typical in more developed economies. Later research, including Ketels and Sölvell (2005) and Ketels et al. (2006), revealed the fact that, in emerging market economies or developing countries, clusters may substantially differ concerning their focus of activity and working models. 5. For maps of NUTS-2 and NUTS-3 administrative geographical units, see Maps 5.1 and 5.2 in the Appendix at the end of the chapter. 6. For more details, see ICEG (2006). 7. For a thorough description of the traded cluster category, see the Website of the Cluster-mapping Project at: http://data.isc.hbs.edu/isc/index.jsp. 8. The database allowed even deeper NUTS-4-level calculations. 9. We also evaluated the branch-comitat pairs at a lower 30 per cent level. 10. It is noteworthy that spatial concentration is just one important condition of cluster formation. Hence, even if we call the observed concentrations clusters or potential clusters, it does by no means mean that there

Szanyi, Iwasaki, Csizmadia, Illésy, and Makó 131 is an actual cluster organization present. HBS documents, as well as the European Cluster Observatory, also use the term ‘cluster’ for spatial activity concentrations. 11. For the car industry and the role of PANAC, the Hungarian automotive cluster, see Grosz (2006). 12. For evidence and case studies, see Szanyi (2008).

References Acs, Z. J., C. O’Gorman, L. Szerb, and S. Terjesen (2007) ‘Could the Irish Miracle be Repeated in Hungary?’ Small Business Economics, 28, 123–42. Antalóczy, K. and M. Sass (2001) ‘Greenfield Investments in Hungary: Are they Different from Privatization FDI?’ Transnational Corporations, 10, 39–60. CLOE (2006) Cluster Management Guide: Guidelines for the Cluster Development and Management of Cluster Initiatives, Clusters Linked over Europe Program (available at www.clusterforum.org). EC (2003) Final Report of the Export Group on Enterprise Clusters and Networks, Enterprise Directorate General, Luxemburg. EC (2008a) Towards World-Class Clusters in the European Union: Implementing the Broad-Based Innovation Strategy. Communication from the Commission to the Council, the European Parliament, the European Economic and Social Committee, and the Committee of the Regions, 17 October 2008. EC (2008b) The Concept of Clusters and Cluster Policies and their Role for Competitiveness and Innovation: Main Statistical Results and Lessons Learned. Commission staff working document accompanying the communication from the Commission to the Council, the European Parliament, the European Economic and Social Committee, and the Committee of the Regions, 20 October 2008. ECOTEC (2003) A Practical Guide to Cluster Development: A Report to the Department of Trade and Industry and the English RDAs UK, Department of Trade and Industry, London. Europe Cluster Observatory (2003) The European Cluster Memorandum: Promoting European Innovation through Clusters, Center for Strategy and Competitiveness, Europe Cluster Observatory. Grosz, A. (2006) A PANAC Pannon Autóipari Klaszter szellemi to˝ke jelentése (Intellectual capital report of Pannon Automotive Cluster – PANAC) RICARDA program, Nyugat-dunántúli Regionális Fejlesztési Ügynökség Kht., Gyo˝r. Hunya, G. (2001) ‘Uneven Competitiveness of Industries in the Wake of Foreign Penetration of Advanced Economies in Transition’, Transnational Corporations, 10, 35–66. ICEG (International Center for Economic Growth) (2006) ‘Több, mint beszállítók? A hálózatosodás leheto˝ségei a háztartásigép-gyártásban Észak-Alföldön és Észak-Magyarországon’ Munkafüzet 17. (More than suppliers? Networking Possibilities in Household-Appliance Production in the Northern GreatPlains and North Hungary Regions. ICEG EC Working Paper No. 17) (Sass, M., V. Czakó and A. Bakács, authors). ICEG EC, Budapest (available at http:// www.icegec.hu/hun/_docs/munkafuzetek/munkafuzet_17.pdf).

132

Cluster Development in Hungary

ICEG (2007) ‘CEE-Cluster Network Summary of the Main Research Results’, July, K. Endrész (ed.) ICEG EC Working paper No. 34. ICEG EC Budapest (available at http://www.icegec.hu/eng/publications/_docs/wp/wp34.pdf). Iwasaki, I. (2007) ‘Corporate Restructuring and the Role of Foreign Direct Investment in Hungary’, in B. Dallago and I. Iwasaki (eds) Corporate Restructuring and Governance in Transition Economies (Basingstoke: Palgrave Macmillan) pp. 213–49. Iwasaki, I., P. Csizmadia, M. Illéssy, Cs. Makó and M. Szanyi (2009) The ConcentricCircle Model of FDI Spillover Effects: Estimation using Hungarian Panel Data, Discussion Paper No.A521 (Tokyo: Institute of Economic Research, Hitotsubashi University). Iwasaki, I., P. Csizmadia, M. Illéssy, Cs. Makó, and M. Szanyi (2010) Foreign Direct Investment, Information Spillovers, and Export Decision: Firm-Level Evidence from Hungary (Unpublished manuscript). Ketels, C. and Ö. Sölvell (2005) ‘Clusters in the EU 10 New Member Countries’, Europe INNOVA (available at http://www.europe-innova.eu). Ketels, C., G. Lindqvist, and Ö. Sölvell (2006) Cluster Initiatives in Developing and Transition Economies (Stockholm: Center for Strategy and Competitiveness). Marshall, A. (1890) Principles of Economics (London: Macmillan). Porter, M. (1990) The Competitive Advantage of Nations (New York: Free Press). Porter, M. (1998) On Competition (Boston: Harvard Business School Press). Porter, M. (2003) ‘The Economic Performance of Regions’, Regional Studies, 37, 549–78. Pouder, W. and W. St. John (1996) ‘Hot Spots and Blind Spots: Geographical Clusters of Firms and Innovation’, Academy of Management Review, 24, 1192–225. Sass, M. (2003) ‘Competitiveness and Economic Policies Related to FDI’, Working Paper No. 3, Hungarian Ministry of Finance, Budapest. Sass, M. (2008) ‘Outsourcing Business Services: The Emergence of NMS, ICEG European Center’, News of the Month, March, 4–6. Sass, M. and M. Szanyi (2004) ‘Is Crowding in a Real Option? The Development of Supplier Linkages of Local Firms to Multinational Corporations’ in Harald Zschiedrich (ed.) Internationales Management in den Märkten Mittel- und Osteuropas (Rainer Hampp Verlag München, Mering), pp. 367–90. Saxenian, A. (1994) Regional Advantage: Culture and Competition in Silicon Valley and Route 128 (Cambridge, MA: Harvard University Press). Sölvell, Ö., G. Lindquist, and C. Ketels (2003) The Cluster Initiative Greenbook (Stockholm: Ivory Tower AB). Sölvell, Ö. (2008) Clusters: Balancing Evolutionary and Constructive Forces (Stockholm: Ivory Tower AB). Szalavetz, A. (2001) ‘Ipari körzetek: A regionális fejlesztés új egységei’, Külgazdaság, 12, 42–56. Szalavetz, A. (2005) ‘Structural Change – Structural Competitiveness’, Working Paper No. 155, Institute of World Economics, Hungarian Academy of Sciences, Budapest. Szanyi, M. (2003) ‘An FDI-Based Development Model for Hungary – New Challenges?’ Working Paper No. 141, Institute of World Economics, Hungarian Academy of Sciences, Budapest.

Szanyi, Iwasaki, Csizmadia, Illésy, and Makó 133 Szanyi, M. (2008a) A versenyképesség javítása együttmu˝ködéssel: Regionális klaszterek (Enhancing of Competitiveness through Cooperation: Regional Clusters) (Napvilág Kiadó, Budapest). Szanyi, M. (2008b) ‘Cluster Concept and Practice in Hungary’ in M. Birsan, G. Hunya, G. and I. Siedschlag (eds) Foreign Direct Investment, Economic Growth and Labor Market Performance: Empirical Evidence from the New EU Countries (Editura Fundatiei pentru Studii Europene Cluj).

6 Local Government Corruption in Hungary Zoltán Szántó, István János Tóth and Tünde Cserpes

6.1 Introduction This chapter reports on the key findings of an ongoing empirical research programme organized by the Corruption Research Centre of the Institute for Sociology and Social Policy at Corvinus University of Budapest.1 The general goal of the research is to make a contribution to the in-depth exploration, better understanding and explanation of different corruption transactions in Hungary. To achieve this aim, we focused on studying actual corruption situations and mechanisms rather than investigating perceptions about corruption or surveying opinions about corruption. We believe that both the interviews and media content analysis on corruption cases that were undertaken give us the potential to identify typical corruption situations, typical players in corruption games and their typical types of motivation.2 During the research, our attention turned to the local government as a pivotal level to be investigated. In this chapter we offer a detailed analysis in order to establish a general picture of the sophisticated structure and actual penetration of different local government corruption mechanisms. We do believe that a profound knowledge of actual corruption situation and mechanism types is an essential prerequisite for creating solid anticorruption measures (for example, changing regulations or the institutional environment) both at the national and at the local level. Various empirical forms of corruption (bribery, slush funds, palmgreasing, illegal bonuses, ‘gifts’, baksheesh, nepotism, subornation, and so on) have occurred almost throughout history. To different extents corruption has been constantly present in business, politics, state administration, law enforcement and justice. Different cultures have attempted to address it in different ways; for instance by rotating public servants, 134

Zoltán Szántó, István János Tóth and Tünde Cserpes 135

paying bonuses for reporting corrupt practices, selecting jurors and judges on a random basis and compensating managers with shares.3 Despite these efforts, corruption has not disappeared and occurs in all modern societies. Its negative consequences are well-known: high social costs reduce welfare, it results in suboptimal solutions, it distorts competition and thus reduces efficiency and innovation, and widespread corruption undermines the operation of social, legal and economic institutions and leads to general frustration and erosion of norms (Tóth, 2000). Despite its relatively constant and extensive presence, economists and sociologists can present only relatively modest results from empirical research into corruption. Even the definition of corruption leads often to debates; there are very few generally accepted theoretical models and very few reliable, valid, accurate and representative results can be found about the mechanism of corruption. Of course, this is partly due to the very nature of the subject: corruption can hardly be observed; those who are concerned do their best to hide it. In addition, available data are mostly descriptive and primarily concerned with the perception of corruption. Traditional sociological research methods (questionnaires, interviews, focus groups, documentaries, media analysis, and so on) alone in many cases do not lead to satisfactory results. Thus, we think, a mix of different research techniques should be applied in empirical research on corruption: the joint use of quantitative and qualitative methods offers a higher chance of revealing corruption mechanisms and estimating their actual extent in penetrating society. In the present phase of research we attempted to mix qualitative (concept analysis, in-depth interviews) and quantitative (media content analysis) methods.4

6.2 The concept of corruption and its types Corruption can be defined in several ways. A normative definition of corruption follows the traditional political philosophy of Machiavelli, Montesquieu and Rousseau. From this perspective ‘corruption is the abuse of power, equal to its moral decay’ (Gulyás 2004: 18). In other words: ‘We speak about political corruption … if power loses its morality, becomes neutral, self-interested and a tool of private interests. Corrupt transactions are potentially accompanied by violation of the law and public interest, the misleading and/or manipulation of public opinion, which can all be regarded as different aspects of abusing power, practically actual manifestations of the violation of the principles of equality and justice’ (Gulyás 2004: 18). The normative definition, in its

136

Local Government Corruption in Hungary

philosophical abstractness, sets the main direction in the discourse on corruption but has less practical value in empirical research on the field, which requires a more concrete scientific definition of the term suitable for empirical use. Corruption can also be defined on the basis of legal, public interest and public opinion considerations. Nevertheless, these contain several contradictions. The legal definition – regardless of its clarity and effectiveness – is ambiguous: it is too wide and yet too narrow at the same time. Namely, not all illegal activities are corrupt and not all corrupt activities are illegal. The weakness in the public interest based definition is that the concept of public interest cannot be easily and exactly constructed – and different definitions can lead to paradoxes. The definition based on public opinion is also exposed to uncertainty: the opinion of the elite and the lay public can differ substantially regarding actual corruption cases. Taking all this into account, a reduction of ambiguity and greater consistency of the concept can be achieved by further subdividing the term instead of attempting to create a general definition. In the following we provide an explanation of the meaning of this ambiguous, inexact and unclear term. In explaining the meaning of corruption we can start with the most general characteristics of simple (that is, two-player – dyadic) corruption transactions. In this approach, corruption is a special exchange process that takes place between two players and the following four basic elements are taken into account in the corruption transactions: (1) Corrupter (or briber), (2) Corrupted (or bribee), (3) Corruption fee (or bribe), and (4) Corruption gain (or bribery service).5 Based on the above elements as criteria, we can classify general corruption transactions into several categories, important for our research purposes. The players may be persons, groups or institutions; may belong to business or to the (local) government sector,6 and may be of low or high social status. The corruption fee and the gain may be material (such as cash, goods, a wage increase or bonus) or other, non-material gain (such as services, licences, permits, favours, positions, jobs, appointments, behaviour, loyalty or votes). The location of the corruption situation may be a village, a town or Budapest, and based on complexity, corrupt transactions may be simple (having two actors) or organized in a chain (with multi-players). These categories, reflecting different forms of corruption, will be used mainly in the media content analysis: variables will be constructed on these types to code the content of the suspected corruption cases reported in the media.

Zoltán Szántó, István János Tóth and Tünde Cserpes 137

Based on the criteria detailed above, corruption transactions can be classified into several subcategories. In our current research we deal mainly with corruption cases where the corruption situation takes place at a local level and when any of the players are part of the local government bureaucracy. At the end of the conceptual argumentation we note that our analysis of corruption situations can be based on the principal–agent–client model developed in modern political economy and economic sociology.7 This model is based on the rational choice theory: the actors weight the expected utility and costs of their decisions and choose the option that maximizes their net utility. The agent (for example, a tax controller) of the principal (for example, the tax office) gets in contact with the client (for example, a taxpayer). Based on this model, the agent is corrupted if his or her expected net gain from corruption is higher than the one expected from fair behaviour and the client offers a bribe if his or her expected net gain from corruption is higher than the one expected from not offering any bribe. The corrupted agent – who enjoys personal gains – creates costs for the principal, because his or her behaviour imposes negative externalities on the economy and reducing these negative effects takes time and resources. The aim of the principal is to have the agent do optimal productive and also optimal unproductive (corrupted) work. The fundamental problem of the principal emerges from an asymmetric information situation – the inherent feature of a principal–agent relationship.

6.3 Corruption and local government We summarize below the results of two pieces of research concerning local government corruption. Sub-field research highlighted the importance of this topic was derived from sub-field research: (1) the analysis of 30 structured in-depth interviews with company managers conducted in March and April 2008 with the co-operation of the Transparency International Hungary Foundation; and, (2) a full sample survey of online reports and articles of eight dailies and weeklies on corruption topics between 2001 and 2007.8 We selected, gathered and analysed those online articles that addressed corruption or suspected corruption cases. We searched for the following words (character sequences) in the texts of the articles: ‘korrupt*’ (corrupt), ‘korrupció*’ (corruption), ‘csúszópénz*’ (slush fund), ‘keno˝pénz*’ (palm-greasing), ‘veszteget*’ (bribe), and ‘pénzmos*’ (money laundering). The articles selected based on the above criteria were processed by focusing on the main features and players of the cases.

138

Local Government Corruption in Hungary

Content analysis was aimed at analysing the media representation of corruption and its symptoms. Analysis of the presentation of corruption (or suspected cases) in the media may contribute in three areas to the understanding of corruption in Hungary. Firstly, it reveals how and how often the press addresses this issue. Secondly, it enables us to make conclusions about the characteristic features of corruption from information published concerning the cases – and based on these features corruption cases can be classified. Thirdly, media representation also helps in identifying significant features of the actual distribution of corruption types – a starting point for estimating this distribution later. We know that the distribution of published corruption cases depends on two factors: (1) the interests of the given publication organ (through selection of actual cases) in publishing the cases; and, (2) the actual distribution of corruption types and their occurrence in the given society – in this case in Hungary. At the moment these two factors cannot be separated and thus only indirect conclusions can be drawn from information obtained through media analysis concerning the actual distribution of corruption in society. A high relative frequency of certain corruption types in the media can indicate that these types also occur frequently in real life. We heard and read stories and noted personal experiences and selected cases to demonstrate the main types of local level corruption. The fact that the personal experiences come from different areas and take multifarious forms allows us to estimate the extent of corruption. The system change in 1989 was also linked with the transformation of local government acts in Hungary. According to the new regulations,9 there are now more than 3400 local governments in the country. As for their control system, economic management is supervised by the State Audit Office (Section 92, Paragraph 1). In practice, there was a lack of supervision and auditing by the state office, which led to the failure of legislative enactment. Moreover, the tendency to decentralization gave people without former experience the opportunity to work in the new local offices. The negligence in supervision, inspection and auditing, supplemented by a lack of political maturity and practice, encouraged the office bearers and local politicians to behave corruptly. This led to the submission of a proposal of the State Audit Office in January 2009 to establish a more effective monitoring system. This system makes an effort to anticipate and prevent corruption at work.

Zoltán Szántó, István János Tóth and Tünde Cserpes 139

Media coverage of stories about local corruption is rather weak. This is not surprising because our main concern was not the analysis of local online news portals and articles. However, detailed interview analysis clearly showed the pivotal role of local governments. On a local level, the high importance of personal networks makes corrupt transactions more stable and symbiotic.

6.4 Local government corruption: Lessons from the interviews 6.4.1 The concept of corruption in local practice according to stakeholders None of our interviewees had a problem giving a rather correct and detailed definition of corruption. This indicates that they are concerned about it; this expression is an integral part of their everyday vocabulary. Most of the interviewees defined corruption as being an issue of morality, based on personal ethics, and gave various and often vague definitions. Because of the ethics-based approach many define corruption in a (relatively) wide sense: they describe even those incidents which do not infringe the law but would be condemned from an ethical perspective as being corrupt. Our respondents mostly classified corruption activities as being the following activities: arranging and providing business opportunities for financial compensation, giving off the record personal remuneration to the buyer by the seller, and disclosing political or organizational information. There are some who clearly link corruption to the transfer of money. Others do not define corruption in monetary terms but unquestionably link it to an act leading to a material form of gain. There are some who classified even the acceptance of gratis family holidays or lunch and dinner invitations as corruption. 6.4.2 Local corruption trends in Hungary According to most of our interviewees, corruption in Hungary has been unquestionably on the rise over the past five to ten years. On the other hand, respondents differ in opinion about the size of this increase. Some interviewees also differentiate business corruption from the corruption at the intersection of the business and (local) government spheres. One of them provided the following explanation: I feel there is an obvious increase in corruption in transactions between business and local government sectors but not within

140

Local Government Corruption in Hungary

the business sector, because economic growth has slowed down, opportunities have become fewer and business players have became more cautious and pay more attention to situations which may be a cause for corruption (procurement, debt collection, court case management, and so on). Three respondents also provided explanations of their observations on recently increasing corruption. One of them argued that it is primarily the emergence of new mechanisms and their general application that has caused the increase. The second said that the motivation now was the same as before, only the access must have become easier. The third believed that it is only that politics has penetrated further. [P]reviously it [corruption in personnel selection] reached down only to the level of under-secretaries, but now it controls all positions down to deputy department heads. One respondent pointed out that the size of local corruption transactions has recently risen continuously. 6.4.3 The size and scope of local level corruption in Hungary Almost all of our interviewees underlined the fact that corruption is rather widespread in Hungary. Most of the interviewees unanimously stated that the corruption taking place between business and (local) government sectors is far larger than in the business sector itself. Many respondents added that these two cannot be easily separated, because they are often strongly intertwined. Only one interviewee said that business corruption is the more serious problem. Concerning corruption in the (local) government sector, many noted that this is in fact the usual way of financing political parties. Our interviewees had difficulties in estimating the size of corruption. There was one who believed that 10– 15 per cent of the total annual 150 billion HUF of public procurements are actually corruption fees. Two interviewees ranked corruption using a scale of one to ten. The first estimated business corruption in Hungary to be at level three and corruption at the intersection of the business and (local) government sectors at seven. The other estimated similarly, giving figures four and eight/nine respectively. The most extreme estimation concerning the size and extent of corruption (obviously an exaggeration) was that ‘roughly half of the GDP can be dissolved this way.’ Responding company managers mentioned the following, summarized in Table 6.1, as the most typical areas for corruption.

Zoltán Szántó, István János Tóth and Tünde Cserpes 141 Table 6.1 Summary of typical areas of corruption MOST FREQUENTLY MENTIONED Local government sector10 Public procurement, tendering: i.e. (local) government orders11 Allocation of EU development subsidies Issuing licences and permits ‘Kickback’, commercial corruption SELDOM, LESS FREQUENTLY MENTIONED Party financing Justice, court procedures Managing suppliers Consultancy, ordered surveys INDIVIDUALLY MENTIONED Legislature Fake lobbying Media presence Contracts with PR companies Acquisitions Source: Interview analysis, Corruption Research Centre, Corvinus University of Budapest.

Six of our interviewees mentioned local government corruption as the most typical. One of them said: It is a typical local government technique that the local government offers an order to a company only on condition that it also signs a contract with a given subcontractor.

6.5 Local government corruption: Lessons from media analysis 6.5.1 Characteristics of the actors From among the 444 cases analysed, we can find only a small percentage of cases where either the corrupter or the corrupted were representatives of institutions (company or state owned) (Figure 6.1). We classified actors as individuals if they acted as private persons in corruption transactions and as groups if they acted in the transaction as a cooperating group of private persons or employees of the public sector (for instance, those motorway policemen who formed a coalition to collect corruption fees from motorists breaking traffic rules by ‘forgetting’ to fine them officially).

142

Local Government Corruption in Hungary

60.0 51.4 50.0

44.0

Corrupted

49.5 45.3

Corrupter

40.0 30.0 20.0 10.0

6.4

3.3

0.0 Individual

Group

Institution

Figure 6.1 Suspected corruption cases by actor type, 2001–7 (%) Source: Media analysis, Corruption Research Centre, Corvinus University of Budapest.

The distribution of cases where the corrupters and corrupted are represented as individual or groups is around 50–50 per cent. We can record only a small difference between the proportion of individuals and groups. From these facts we can assume that half of the corrupt actions in Hungary are committed by groups with the cooperation of multiple actors – which can be seen as the emergence of a corruption network system. Among the cases analysed, we noted whether the corrupted actor came from the business sector, from (local) government or from another institution. For more than two thirds of the transactions, the corrupter came from the business sector while in the remaining one third of the transactions the corrupter represented other institutions. The majority of corrupted actors were from the (local) government side (Figure 6.2). This fact underlines the opinions of our interviewees, so we may assume that local level corruption is rather extended. Table 6.2 summarizes the typical actors mentioned by our interviewees. Analysing the social rank of actors in corrupt transactions we can identify that the majority (almost 60 per cent) of the corrupters are of high social status (middle or senior executives), while among the corrupted actors this rate is only 52 per cent. We underline again that the distribution of corrupted actors from the point of view of social rank seems to be balanced while most of the corrupters are of high social status (Figure 6.3).

Zoltán Szántó, István János Tóth and Tünde Cserpes 143 100.0

91.4

90.0

Corrupted Corrupter

80.0 70.0 59.7

60.0 50.0 40.0

31.8

30.0 20.0 10.0

4.1

8.5

4.5

0.0 Representative of business sector

Representative of state or local government

Representative of other institute

Figure 6.2 Suspected corruption cases by sectors, 2001–7 (%) Source: Media analysis, Corruption Research Centre, Corvinus University of Budapest.

Table 6.2 Summary of typical actors in corruption situations FREQUENTLY MENTIONED Low-paid public servants, public employees Politicians who raise funds for themselves and their parties Tender publishers and decision makers INDIVIDUALLY MENTIONED Middlemen PR directors Board members Source: Interview analysis, Corruption Research Centre, Corvinus University of Budapest.

6.5.2 Characteristics of the corruption situations and transactions Concerning the ‘transfer’ of the corruption fee, our interviewees reported the following: It happens that the company offering a bribe has a bank account abroad and a messenger is sent abroad to get the cash in a bag and bring it to Hungary. The corrupting company should have suitable infrastructure. It can happen that – although indirectly – a contract is signed. Another interviewee said that cash payments and transfers are made between

144

Local Government Corruption in Hungary

70.0 60.0

Corrupted

Corrupter

58.8 52.0

50.0

48.0 41.2

40.0 30.0 20.0 10.0 0.0 Low status (not in leader position)

High status (middle or senior executive, entrepreneur)

Figure 6.3 Suspected corruption cases by sectors, 2001–7 (%) Source: Media analysis, Corruption Research Centre, Corvinus University of Budapest.

personal bank accounts to facilitate hiding the transaction. According to this respondent, actions are varied so that nothing can be traced. A further interviewee said that the basic techniques such as handing over cash in an envelope or briefcase have been replaced by more sophisticated techniques. Sophisticated techniques have also been developed for creating, managing and organizing corruption situations – like the use of a small piece of paper to show the place and time of a meeting in writing – in case the dialogue is recorded. The ‘amount of the bribe’ depends on the time an officer spends in a position. The more time spent in a position, the higher the chance that someone will be corrupt; and in addition, the amount of the bribe increases with time. The type of institutions involved in the suspected corruption transactions are an important criterion for classifying corruption cases. In almost all cases only one – a government or state owned – institution was involved. In nearly one third of the cases a ministry or a national authority was one of the concerned parties: the corrupted person worked for them in almost all of the cases. If we add local governments to national authorities, we can state that in more than half of the cases the corrupted was an employee from one of these institutions. The police were the other typical institution involved (Figure 6.4), and presumably the courts cannot avoid corruption either. As can be seen, it is rather strange that in Hungary more than a third of the suspected corruption cases can be related to organizations that have been given the mandate to fight corruption. Based on this fact, in further research

Zoltán Szántó, István János Tóth and Tünde Cserpes 145

34.5 32.2

18.7

11.0 5.2

3.8

Police

Courts

Local governments

Ministries/ Tax and Hungarian national financial control customs and authorities administration finance guard (APEH) (VPOP)

7.0

6.5

Other authorities (city, health)

Other…

Figure 6.4 Suspected corruption cases by institution involved, 2001–7 (%) Source: Media analysis, Corruption Research Centre, Corvinus University of Budapest.

plans special attention should be given to examining corruption within the police and courts. In the suspected corruption cases, it is also important what procedures/ administrative measures are involved and what the corruption aims to settle. Most of the corruption cases discovered in 2001 and 2007 are connected to inspections (44 per cent), but the share of cases related to licence and permit granting and public procurement is high (Figure 6.5). We believe that these corruption mechanisms are separate, thus each type of corruption activity needs tailor-made policies to counter it. To develop these policies, and to separate and characterize the types more clearly needs further research. With the following case-study-like examples we try to highlight and stress the main characteristic features of local government corruption. Here we have collected the personal experiences of our interviewees about corruption and used articles from our database. Public procurement Recurrent complaints about public procurement practices involve the fact that the decision is made before the actual end of the tender. Applications of unlucky aspirants are usually rejected for some trumpedup reason. A vivid example of this practice is the case of the capital city’s government decision concerning the reconstruction of city roads. According to the government decision, the favoured (HUF 200–300 million more expensive) tender won.

146

Local Government Corruption in Hungary

Inspections

44.0

Public procurements

20.0

Licences, permits

15.2

Get state support

1.4

other…

19.3 0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

45.0

50.0

Figure 6.5 Suspected corruption cases by procedure involved, 2001–7 (%) Source: Media analysis, Corruption Research Centre, Corvinus University of Budapest.

The procedure may take this form: there is a need for procurement and a tender is announced. The bidders are approached by stooges who say that X per cent is the price for settling the case (there is a mayor who was nicknamed ‘Mr. Ten per cent’ on similar grounds). Our interviewee estimated X at three to ten per cent. According to our interviewee, the purchaser already knows whom to turn to: this is usually through political party financing and related circles. Payment is most frequently made with the help of subcontractors; for instance, through a consultancy, and sometimes the payment is made via off-shore structures. It is more stylish to let a certain company also be a member in the consortium. More recently, corruption has not involved suitcases being transferred under the table, thus what happened to one of our interviewees 15 years ago no longer occurs (in this case the representative of the State Privatisation Agency (ÁPV) directly told our respondent that he wanted HUF 200,000 for certain activities). These days, serious companies employ subcontractors and consultants who let it be known that they can be approached. Nowadays, examples can be found where a company approaches the local government and offers its services: they mostly want to get EU subsidized projects. Actual examples show that the supplier finances the ‘own sources’ of the local government to win the project. It is said that there are two types of mayors: those who steal for themselves and those who steal for the community. If they receive an offer, for example, that a company can build three public toilets for the town – and in addition pay ten per cent of the amount that can be won on a

Zoltán Szántó, István János Tóth and Tünde Cserpes 147

subsidy tender into the pocket of the government employee there is no risk and no additional cost to pay. The problem of providing one’s own contribution is usually solved by announcing a preliminary public procurement tender which one of the banks will finance. The drive behind the process is that the company in question seeks an opportunity to sell its products and knows how to manipulate the exploitable subsidy tenders – to ‘make things easier’. Licences, permits There is also some evidence that officers have the potential to be corrupt by giving out local licences and permits such as building permits. The risk of bribe money being involved in these transactions is high because there is no supervision. The media reported on a local government officer who accepted more than HUF 100 million of bribe money in a couple of years. One company entered the Architecture, Building and Construction (ABC) market and started to build up business connections. They approached service companies owned by local governments and were surprised that they had no interest in making cheaper purchases. Earlier, a company had contacted a local government because it had taken over the project X from a different company and needed a permit to repaint a building within this project. The work went well, but just before completing it the local government said that a study was necessary to evaluate how the building fitted into the townscape. The building company was told how much the study would cost and from which company to order it. Finally they agreed and ordered it, because the entire project was worth HUF 20 million to them. As a result Santa Claus brought them the permit on 6 December. Assignments and buying services It seems to be an effective way to siphon money out of the budget system if the local government buys services at an ‘improved’ price. Yet sometimes the service may be considered completely useless, as in the abovementioned case where the government gave an assignment to a PR firm in order to sway public opinion and popularize decisions about city roads. Buying and selling local government property There is not much juridical evidence, but our interviewees report that sometimes the government tries to sell their own property at an improved price to get more money out of the transaction. We can evoke the example of Terézváros, where the local government sold HUF 139 million

148

Local Government Corruption in Hungary

worth of real estate for HUF 250 million. This transaction received a lot of publicity but presumably this is only the tip of the iceberg. In one town the local government decided to purchase a building that our interviewees’ company wanted to sell. In this case, the members of the town council declared that they wanted a 20 per cent ‘kickback’ from the purchase price. They checked that the seller had cash to pay their ‘commission’ and approved the purchase at higher than market price although the town did not really need the building. This mechanism had mutual benefits for the council members concerned: they could play the same game again during the renovation and later sale of the building.

6.6 Causes and consequences of local level corruption Some interviewees gave detailed explanations about the general problems, in their opinions, which lead to widespread corruption in Hungary. They mentioned that at a local level it has by now become a ‘fully organized, non-party system based on the common complicity of local government officials’. Table 6.3 summarizes the reasons they mentioned. During the interviews, our interviewees mentioned the following (negative and positive) consequences of corruption, summarized in Table 6.4. Almost all of our interviewees named the government and politicians as the possible primary promoters and players for countering corruption.

Table 6.3 Causes of corruption CAUSES OF BUSINESS CORRUPTION FREQUENTLY MENTIONED Administrative and legal requirements are overcomplicated Mistrust – requiring familiar persons to provide a solution, the network of personal relationships This system socialises the next generation Lack of transparency SELDOM MENTIONED Excessive bureaucracy Loopholes in the Public Procurement Act Lack of (legal) consequences Party financing INDIVIDUALLY MENTIONED Bad economic environment The economic institutional system in Hungary is excessively complex Political interests dominate; there is no strategy Source: Interview analysis, Corruption Research Centre, Corvinus University of Budapest.

Zoltán Szántó, István János Tóth and Tünde Cserpes 149 Table 6.4 Consequences of corruption CORRUPTION CONSEQUENCES

Economic

Moral

Negative

Positive

Disappearing financial revenue Corruption fees increase prices Distorted competition Demoralising society and the next generation Hindering EU integration Inducing additional business crimes

Speeding up administration Increasing consumption

Source: Corruption Research Centre, Corvinus University of Budapest.

Table 6.5 Suggestions on how to counter corruption FREQUENTLY MENTIONED Simplifying procedures, making them clear and transparent and closing loopholes in the law Sanctioning norm breaking by the society, media and law Laying down professional ethical norms more clearly, socialisation Easing the problem of low wages INDIVIDUALLY MENTIONED Disseminating more information Making hiding impossible Competition Office measures Shock therapy Natural developments Nothing can be done Source: Interview analysis, Corruption Research Centre, Corvinus University of Budapest.

One mentioned that it is unquestionably the local government sector and smaller institutions where this process should be started – following a bottom-up strategy – as happens with corruption, as we can see from the following example. In 1998, Hungary was on the way to EU accession. A local government applied for PHARE ‘small region’ subsidies to build a sewage network. The local government had no money and the project cost was estimated at HUF 580 million. An application for HUF 800 million was filed to the county where it was complemented by an additional HUF 400 million. The application finally arrived at the committee in Budapest with a claim of HUF 1.5 billion: up from the initial HUF 580 million. Our interviewees made the suggestions in Table 6.5 about countering corruption.

150

Local Government Corruption in Hungary

Nevertheless, two interviewees also mentioned that business players, in addition to politicians, could also have a relevant role to play in countering corruption. One of them stressed the possible role of business chambers but, according to him, developments do not tend towards this solution.

6.7 Conclusions Corruption, including local government corruption, is widespread in Hungarian society. Nevertheless, we know little about its actual scale, mechanisms and concrete types (that is, exactly how it happens). One of the main conclusions derived from the critical analysis of empirical research results is that these results are predominantly obtained from the perception of corruption and judgement of corruption. We experienced this both in the Hungarian and international literature. On the other hand, research aimed at a deeper understanding of typical corruption situations and actors, typical mechanisms and underlying motivations is missing. This is partly the result of utilizing only one research method (for example, questionnaires or focus groups) for data collection. Based on this, it seems a good idea to apply different methods simultaneously in future research into corruption. First of all, it would be desirable to apply a mix of qualitative (in-depth interviews, situation analysis, interpretation, focus groups) and quantitative (polling with questionnaires, analysing social networks, content analysis) methods. Besides this, the research focus should be aimed at revealing and classifying the mechanisms of local government corruption symptoms and an explanatory/understanding approach should be preferred. In addition, understanding these mechanisms can also substantially contribute to the development of anti-corruption measures. Corruption is an inevitable part of modern society; it cannot be abolished although its weight can be reduced to an optimal level for the given situation. Anti-corruption policies cannot successfully fight ‘corruption in general’. Only those policies that identify the typical corruption situations and target these situations with their interventions can reach their goals. Institutional and regulatory measures can target either the underlying transactions or corruption transactions. In the first case, the intervention seeks to change the conditions of the transactions that can create corruption situations (for example, public procurement, inspections, issuing licences and permits). In the second case, measures may be designed to minimize corruption by affecting both its supply and demand side (selecting the optimal size and form of

Zoltán Szántó, István János Tóth and Tünde Cserpes 151

penalty, strengthening inspections, changing the wages of the agents, increasing moral costs, and so on). Regarding the concept of corruption, we already faced the problem, at the beginning of our research, of defining this term clearly, because the persons involved use it vaguely and with several meanings. Although it was not a problem for our interviewees to define the meaning of corruption they gave very different definitions of this term. During our media analysis, we also found this term used with multiple meanings as well as being linked with other crimes (such as tax fraud, mismanagement of funds, trading in power, and so on). Thus it seems useful to separate the many different meanings of corruption and to define corruption types that can be successfully applied in empirical research. The political elite, and especially the government, have the determining role in the development of corruption and also in the fight against it. This conclusion is not only derived from theory (Rose-Ackermann, 1978) but also from our interviews: the first step in increasing the moral costs of corruption is that the government fully implements a policy of not tolerating any corruption, or even suspected corruption, within its own circles as well as making the dismissal of leading administration figures facing corruption charges natural and necessary. The second step is to follow a consistent government policy to reveal and minimize corruption situations in society. Of course, improving the business corruption situation in Hungary can also be helped by inherent processes of the business sphere but initiatives and implementation should come from the political sphere. At the same time, the role of NGOs is extremely relevant: strong NGOs may impose the necessary pressure on politics and may become the most important catalysts of efforts to counter corruption. This may justify expanding the scope of interviewees to include members of the political elite, local governments leaders, and NGO representatives. Understanding their motivations can make important contributions to revealing corruption mechanisms. The media and the public have important roles to play: the literature on corruption defines independent media as being one of the important institutions in countering corruption (Rose-Ackerman, 1978). However, it can only fulfil its role if it uses certain general criteria in reporting and reveals and counters suspected corruption through posing clear questions, seeking answers to these questions and trying to obtain information on all relevant aspects of the case. If it fails to get proper information then it should make the unclear details explicit. By revealing and publishing the mechanisms of corruption we can achieve two independent goals at the same time: (a) drawing the attention of the

152

Local Government Corruption in Hungary

public and public discourse to actual corruption patterns and thereby reducing the probability of the use of the given technique, because it becomes transparent and predictable; (b) creating a foundation of changes in the regulatory and institutional environment of those situations that favour the emergence of corruption transactions. Results from interview and media analysis on local government corruption have drawn attention to several worrying developments: corruption is spreading and middlemen have appeared in many areas; the simple bilateral transactions observed earlier have been connected and are now chains with many actors. So-called businesses are being created around corruption transactions. We might say that the signs also indicate that business and local government corruption has, to a certain extent, become institutionalized. This is why we recommend doing cross-country analyses to study such countries that have experienced institutionalized corruption (such as Italy) and that have successfully fought against it (for example, Singapore, Hong Kong). In addition, induced by the negative trends observed, it seems that developing an anti-corruption strategy is urgent, because it is much harder to fight highly institutionalized corruption when it has become embedded.

Notes 1. Research leaders: Zoltán Szántó, Ph.D., university professor, Corvinus University of Budapest; István János Tóth, Ph.D., affiliated university professor, Corvinus University of Budapest – senior research fellow, IE HAS. Research team members: Hilda Kinga Balázs, graduate student, Kinga Bartis, graduate student, Tünde Cserpes, graduate student, Márk Tamás Fülöp, graduate student, Gergely Lukácsházi, graduate student, Annamária Márkus, graduate student, Zita Éva Nagy, Phd student, Éva Pálinkó, Ph.D. student, Szabolcs Varga, Ph.D. student. Research was partially financed by the National Office for Research and Technology, Jedlik Ányos Programme, (OM-00001/2008, NKFP_07_A2-TEXTREND). 2. For the earlier findings of the research see: Alexa, Bárdos, Szántó and Tóth 2008; Szántó and Tóth (eds) 2008. This part of the research was financed by and made in cooperation with the Transparency International Hungary Foundation. 3. See for details on the various institutional tools potentially existing in the fight against corruption, Rose-Ackerman, 1978, and also Lambsdorff, 2007. 4. Zoltán Szente and his collaborators (Szente, 2007) similarly utilize several perspectives and methods (official statistics, media analysis, in-depth interviews, risk analysis) in their research into local government corruption. 5. Here we are using the term corruption in the narrow meaning of bribery. We are not concerned here with other forms of corruption, such as extortion, embezzlement or fraud.

Zoltán Szántó, István János Tóth and Tünde Cserpes 153 6. All theoretically possible types: 1. business player bribes business player, 2. business player bribes (local) government officer, 3. (local) government officer bribes business player, 4. (local) government officer bribes (local) government officer. 7. According to this theoretical framework, bribery and extortion are described as being two different types of agent–client relationship, while embezzlement and fraud are two different types of principal–agent relationship. See for details Szántó, 1997, Lamsdorff, 2007. 8. We studied eight Internet news portals or online versions of newspapers between 1 January 2001 and 31 December 2007. The following online publications were analysed: Magyar Nemzet (www.mno.hu), Figyelo˝ (www. fn.hu), Index (www.index.hu), Népszabadság (www.nol.hu), Origo (www. origo.hu), HVG (www.hvg.hu), Világgazdaság (www.vg.hu) and Heti Válasz (www.hetivalasz.hu). After coding the content of the articles, a detailed content analysis was made and the different types of corruption were described using quantitative tools. The database comprises a total of 3469 articles that provided information on 444 reported (suspected) corruption cases. 9. Act LXV of 1990 on Local Governments. http://www.mtaki.hu/docs/cd2/ Magyarorszag/6-1990-65ang.htm. 10. Most frequent first mentioned. 11. Most frequent first mentioned.

References Alexa, N., R. Bárdos, Z. Szántó and I. J. Tóth (2008) Corruption Risks in the Business Sector. National Integrity System Country Study (Part Two) Transparency International (Budapest: Nyitott Könyvmu˝hely). Gulyás, G. (2004) ‘A politikai korrupcióról’ (About Political Corruption) in G. Gulyás (ed.) Politikai korrupció (Political Corruption) (Budapest: Aula, pp. 7–43). Lambsdorff, J. G. (2007) The Institutional Economics of Corruption and Reform: Theory, Evidence and Policy (Cambridge: CUP). Rose-Ackerman, S. (1978) Corruption: A Study in Political Economy (New York: Academic Press). Szántó, Z. (1997) Megbízó, megbízottak és kliensek: Vázlat a korrupció fogalmáról (Principals, Agents and Clients. An Outline on the Concept of Corruption) Szociológiai Szemle, 4, 109–14. Szántó, Z., I. J. Tóth (eds) (2008) Korrupciós kockázatok az üzleti szektorban: Kutatási háttértanulmányok (Corruption Risks in the Business Sector: Research Background Studies) (Budapest: BCE – Korrupciókutató Központ). Szente, Z. (ed.) (2007) Korrupciós jelenségek az önkormányzati közigazgatásban (Corruption Mechanisms in Local Government Administration) (Budapest: Közigazgtási Intézet). Tóth, I. J. (2000) A korrupció néhány tényezo˝je az átalakuló gazdaságokban (Some Corruption Factors in Transition Economies) manuscript, http://econ.core. hu/~tothij.

7 Cluster Identification, Firm Culture and Cooperation Activities in a European Metropolitan Region: The Case of Nuremberg Lutz Eigenhüller, Stefan Fuchs, Nicole Litzel and Joachim Möller

7.1 Introduction1 As definitions of the term ‘cluster’ are fuzzy, there is a range of possibilities to use in approaching the phenomenon – from highly formalized models in regional economic theory to practical training units for business development institutions. Still, the concept offers the possibility to pick some features out of different well-established methods of economic theory to shape a comprehensive picture of individual clusters. For the example of Central Franconia, the core of the European Metropolitan Region (EMR) Nuremberg, we developed a methodology to identify, analyse, characterize and visualize clusters. It is based on semi-structured interviews with experts from institutions and companies, supported by a written survey of companies in cluster-relevant industries and services along regional supply chains. A set of five criteria is used to check whether fields of functional specialization can be considered as working clusters or, alternatively, as supply chains with potential for clustering. The focus of study is on the late 1990s when the regional development authorities in the agglomeration started with cluster management activities, making it an interesting economic space for research. The questionnaire developed for the survey contains sections on customer-supplier-relationships and cooperations, joint projects, for example, in the fields of development of human capital or research, functional versus industry affiliation, innovations and company demographics. In this chapter we focus on the cooperation between companies as well as between companies and institutions. We present descriptive results for cooperation-related issues from our survey. Firms’ 154

Eigenhüller, Fuchs, Litzel and Möller 155

cooperation culture is measured by joint activities within or outside the region. We differentiate firm culture by firm size and cluster affiliation and give information on cooperation patterns, activities in clusters as well as on factors for establishing cooperation. The chapter is organized as follows. Section 7.2 provides an overview of the cooperation aspects in cluster literature. Section 7.3 contains a description of our methodology of cluster identification. Section 7.4 starts with an introduction to the region we are studying in this chapter, followed by the application of our methodology to collect and analyse data. It deals first with cooperation patterns, followed by activities in clusters and information on cooperation and firm culture and ends with factors for establishing cooperation. Section 7.5 concludes and gives an outlook.

7.2 Literature According to Feser and Sweeney2, ‘industry clusters are typically defined as significant geographic concentrations of major end-market industries, their extended supply chains, other sectors that share close technological or human capital affinities, and various specialized supporting institutions’. This definition illustrates the fuzziness of the term ‘cluster’. One could picture a black box with no sharp outlines, unknown size and unspecific complexity. However, there are links to well-established methods of economic theory to try and shape a comprehensive picture. Literature from the field of regional economics emphasizes the role of geographic proximity for the emergence of successful regional innovation clusters, resulting from agglomeration effects, localization or network effects. For instance, Van den Berg et al. (2001) state on the basis of a detailed empirical study on growing clusters in nine European cities: ‘There are many indications that, increasingly, urban economic growth seems to emerge from fruitful co-operation between economic actors, who form innovative complexes of firms and organisations.’3 Already during the Industrial Revolution in Europe the correlation between economic growth and agglomeration can be observed. High economic growth comes along with urbanization, the emergence of industrial regions and deepening regional disparities.4 Consequently Fujita and Thisse (2002) argue that agglomeration can be seen as the spatial counterpart of industrial growth. Literature in regional economics differentiates between two major types of agglomeration advantages: localization economies as the advantages resulting from concentration of companies of one industry in a location, and urbanization economies as the spatial concentration

156

Cluster Identification in a European Metropolitan Region

of companies from different industries. The interaction of these factors leads to agglomeration advantages that can also be measured empirically: for the US, Ciccone and Hall (1996) estimate a productivity growth of 4 to 6 per cent with the doubling of population density; for Europe a similar effect is shown.5 The emergence of clusters can also be explained by interactions of companies and consumers. An important milestone in New Economic Geography – it discusses models based on monopolistic competition6 in a world with transport costs in the widest sense, scale economies and externalities of market size7 – is Krugman’s core-periphery model that was extended and modified several times.8 The interplay of production, consumption and localization decisions in certain constellations can develop centripetal forces that lead to a centralization of production. However, empirical studies show that the specialization of regions tends to decline,9 at least as long as it is measured along the conventional industry classifications. But there is evidence that the importance of functional specialization, that is, specialization along inter-sectoral regional value chains, is growing.10 The characteristic feature of value chains or supply chains is vertical integration with their forward and backward linkages, externalities that affect a company either because of changes in supplier or customer actions.11 In addition, diagonal links, for example, to research institutions and service partners gain importance for successful innovation. The analysis of horizontal links between companies provides yet another approach to examining clusters. The three factors that Feldman and Audretsch (1999) stress in making the step towards successful innovation clusters refer to these horizontal interconnections. First, complementary activities should be to a certain extent diverse and, if possible, share a topic. This idea recurs in empirical studies,12 which find that diversity proves to be more conducive to innovation than specialization. Second, they state that competition spurs innovation more than a monopoly does.13 It is not just the fact of competition that stimulates technological developments, but also the cooperation among competitors. For this constellation, Brandenburger and Nalebuff (1996) created the notion ‘co-opetition’. Third, they find that the endowment with technological potential in the past explains just partly the development of innovation clusters. For success, it seems to be far more important to organize the existing structures efficiently.14 Finally, several authors emphasize the considerable differences between the structures of clusters that should not be neglected in data collection and analysis. ‘Clusters are inherently different between

Eigenhüller, Fuchs, Litzel and Möller 157

countries (or regions), between technological areas, and ultimately between individual clusters themselves.’15 So the manifold methods to approach clusters should be combined and used to get a concise picture of the individual regional clusters to provide a valuable basis for sound (regional) economic policy.

7.3 Methodology of cluster identification In order to identify a region’s clusters and to merge different approaches offered by the literature we developed a methodology16 to register systematically the value-chain-oriented structures and functional specialization in an economic space. Our main tool is a survey conducted along the core competencies of individual companies and institutions and the interactions that can be observed on the micro-level. Clusterrelevant individual firm data are collected and backed by geographic information. The questionnaires avoid the fuzzy ‘cluster’ notion and try to capture the most important aspects of clustering. The range of topics is illustrated in Figure 7.1. Our methodology involves several interconnected elements. To gain a first insight into the economic structures and to identify the leading companies in the region, in-depth semi-structured interviews with experts from different institutions are conducted. In the following, members of the managing board of top companies are interviewed as well, leading among other things to information about additional relevant firms and institutions in the region that are also considered for

Regional value chains Innovation

Customers

Suppliers

Functional specialisation

Competitors

Cluster

Core competences

Employees

Industries

Cooperation Contacts

Out- / in-sourcing Technology transfer

Figure 7.1 The complexity of cluster-related aspects Source: Own illustration.

158

Cluster Identification in a European Metropolitan Region

further interviews. As many different fields of interest have to be taken into account, a manual for each type of interview has been developed. After this stage, a rough outline of the region’s main value chains is visible – including first indications about the segments covered by regional competencies – and a share of the relevant companies and institutions are identified. In addition, the cluster-specific extent of the economic space – that very often does not correspond to administrative borders and should, if possible, be defined by functional considerations17 – becomes clear. On the basis of this information about potential regional clusters, main vertical, horizontal and diagonal links between companies and between firms and institutions, and some strengths and weaknesses of the location, a written survey is conducted among manufacturing companies and firms in the service industry. The questionnaire’s focus is on in-depth cluster-specific information with sections on customer-supplier-relationships and cooperations, functional versus industry affiliation, products and services offered, the core competencies, innovations and company demographics. The detailed firm-specific information is backed by a focused analysis of secondary statistical data. The different interview guidelines and the questionnaire are designed to approach and encircle the fuzzy ‘cluster’ notion with companyoriented questions and questions on business issues familiar to the management (see again Figure 7.1). Company representatives are able to answer detailed questions about these cluster-related topics. We approached the ‘cluster’ theme only at the very end with questions on cluster awareness. Thus major practical problems arising from being unacquainted with the fuzzy ‘cluster’ notion could be avoided. For the identification of a region’s cluster potential we developed a set of five criteria and applied these to the data to examine whether fields of functional specialization can be considered as working clusters or, alternatively, as supply chains with the potential for clustering. This methodology was implemented first in Eastern Bavaria in 2000 and 2001, with an extension along the river Danube between Regensburg and the Austrian border in 2006. In 2006 we then adapted the methodology to the specific needs of the survey in the core of the European Metropolitan Region Nuremberg.18 For this chapter, we use data of the latter project.

7.4 The region, data and empirical results In this section we first introduce the region under study. We then describe the application of the methodology outlined in the previous

Eigenhüller, Fuchs, Litzel and Möller 159

section to collect and analyse data, followed by information on the database. Finally, we present descriptive results of our analysis, focusing on cooperation between companies as well as between companies and institutions. The firms’ cooperation culture is indicated by joint activities with other companies, universities, research institutes or other institutions within or outside the region that is interlinked with characteristics of the firm (for example, cluster affiliation and firm size). 7.4.1 The region In 2005 the Nuremberg region (see Figure 7.2) was admitted as a European Metropolitan Region (EMR), underlining its importance on a national and international scale. The agglomeration forms – after the Greater Munich area – the second largest economic centre in Bavaria and is one of the ten strongest regions in Germany with respect to technology.19 European Metropolitan Regions are considered ‘the motors of social and cultural development. They are taken for spatial and functional locations whose outstanding functions on international scale are radiating also across the national borders’.20 Our study focuses on the core of the EMR Nuremberg, being the Bavarian district of Central Franconia and the two adjacent counties, Forchheim (in Upper Franconia) and Neumarkt (part of Upper Palatinate). The region, with its two million inhabitants, is characterized by the triangle of the cities Nuremberg-Fuerth-Erlangen. This agglomeration is surrounded by counties with high population and industry density; the counties further away are rural areas. Today the entire Metropolitan Region comprises 21 counties, 12 cities and represents roughly 3.5 million inhabitants. Concerning skill structure, the region under consideration follows roughly the West German pattern, for example, the national share of high-skilled graduated employees is 8.7 per cent, compared to 9 per cent in the EMR Nuremberg. Outstanding is the value for the city of Erlangen with 25 per cent of employees holding a degree due to the concentration of employers like the University of Erlangen-Nuremberg, several headquarter facilities of a world-renowned multinational company, and a wide range of high-tech firms grouped around them. On the other hand, the region’s share of workers without vocational qualification (14.2 per cent) is also considerably higher than the national average (12.9 per cent). Within the EMR Nuremberg the cultural interconnections and economic integration are strong, for example, regarding the intra- and interregional commuting patterns focused on the agglomeration, the

160

Cluster Identification in a European Metropolitan Region

Czech Republic Prague

EMR Nuremberg

Pilsen

Nuremberg region Central agglomeration

BAVARIA Austria Munich

Salzburg

Figure 7.2 The Federal State of Bavaria (light grey), the Nuremberg region as our study area (black, white) being the district of Central Franconia and the two adjacent counties Forchheim and Neumarkt, the triangle of the cities (black), the entire EMR (dark grey, black, white) Source: Own illustration.

double-location of the University of Erlangen-Nuremberg, and the distribution of headquarters in the cities and production sites in the outskirts. What makes the economic space around Nuremberg particularly interesting for cluster studies is the advanced level of coordinated network activities in the region. They emerged in the 1990s, after two decades of massive structural change. Traditional industries like the metal and electrical industries switched in importance with service industries: ‘The proportion of industrial employees fell from 61 per cent to 39 per cent, whilst the proportion of service employees rose from 38 per cent to 61 per cent.’21 To face these challenges, the regional development authorities started with a strategy that referred to cluster concepts – to strengthen existing potentials and the regional labour market by initiating cooperation between companies as well as between companies and institutions.

Eigenhüller, Fuchs, Litzel and Möller 161

A central feature was the development of a ‘Master Concept of Development’ (Entwicklungsleitbild) that was first passed in 1998 and updated in 2005. Taking into account existing network partners and interested companies it was aiming at identifying regional fields of competence, that is, clusters. These were to be organized in ‘competence initiatives’ – different kinds of organizations managing cluster activities to individual extents – in order to shape Central Franconia’s national and international profile.22 The first cluster management activities have been implemented in five fields of competence: Transport and Logistics, Information and Communication, Medicine and Health, Energy and Environment and New Materials. In 2005, the sixth field of Automation and Production Technology was started. Subclusters focus on certain aspects. To take account of the dominant production-related service industry, for example, with companies in market research and software development with international importance, the field of Innovative Services was also named as a regional core competence with strong potential for future growth. 7.4.2 Database We use data collected in the research project ‘Clusters and Inter-Firm Networks in the Region of Nuremberg’. This is a joint work of the Institute for Employment Research (IAB), Nuremberg, and the Economics Department of the University of Regensburg (UR). Part of this research project is the implementation of the methodology of cluster identification described in the previous section in the Nuremberg region. For the purpose of a written survey, all firms without employees subject to social security and companies in a non-active status were excluded. In addition, a selection was made according to the affiliation of firms to NACE industries and methods of stratified random sampling were applied. Some sectors that are not of interest in the cluster context were excluded entirely, for example, antique shops and private child care facilities. The questionnaire was sent to 8693 companies in the region and was returned by 888 (10.2 per cent). They are the population of the following analysis. We use only company information. The sample represents roughly 88,000 employees, or a little more than 10 per cent of all dependent workers. 7.4.3 Application of the cluster-identification methodology The data described above were subjected to a set of five criteria to examine whether fields of functional specialization can be considered as working clusters or, alternatively, as supply chains with the potential

162

Cluster Identification in a European Metropolitan Region

for clustering. These criteria are concentration in space, labour market pooling, existence of ‘leading companies’ (technology leaders, market leaders, image carriers), of supporting institutions and regional network activities. Along with the interviews and the survey is information on the spatial dimension of the fields of functional specialization under consideration. Possibly certain value chains are strongly concentrated in a location within the economic space, or some cluster-relevant companies or institutions are located outside the region. The eight value chains we identified as clusters for this economic space (see Table 7.1) operate in Medical technology & health (MED), Automotive (AUT), Logistics & transport technology (L&T), Information technology & communication services (I&C), Plastics industry (PLA), Specialized automation (MAC), Electronics (EL) and Environmental technology & energy (ETE). Obviously our results back the fields of competence in which ‘competence initiatives’ are active. To some extent, our research identifies different and additional subclusters, including two more potential clusters. After the first expert interviews various other

Table 7.1 Overview of the criteria for cluster identification and how strongly they are fulfilled by different fields in the reference region

Cluster MED AUT L&T I&C PLA MAC EL ETE Toy

Concentration ++ + ++ + ++ ++ ++ + ++

Leading companies +++ ++ +++ ++ ++ ++ ++ ++ +

Labour market pooling

Supporting institutions

+++ + ++ ++ ++ ++ ++ + o

+++ ++ +++ ++ +++ ++ ++ ++ +

Notes: +++ very strong, ++ strong, + weak, o very weak or not fulfilled. Medical technology & health (MED) Automotive (AUT) Logistics & transport technology (L&T) Information technology & communication services (I&C) Plastics industry (PLA) Specialized automation (MAC) Electronics (EL) Environmental technology & energy (ETE) Toy industry (Toy)

Networking +++ ++ +++ +++ +++ + ++ ++ o

Eigenhüller, Fuchs, Litzel and Möller 163

fields, for instance the toy industry (Toy), have also been considered, but their cluster prerequisites could not be supported sufficiently by the information. In the following we briefly describe the five criteria we used for the identification of clusters and refer to some examples from the Nuremberg region.23 First, we check whether the regional economic activities have particular and outstanding features. Along with that goes a structuring of each value chain according to the main competences covered by the regional players. It proves to be useful – especially when using the database for economic policy guidelines and cluster management – to move beyond the obvious categories of producer, supplier and institution, but to differentiate further the parts of the value chain. This is one way of shedding some light on the hierarchical structures in a value chain and at the same time further describing and analysing the region’s economic competencies. Second, we look for the existence of ‘leading companies’ or ‘flagpole companies’ in the industries under consideration. We speak of a leading company if a local firm shows at least two of the three following characteristics: it is highly dynamic and leads the development of technologies and manufacturing processes (technology leader); it occupies a major market position in certain segments (market leader); it has a national and/or international brand name or a strong image coming from an advanced market position for a certain product or technology. For the core of the EMR Nuremberg, we find, for example, in Medical technology & health a leading company that produces medical systems for diagnostic imaging, IT and therapy, having all central company functions, especially R&D in the region; and two leading pharmaceutical companies, all with close regional ties. Third, the phenomenon of labour market pooling is taken into account. Can the existence of a specialized workforce be observed? In some areas an obvious pooling of skills is found, for example, highly specialized craftsmen in the ceramics industry or industrial occupations and engineers in electronics and high-voltage power engineering. Interviews reveal that employers are aware of the improved possibilities of matching in a functionally specialized region.24 There is also evidence for poaching incidents as described by Combes and Duranton (2001) and Fosfuri and Rønde (2004). Indications for the assessment of the trade-off between pooling and poaching can be derived from a range of cooperation projects that include the intense cross-company exchange of employees.

164

Cluster Identification in a European Metropolitan Region

In addition, we consider the existence of supporting institutions and their sectoral importance. Vital contributors to cluster structures are, for example, universities and universities of applied sciences with clusterrelevant faculties and fields of research and the willingness to cooperate, research institutes, technical and vocational schools, technology transfer institutions, regional development agencies, working committees and network management. All of these can be found in the economic space analysed. The last criterion – and the one we are focusing on in this chapter – is the evidence of cooperation. Of some importance are also joint actions in the sense of ‘co-opetition’, the cooperation between competitors. The latter can be observed, for example, in joint R&D projects of porcelain manufacturers located in the neighbouring region of Eastern Bavaria – usually fierce competitors in their end markets – and a research institution that is located in Central Franconia. Many different kinds of cooperation occur in the managed networks. 7.4.4 Evidence on cooperation activities in the core of the EMR Nuremberg In the following we focus on cooperation activities as one of the basic features typical of clusters, their emergence, identification, growth, and success. We present a range of descriptive results from our survey.25 How actively the firms cooperate is indicated by joint activities with other companies, universities, research institutes or other institutions within or outside the region. Firm culture is then analysed with regards to firm size and cluster affiliation. We give information on cooperation patterns and activities in clusters as well as factors helpful in establishing cooperation. Cooperation patterns Of the companies answering the cluster questionnaire, roughly 70 per cent claim to cooperate with other companies and more than one fifth is involved in regional cooperation activities. However, the share of local companies cooperating only in supra-regional projects is as high as 29.2 per cent. 17.5 per cent are involved both in joint regional and supra-regional activities with other companies (see Figure 7.3). The second most prominent field for company cooperation is with managed networks and initiatives, where a share of 18.2 per cent of companies indicates a regional focus. But still more than 60 per cent of the companies are not in close touch with networks. Concerning joint activities with locally oriented partners like the Chambers of Industry

Eigenhüller, Fuchs, Litzel and Möller 165 80 Yes, regional 60

40

Yes, supra-regional

Yes, both

17.4

29.2

5.9 15.1

20

7.6 9.4

23.0

3.1 5.3

3.2

3.4

2.7 18.2

13.9

19.0

14.7

11.9 4.6

0 Companies (N = 840)

Networks (N = 793)

Universities (N = 790)

Chambers (N = 775)

Municipalities Research inst. (N = 777) (N = 766)

Figure 7.3 Answers to the question: ‘Has your company already cooperated with the following partners?’ Notes: N=888, lower N in the Figure down to missing values. Source: IAB & UR company survey 2006/2007, EMR Nuremberg.

and Commerce and the Chambers of Crafts and municipalities, the regional share is certainly higher than the supra-regional one with 19 and 14.7.per cent respectively. Few companies address both regional and supra-regional institutions. Regarding joint research activities, contacts with local universities and universities of applied sciences are established by 109 companies out of the 790 answering this question. 7.6 per cent are cooperating with universities on both the regional and national level, more than 9 per cent act only supra-regionally. Concerning projects with research institutions, the situation is reversed: 4.6 per cent of the companies answered that they find research capacities locally whereas nearly 12 per cent of the companies in our survey work jointly with research facilities beyond the regional economic space. However, the majority of between 70 and 80 per cent of the companies indicated that they have never cooperated with universities, chambers, municipalities or research institutions. Concerning cooperation behaviour, large companies (over 250 employees) cooperate more frequently than medium-sized or small companies (less than 20 employees, see Figure 7.4). However, regarding cooperation with other companies, firm size does not seem to matter that

166

Cluster Identification in a European Metropolitan Region

much – across the three size categories the share of cooperating companies is between 67 and 81 per cent. Looking at contacts with networks and initiatives, the difference between large companies (54.5 per cent) and small and medium-sized firms (37.7 per cent and 38.6 per cent) is higher, but in any category cooperation activity is less frequent than cooperation with other companies. The most striking discrepancy can be found in cooperation with universities. 78.9 per cent of firms with more than 250 employees state that they cooperate with universities. Only one third of medium-sized companies are involved, and as few as 21.3 per cent of firms with less than 20 employees cooperate with universities. A set of questions addressed the companies’ awareness of being part of a cluster.26 15.8 per cent state that they are an active member of at least one regional cluster, 10.6 per cent of a Bavarian cluster.27 The results correspond to the replies above, where the local share of network activities is higher. We also asked about potential cluster membership, in an attempt to find out the level of information about the existing

100

80

60

80.7

40 67.1

78.9

70.9

54.5 20

33.9

37.7

38.6

Small

Mediumsized

21.3 0 Small

Mediumsized

Big

Small

Mediumsized

Big

Cooperation with companies Cooperation with universities (N = 840) (N = 790)

Big

Cooperation with networks (N = 793)

Figure 7.4 Cooperation activities of differently sized companies with other companies, universities and universities of applied science as well as with networks and initiatives Notes: N=888, lower N in the figure down to missing values; small enterprises = 0 to 19 employees, medium-sized enterprises = 20 to 249 employees, big enterprises = more than 250 employees. Source: IAB & UR company survey 2006/2007, EMR Nuremberg.

Eigenhüller, Fuchs, Litzel and Möller 167

structures and an interest in corresponding offers. 26.2 per cent of the companies see themselves as a potential member of a regional cluster and 24.7 per cent of a Bavarian cluster. However, additional open answers reveal some extent of uncertainty about the nature of clusters which has to be taken into consideration here. As could be expected, the cooperation culture of companies that see themselves as active cluster members is more developed than that of other companies (see Figure 7.5). 87.8 per cent are involved in cooperation activities with other firms; the corresponding share of potential cluster members is 76.9 per cent and a little more than 60 per cent for non-members. The differences are even more marked when looking at cooperation with networks and initiatives. 71.2 per cent of the active members have joint projects with organizations, the share being nearly three times as high than that of non-members, where less than one fourth cooperates with initiatives. Activities in clusters Joining clusters and their activities is not without problems for the participants (see Figure 7.6). In the questionnaire we offered six

100 Cluster membership:

Active

Potential

None

80 76.9 71.2

60 60.8 40

87.8 48.0

46.4

38.1 20 26.1 0

Cooperation with companies (N = 810)

Cooperation with networks (N = 764)

22.6 Cooperation with universities (N = 763)

Figure 7.5 Cooperation activities of active and potential members of regional clusters and firms with no connections to clusters Notes: N=888, lower N in the figure down to missing values. Source: IAB & UR company survey 2006/2007.

168

Cluster Identification in a European Metropolitan Region

100% 11.8 80%

16.8

21.8

18.8

26.3 36.4

21.8 25.2

20.2

29.9

60% 38.1

23.5 20.2 40%

27.1 28.6 24.8

32.8 20% 10.1 0%

28.6

9.2

26.9

17.1

2.5

9.4

Time No info on pot. Low benefit requirements partners (N = 119) (N = 119) (N = 119) Applies strongly

Applies

Undecided

19.5

21.2

14.4

11.0 3.4

2.5

Knowledge No compatible Dependence disclosure partners on partners (N = 117) (N = 118) (N = 118) Applies not a lot

Applies not at all

Figure 7.6 Obstacles and problems in joining a cluster Notes: N=132, lower N in the figure down to missing values. Source: IAB & UR company survey 2006/2007, EMR Nuremberg.

possible negative consequences of participation (with the option to add remarks). 43 per cent of regional cluster members think that the additional time requirements and coordination efforts within the company are a negative side of being actively involved. The lack of information about potential partners for joint activities is an obstacle for almost 38 per cent of the companies, whereas nearly 17 per cent claim that there are no suitable cooperation partners within the regional cluster. Roughly 30 per cent cannot see a great benefit for their own business. A share of 9.4 per cent of active cluster members strongly fears knowledge disclosure to cluster partners or competitors, whereas 48.7 per cent do not consider this an obstacle for cluster participation. The factor considered least problematic is the possibility of too strong a dependence on other companies. Cooperation and firm culture We also shed some light on the contacts between the affiliates to the different clusters. Clusters are not isolated conglomerates in their respective fields, but are interlinked. The extent of inter-cluster-relationships is depicted in Figure 7.7. To generate strong and weak lines between the individual clusters we counted the double or triple cluster affiliations

Eigenhüller, Fuchs, Litzel and Möller 169

AUT EL

ETE L&T

MAC

I&C MED

PLA

Figure 7.7 Differently strong interlinkages between clusters Note: For abbreviations, see Table 7.1. Source: IAB & UR company survey 2006/2007 and expert interviews, EMR Nuremberg

of companies. The affiliations are most importantly the result of their local customer and supplier relationships. For instance, a company producing plastic parts for cars as well as cases for electronic devices would be a potential member of the clusters PLA, AUT and EL. However, the local cooperation activities with affiliates from different clusters and membership in cluster-relevant local network initiatives are also taken into account. Our data show that, for instance, the interlinkages between the local clusters MAC and MED are strong, as well as between MAC and EL and AUT respectively. In the Nuremberg region MAC, as producers of capital goods, are specialized in these fields, as a number of joint developments shows. However, the links between MAC and I&C are not as strong as might be expected, given the growing importance of programmable controllers and embedded systems in automation. L&T can be seen as a cross-sectional technology interlinked with all other value chains. In the core of the EMR the links to I&C are stronger than expected. The reason might lie in the specialization of Nuremberg in transport technology, for example, the development and implementation of the driverless underground train with a high share of software and sensors.

7.5 Résumé and perspectives In this chapter we presented descriptive results of the research project ‘Clusters and Inter-Firm Networks in the Region of Nuremberg’, a joint work of the Institute of Employment Research (IAB) and the University of Regensburg. The focus is on a methodology we developed to identify and analyse clusters in an economic space.

170

Cluster Identification in a European Metropolitan Region

Our cluster research combines qualitative with quantitative methods. The study is on the core of the European Metropolitan Region Nuremberg. In the late 1990s, the regional development authorities in the agglomeration started with cluster management activities. These fields of specialization are confirmed by our research, which also identified two more potential clusters. We pick out cooperation between companies as well as between companies and institutions as one section of the study and present descriptive evidence. From this it appears that the share of companies cooperating with other companies – be it under consideration of firm size, active or potential cluster membership or the affiliation to individual clusters – is a lot higher than with networks and institutions or universities and universities of applied science. Of the numerous cluster activities, information meetings and presentations that require limited efforts from participants in terms of time and resources are the most frequently used offers. However, we find that guided cooperation projects and cluster workgroups are also very popular. Regarding the pros and cons of participating in a cluster we find that, from the perspective of the companies, the advantages of participating continually outweigh perceived obstacles and problems. We give evidence that cooperation behaviour is changing between clusters. Furthermore, we find that clusters are not isolated conglomerates in their respective fields but interlinked to different extents. Looking at the association between firm size and preferred cooperation partners we find that big companies are more frequently cooperating than small or medium-sized firms. However, differences regarding cooperation and firm size are salient only in the field of cooperation with universities and research institutions. Concerning joint projects with other companies and networks, these differences are less evident. Of the factors considered important in establishing cooperation as well as a source of information, personal and individual factors are pivotal. These results are the basis for future multivariate analyses. Finally, the intensity of regional cooperation as a driving force for innovation activities and economic performance, including consequences for the local labour market, is another field for future research.

Notes 1. We gratefully acknowledge the contribution of the members of the ProIABTeam to this research (expertise, experience, expert interviews and patience). We also thank Stefan Boehme of the IAB for providing Figure 7.2. We are also grateful to Sumit Mitra (University of Wollongong in Dubai, United Arab

Eigenhüller, Fuchs, Litzel and Möller 171

2. 3. 4. 5. 6. 7.

8. 9. 10.

11. 12. 13. 14. 15. 16. 17.

18. 19. 20. 21. 22. 23. 24. 25.

Emirates) and the participants of the international conference ‘Apparent Antithesis: Globalization and Local Development’ (Trento, October 2008) and the TCI 12th Annual Global Conference (Jyväskylä, October 2009) for helpful comments. The usual disclaimer applies. Feser and Sweeney (2002), p. 111. Van den Berg et al. (2001), p. 185. See, for example, Martin and Ottaviano (2001); Duranton (1999). Ciccone and Cingano (2003); Baptista (2003); Möller and Haas (2003). Dixit and Stiglitz (1977); Ethier (1982). For example, Krugman (1991); Ottaviano and Puga (1997); Fujita and Krugman and Venables (1999); Fujita and Thisse (2002); Head and Mayer (2003). For example, Krugman and Venables (1995); Helpman (1998); Puga (1999); Forslid and Ottaviano (2003). Kim (1995) for USA; Möller and Tassinopoulos (2000) and Haas and Südekum (2005) for Germany. See Möller and Litzel (2008) for applying cluster data from the Eastern Bavarian research project CORIS (cluster-oriented regional information system, www.coris.eu) to established measurements of regional specialization and spatial concentration of economic activities. Hirschman (1958). See, for example, Glaeser et al. (1992). Glaeser et al. (1992); Audretsch and Feldman (1996). Audretsch (2003). Guinet (2001), p. 5. This section is based largely on section 8.3.1 in Möller and Litzel (2008). Feser et al. (2001) also work on the conceptual problem of clusters neglecting administrative borders. As a basis for further quantitative and qualitative analyses they developed a methodology that combines a non-spatial technique revealing inter-industry links with an analysis of employment patterns in economic space. All in all, in the Nuremberg region 49 experts from institutions and companies were interviewed and 888 questionnaires were returned. See Egeln et al. (2006). Adam et al. (2005), p. 417, translation by the authors. Heidenreich (2005), p. 746 – also see IHK Industrie- und Handelskammer Mittelfranken (2005); Stadt Nürnberg (2003). See Neumann (1996); Stadt Nürnberg (2003); Entwicklungsleitbild (2005) for information on the development and implementation of the process. The general descriptions in this section are based on section 8.3.1 in Möller and Litzel (2008). As observed as well for example, by Andersson et al. (2004). (a) Some of the results (Figures 7.3, 7.4, 7.5) are based on all 888 questionnaires returned. (b) The cluster affiliation was developed by the authors by picking up on functional company information that suggests a potential cluster membership (products, local customers, suppliers, and cooperation activities as well as position in the value chain). As some of the companies are functionally affiliated to more than one cluster the total number of observations for cluster-related questions is 1397 (see Figure 7.7). (c) The

172

Cluster Identification in a European Metropolitan Region

other results (Figure 7.6) are based on the answers of the 132 companies that claimed to be an active member of a regional cluster. 26. A definition was provided in the questionnaire. 27. As the Nuremberg region is a part of the German Federal State of Bavaria (see Figure 7.2), Bavarian clusters are to a certain extent supra-regional. In 2007 the Bavarian Government started a cluster strategy and implemented 19 state-wide clusters organized by different kinds of organizations and network initiatives.

References Adam, B., J. Göddecke-Stellmann and I. Heidbrink (2005) ‘Metropolregionen als Forschungsgegenstand. Aktueller Stand, erste Ergebnisse und Perspektiven’, Informationen zur Raumentwicklung, H. 7: 417–30. Andersson, F., S. Burgess and J. I. Lane (2004) ‘Cities, Matching and the Productivity Gains of Agglomeration’, CEP Discussion Paper No. 648, Centre for Economic Performance, London. Audretsch, D. B. (2003) ‘Globalization, Innovation and the Strategic Management of Places’, in J. Bröcker et al. (eds) pp. 11–27. Audretsch, D. B. and M. Feldman (1996) ‘R&D Spillovers and the Geography of Innovation and Production’, American Economic Review 86(3): 630–40. Baptista, R. (2003) ‘Productivity and the Density of Regional Clusters’, in J. Bröcker et al. (eds) pp. 163–81. Berg, van den, L., E. Braun and W. van Winden (2001) ‘Growth Clusters in European Cities: An Integral Approach’, Urban Studies, 38 (1): 185–205. Brandenburger, A. M. and B. J. Nalebuff (1996) Co-Opetition (New York: Currency Doubleday). Bröcker, J., D. Dohse and R. Soltwedel (eds) (2003) Innovation Clusters and Interregional Competition (Berlin, Heidelberg, New York: Springer). Ciccone, A. and F. Cingano (2003) ‘Skills and Clusters’ in J. Bröcker et al. (eds) pp. 218–40. Ciccone, A. and R. E. Hall (1996) ‘Productivity and the Density of Economic Activity’, American Economic Review 86: 54–70. Combes, P. P. and G. Duranton (2001) ‘Labour Pooling, Labour Poaching, and Spatial Clustering’, Centre for Economic Performance, London School of Economics and Political Science, London. Dixit, A. K. and J. E. Stiglitz (1977) ‘Monopolistic Competition and Optimum Product Diversity’, American Economic Review 67: 297–308. Duranton, G. (1999) ‘Distance, Land, and Proximity, Economic Analysis and the Evolution of Cities’, Research Papers in Environmental and Spatial Analysis, 53, Department of Geography and Environment, London School of Economics. Egeln, J., C. Grimpe, O. Heneric, M. Niefert, T. Eckert and R. Meng (2006) ‘Die Rhein-Neckar-Region im Vergleich zu ausgewählten anderen deutschen und europäischen Metropolregionen’, Studie für die BASF AG (Mannheim: ZEW Zentrum für Europäische Wirtschaftsforschung). Entwicklungsleitbild (2005) ‘Entwicklungsleitbild der Wirtschaftsregion Nürnberg. Eine mittelfränkische Gemeinschaftsinitiative der Regierung, Städte

Eigenhüller, Fuchs, Litzel and Möller 173 und Landkreise’, Kammern (IHK, HWK), Gewerkschaften, Hochschulen unter wissenschaftlicher Begleitung der Prognos AG. Ethier, W. J. (1982) ‘National and International Returns to Scale in the Modern Theory of International Trade’, American Economic Review, 72(3): 389–405. Feldman, M. and D. B. Audretsch (1999) ‘Innovation in Cities: Science-Based Diversity, Specialization and Localized Competition’, European Economic Review 43: 409–29. Feser, E. J. and S. H. Sweeney (2002) ‘Spatially Binding Linkages in Manufacturing Product Chains’ in R. McNaughton and M. Green (eds) Global Competition and Local Networks (New York: Ashgate). Feser, E. J., K. Koo, H. C. Renski and S. H. Sweeney (2001) ‘Incorporating Spatial Analysis in Applied Industry Cluster Studies’, prepared for Economic Development Quarterly. Forslid, R. and G. I. P. Ottaviano (2003) ‘An Analytically Solvable Core-Periphery Model’, Journal of Economic Geography 3: 229–40. Fosfuri, A. and T. Rønde (2004) ‘High-Tech Clusters, Technology Spillovers, and Trade Secret Laws’, International Journal of Industrial Organization, 22(1): 45–65. Fujita, M., P. Krugman and A. J. Venables (1999) The Spatial Economy (Cambridge, MA; London: MIT Press). Fujita, M. and J.-F. Thisse (2002) Economics of Agglomeration – Cities, Industrial Location, and Regional Growth (Cambridge; New York; Port Melbourne; Madrid; Cape Town: Cambridge University Press). Glaeser, E. L., H. Kallal, J. A. Scheinkman and A. Shleifer (1992) ‘Growth in Cities’, Journal of Political Economy, 100: 1126–52. Guinet, J. (2001) ‘Boosting Innovation: The Cluster Approach’, paper prepared for the Kiel Institute International Workshop on Innovation Clusters and Interregional Competition, Kiel, 12–13 November. Haas, A. and J. Südekum (2005) ‘Spezialisierung und Branchenkonzentration in Deutschland – Regionalanalyse’, IAB Kurzbericht 01/2005. Head, K. and T. Mayer (2003) ‘The Empirics of Agglomeration and Trade’, paper prepared as a chapter for J. V. Henderson and J.-F. Thisse (eds) Handbook of Urban and Regional Economics, Volume 4 Cities and Geography (Amsterdam: NorthHolland). Heidenreich, M. (2005) ‘The Renewal of Regional Capabilities: Experimental Regionalism in Germany’, Research Policy, 34: 739–57. Helpman, E. (1998) ‘The Size of Regions’, in D. Pines, E. Sadka and I. Zilcha (eds) Topics in Public Economics (Cambridge; New York; Port Melbourne; Madrid; Cape Town: Cambridge University Press), pp. 33–54. Hirschman, A. O. (1958): The Strategy of Economic Development (Newhaven, CT: Yale University Press). IHK Industrie- und Handwerkskammer für Mittelfranken (2005) ‚Wirtschaft in Mittelfranken’, Bericht 2004/05 (Nürnberg). Kim, S. (1995) ‘Expansion of Markets and the Geographic Distribution of Economic Activities: The Trends in US Regional Manufacturing Structure, 1860–1987’, Quarterly Journal of Economics 110(4): 881–908. Krugman, P. (1991) Geography and Trade, 2nd edition (Cambridge, MA; London: MIT Press).

174

Cluster Identification in a European Metropolitan Region

Krugman, P. and A. J. Venables (1995) ‘Globalization and the Inequality of Nations’, Quarterly Journal of Economics 110: 857–80. Martin, P. and G. I. P. Ottaviano (2001) ‘Growth and Agglomeration’, International Economic Review, 42 (4): 947–68. Möller, J. and A. Haas (2003) ‘The Agglomeration Wage Differential Reconsidered: An Investigation Using German Micro Data 1984–1997’ in J. Bröcker et al. (eds), pp. 182–217. Möller, J. and N. Litzel (2008) ‘Measuring Specialisation and Concentration in Regional Clusters – An Empirical Analysis for Eastern Bavaria’, in U. Blien and G. Maier (eds) The Economics of Regional Clusters: Networks, Technology and Policy (Cheltenham; Northampton, MA: Edward Elgar), pp. 119–44. Möller, J. and A. Tassinopoulos (2000) ‘Zunehmende Spezialisierung oder Strukturkonvergenz? Eine Analyse der sektoralen Beschäftigungsentwicklung auf regionaler Ebene’, Jahrbuch für Regionalwissenschaft, 20 (1): 1–38. Neumann, G. (1996) ‘Regionales Change-Management: Das Nürnberg Programm – Ein exemplarischer Ansatz zur Verknüpfung von Regional-, Wirtschafts- und Arbeitsmarktpolitik’, WSI Mitteilungen 49 (12): 754–63. Ottaviano, G. I. P. and D. Puga (1997) ‘Agglomeration in the Global Economy: A Survey of the “New Economic Geography”’, Centre for Economic Performance, Discussion Paper No. 356. Puga, D. (1999) ‘The Rise and Fall of Regional Inequalities’, European Economic Review 43: 303–34. Stadt Nürnberg (2003) Wirtschaftsbericht 2003: Daten, Konzepte, Initiativen, (Nürnberg).

8 Beyond Commons: New Perspectives and Roles for Common Properties Alessandro Gretter, Ilaria Goio, and Geremia Gios

8.1 Introduction1 The aim of this chapter is to give a different perspective on the evaluation of land and goods of common property. These commons are rather frequent in many nations and characterize most of the mountain and upland territories. Biological and cultural diversity in the common property has been generated by adaptation and by exploitation, namely, traditional forest use permitted the expansion of natural diversity (CIPRA, 2008). This diversity is, nowadays, to be considered as a sort of capital from environmental, economic and social perspectives. It leads to an extremely relevant role of social-ecological systems: biodiversity – in fact – has to be considered as a part of the cultural context (UNESCO, 2005). Collective forms of organization and management represent a viable opportunity to enhance local development that is capable of preserving the various amounts of assets (natural, economic and social). The governance systems usually related to commons represent, as well, a possible and distinctive alternative to that of market forces or state intervention. Experience has shown that collective forms of management are effective not only in preserving natural assets, but also in enforcing local social capital and in fostering development actions in rural areas. The studies conducted by Elinor Ostrom, and other scholars, since the 1980s are going beyond ‘The Tragedy of the Commons’ perspective individuated by Garrett Hardin in the late 1960s. In this chapter we focus on the aspects related to agriculture, forestry and grazing, namely the ‘traditional commons’, with a comparative analysis between two different areas, located in Italy and in the UK. The chapter aims at identifying those 175

176

Beyond Commons

key elements and conditions which are critical for an efficient and sustainable management of commons. Despite our focus on traditional commons, the elements and conditions identified could also be applied to other kind of commons, such as atmospheric pollution, climate change, frequencies and means of communication, for example, the Internet, which are now identified in the literature as ‘modern commons’ and have become more relevant than the traditional ones (Dolšak and Ostrom, 2003; Frakes, 2003; Nordhaus, 1994; Rothbard, 1982; Swanson, 1996). In the Italian Alps, the role of land and goods of common property (mainly forests and grazing areas) has been revitalized in recent years, in accordance with the increasing relevance of the environmental functions embedded in them. Traditionally the management of commons/public good was understood as the management of those natural resources which provided inputs for the production process (that is, pasture for breeding, wood for fuel or for carpentry). Yet, the conceptualization of the management of commons has changed, encompassing the management of natural goods that provide many different utility flows not directly connected with the market, for example the landscape. From a different point of view, ways to control pollution can also be managed as commons. Clearly this requires the updating of tools and organizational methods in order to consider new demands and needs. The processes and the institutional arrangements adopted in the management of the commons are of particular interest, differing from the most efficient solutions typical for public and private goods (Ostrom, 1990). The research and analysis presented here could represent a basis for the identification of some principles of general interest that could be applied in mountain areas of Europe and worldwide. Lowland–highland relationships, whether formal or informal, have the potential to pay for investments in the protection and the sustainable use of mountain resources. When full costs are taken into account, the stewardship of upland resources generally yields greater and more sustainable economic returns both to the people living in the mountain areas and to the immediate downstream economies when compared with – traditional – extractive activities. Thus, environmental conservation and sustainable land use in the world’s mountains are not only necessary conditions for sustainable local livelihoods, but they are also critical to the well-being of nearly half the world’s population who live downstream and depend on mountain resources (MA, 2005). The ecosystem services of mountains, often ignored, provide in most cases greater economic benefits than extractive resource use. Intact biodiversity protects watersheds, attracts tourism and furnishes rich natural

Alessandro Gretter, Ilaria Goio, and Geremia Gios 177

resources for key industries. When measured, watershed protection values have been found to outweigh extractive resource use significantly. The challenge of reversing the degradation of ecosystems while meeting increasing demands for services can be partially met in some scenarios proposed by the Millennium Ecosystem Assessment (MA)2. This degradation could grow significantly worse during the first half of this century and would be a barrier to achieving the Millennium Development Goals. The reversing of this trend implies significant changes in policies, institutions and practices that are not currently underway. Many options exist to preserve or enhance specific ecosystem services in ways that reduce negative trade-offs or that provide positive synergies with other ecosystem services. Within the above-mentioned perspectives, the bases of common management of the natural resources assume a great relevance. Land and goods of common property and the institutions that have managed them for centuries now represent an example to be followed in order to satisfy collective interests. In fact, the individual approach of different stakeholders and the components of society are usually based on a short-term perspective in reference to many natural resources and to the management of land. By adopting the MA approach, we are attempting to analyse the actual role played by common properties in two different territories: the province of Trento (Italy) and the county of Cumbria (UK). In the next section the issue of commons is presented from different economic perspectives. In the second section, the presentation of evidence from local experiences (namely forestry accounting and community action) draws the attention to in-field practices and to the fact that similar territories have differently coped with a crisis, and anticipates some final recommendations.

8.2 Commons and economics 8.2.1 Towards an economy of commons? The evolution of the concept of development has driven economics to focus on issues that clearly encompass the basics for an economy of commons. The goals of development now focus mainly on sustainable development, which refers to social capital as a form of capital accumulation. The role of the state and market foster evidence of institutional failures, as they may or may not occur in the commons management system, and, finally, policy reform should ‘get institution right’ (Meier and Stiglitz, 2000).

178

Beyond Commons

The economy that regulated commons for centuries should be considered as rational management and use of resources rather than subsistence economy. It can be identified, according to recent approaches, as a sustainable local economy. The capacity to rely on natural resources and a mutual system of management permitted the maintenance of the living communities; in relation to this attention has been drawn to the pressures on natural resources (Andelson, 1991; Swanson, 1996) and the particular features of culture and ecology related to communal resources (Mc Cay and Acheson, 1992). During recent years, the upland territories have suffered due to many external threats as well as from the loss of their vital forces, such as their younger inhabitants. Depopulated and aged communities are more susceptible to failure under economic and social aspects. Could the recognition of the richness embedded in the communal form of management of land and goods bring positive values to local communities? The identification of economic values related to the services offered by local social-ecological systems should be used as a form of payback for the external use of local resources, acting like a policy for revitalizing the rural areas. This new approach could be more helpful than the one used up to now (for example the Common Agricultural Policy and the Support Scheme) to enforce the social capital of these communities, supporting the sense of mutuality and the responsibility for managing the land. The role of commons in the rural space, as well as supporting the local development, has been investigated by many authors (Wilson and Wilson, 1997; Short, 2000; Brown, 2006; Hodge, 2007). Economists belonging to the property rights school would, of course, point out the basic inefficiency of resource use in the commons. They would favour the establishment of well-defined private property rights over the common resources, in order to generate incentives for greater internalization of externalities and for the careful husbanding of resources by private owners. However, even if we ignore the serious distributional consequences of the privatization of common-property resources, this could weaken the mechanisms of cooperation already in operation, undermining the reliability of a long-term relationship among the beneficiaries of resources and discouraging investments (Seabright, 1993). The issue of climate change has been identified as a problem to the commons. According to various authors (Keohan and Ostrom, 1995; Vogler , 2000; Dolesak and Ostrom, 2003), the impact of climactic changes should be managed as any other common-pool resources, regarding their public effects and because they involve many resources for which property is not defined.

Alessandro Gretter, Ilaria Goio, and Geremia Gios 179

Notable studies on this perspective have been conducted by Nordhaus (1994), Fankhauser (1995) and Griffin (2003). In this perspective the concept of ‘economics of adaptation’ can be fruitfully employed; this is one of the most interesting contributions of the report made by the UK Government (Stern, 2007). Adaptation differs from mitigation because ‘it will in most cases provide local benefits, and these benefits will typically be realised without long lag times’ (Stern, 2007). In unmanaged natural ecosystems, adaptation will occur autonomously; a similar process could happen as a result of private actors. Adaptation can operate at two broad levels: building adaptive capacity and delivering adaptation actions on two different timescales, the short run (usually constrained by fixed capital stock) and the long run. Even with an appropriate policy framework, adaptation will be constrained both by uncertainty and technical limits to adaptation. Therefore, institutions with long-time experience of managing natural resources and commons should not have to face these barriers frequently. Thus, they could represent a benchmark, for market and non-market forces, in the pursuit of adaptive processes. 8.2.2 Evaluating ecosystem services Theoretically, the provision of goods of primary need for human life is the main role of ecosystems. Along with goods, there are a larger number of services: that ‘are the conditions and processes through which natural ecosystems, and the species that make them up, sustain and fulfil human life. They maintain biodiversity and the production of ecosystem goods’ (Daily, 1997). Ecosystem services include not only the regulation of natural flows and protection from risks and disasters, but also management and social services (see Figure 8.1). Whether associated with commons, the former is related to various rights (grazing rights, use of fuel wood, rights of access, mushroom-picking and so on); the latter to a social system that provides cohesion and mutual respect. The evaluation of ecosystem services is a recent approach developed in North America and Scandinavia. In 1997, a team led by Costanza began with existing estimates of the productivity of a hectare for each ecosystem type for each service and a willingness-to-pay estimate for the service. The most challenging point in this kind of assessment is related to time. Goods and services have been recognized only as the knowledge of a global ecosystem has evolved. Some of these include the maintenance of biodiversity and the contribution to biogeochemical cycles and the global climate. As previously mentioned, it is likely that

180

Beyond Commons Constituents of well-being Ecosystem services

Security Personal safety Secure resource access Security from disasters

Provisioning Food Fresh water Wood and fiber Fuel ...

Supporting Nutrient cycling Soil formation Primary production ...

Basic material for good life Adequate livelihoods Sufficient nutritious food Shelter Access to goods

Regualting Climate regulation Flood regulation Disease regulation Water purification ...

Health Strength Feeling well Access to clean air and water

Cultural Aesthetic Spiritual Educational Recreational ...

Freedom of choice and action Opportunity to be able to achieve what an individual values doing and being

Good social relations Social cohesion Mutual respect Ability to help others

Life on earth-biodiversity

Source: Millennium Ecosystem Assessment

Arrow’s color Potential for mediation by socioeconomic factors

Arrow’s width Intensity of linkages between ecosystem services and human well-being

Low

Weak

Medium

Medium

High

Strong

Figure 8.1 Ecosystem services and human well-being (adapted from De Groot et al., 2002)

the list of potential ecosystem goods and services will continue to evolve. Services are sometimes grouped from the perspective of human users into categories such as extractive and non-extractive or consumptive and non-consumptive. Briefly, the MA represents an interpretative model, applied on a worldwide scale, for valuing ecosystem services. It was called for by the Secretary of the United Nations. Initiated in 2001, the objective of the MA was to assess the consequences of ecosystem change for human well-being and the scientific basis for action needed to enhance the conservation and sustainable use of those systems and their contribution to human well-being. 8.3 Some evidence from local experiences (Trentino, Italy and Cumbria, UK) Almost 60 per cent of the overall surface of Trentino is common property, with designated rights called ‘uso civico’, and has been managed for over

Alessandro Gretter, Ilaria Goio, and Geremia Gios 181

a century by participative bodies. The largest parts of those territories are covered by forest and grassland, and are characterized by a high natural value. In England and Wales, the surface classified as ‘common land’, according to National Law, amounts to 560,000 hectares, and most of them are located in the North-Western county of Cumbria. Ways of overcoming the limitations identified with the traditional supporting schemes for the countryside, might include a ‘participatory wave’ within the rural communities aimed to enforce the local economy investing in the cultural and social capital of the local populations. Within the commons, the ability to build on relevant market-based functions and the frequent occurrence of characteristics typical of mixed goods (partial rivalry and partial excludability), provide new opportunities to focus on the adaptive management of social-ecological systems. Indeed Hubacek et al. (2009) argues that adaptive management should aim to maintain resilience in social-ecological systems. Nevertheless the system will need to absorb new models and forms of governance capable of providing new needs for ecosystem services for a wider range of beneficiaries. However, an asset worth safeguarding to secure the resilience of the social-ecological system may be the principles of commons while providing innovation in organizational and management issues. Thus, the traditional system of management may require adaptation by mechanisms that require a combination of external expertise (of ecosystem function) with the indigenous knowledge and experience of land managers. This will require a participative process to research needs and mechanisms and to identify future policies. In both the territories presented here, it can be achieved through adopting traditional techniques (Holling et al., 1998; Holmgren, 2004). In fact, from the economics of commons it is possible to pinpoint certain aspects of this ancient economy for development, such as those related to the stakeholders’ involvement and participation, and the opportunities to try new approaches for fostering the conservation of the cultural landscape and its components. With this approach, very positive implications for the socio-economic development of the local communities can be linked with the timber, energy and tourism sector (Carestiato, 2006; Dolšak and Ostrom, 2003). 8.3.1 The development of comprehensive forest accounting (Italy) Expectations expressed by society regarding the utility flows generated by commons have completely changed in recent years. They were once considered producers of vital goods (timber and cattle), but recent needs

182

Beyond Commons

have turned into new services (for example, fixation of carbon dioxide), giving relevance to functions once taken for granted. The benefits of these new goods and services are relevant not only to local communities, but also to the social groups that sometimes live far away from the commons area. This new role brings radical changes to management processes. For example from an economic perspective, the growing relevance of non-productive functions of forests should be considered in spite of the productive goods and services, which are usually classified differently with respect to the parameters of rivalry and excludability. Tables 8.1 and 8.2 present some evidence. The minor relevance of private goods (timber and cattle) has led, in many cases, to the abandonment of the commons and thus to a reduction in other utility flows, namely those related to landscape. The aim, now, is to find a manner to remunerate the positive externalities deriving from traditional uses. Three different forms of intervention could be used as policy tools to handle this situation. The first is based on the payments derived from users of these externalities (internalization); the second uses Table 8.1 Value expressed by the utility flow of forest functions

Forest functions Timber Non-timber goods Game Changing stock: wood and game Landscape and recreation Protection and hydro geological Carbon sequestration Total

FRIULI VENEZIA OULX (Piedmont) GIULIA

TRENTINO

Economic Value 2001/ha (€)

Value %

Economic Value 2003/ Value ha (€) %

40.01 33.48

12.4 10.4

137.4 27.9

6.2 1.3

55.44 22.89

13.8 5.7

1.45

0.4

—

—

4.97 46.82

1.2 11.6

55.16

17.1

158.9

7.2

47.94

11.9

183.28

56.7

1,864.5

84.2

212.19

52.7

7.36

2.3

24.9

1.1

12.6

3.1

323.44

100.0

2,213.5

100.0

402.85

100.00

Economic Value 1997/ Value ha (€) %

Source: Paletto, 2002; Marangon and Gottardo, 2001; Goio et al., 2008.

Alessandro Gretter, Ilaria Goio, and Geremia Gios 183 Table 8.2 Utility flow generated by forest and pastures

Not excludability

Excludability (in the case of a specific dimension or proximity of a community) Excludability

Not rivalry

Congestible

Pure public goods – fixing CO2 – pollution reduction – landscape (not–use value) Local public goods – hydro geological protection – water-cycle regulation – landscape (scenic) Tool goods – landscape (option value)

Open access resources – landscape (in recreational areas resourcebased) Commonproperty resources Hunting

Club goods

Rivalry

Private goods – timber – landscape (in recreational areas oriented to utilization) – grazing herbs

Source: OECD, 2001; Gios and Clauser, 2009.

compensative strategies from public bodies and the third adopts a traditional management of commons in order to foster local development. Normally, all the typologies presented above are not alternative, but are combined or adapted to the specific geographical and socio-economic context. In most of the Alpine territories, forests produce private, public and mixed goods; the last kind of goods prevails over the others (Goio and Gios, 2008). Thus, the processes of privatization of commons, or considering them as public goods, are irrational from an economic point of view. This situation suggests a revitalization of some of the ancient skills of collective management that still survive in the Alps (Carestiato, 2006). It is clear that for many commons the objective (related to the resources to be managed) and subjective conditions still persist. 8.3.2 Enhancing the resilience of social-ecological systems: The case of Cumbria (UK) The continued relationships between man and nature call for the identification of social-ecological systems. They are complex, integrated systems in which humans are part of nature (Berkes and Folke, 2000).

184

Beyond Commons

Social-ecological systems have strongly coupled ecological and societal components. For example, in many coastal fishing communities, marine resources are usually tightly integrated with the local economy, culture and political dynamics. In other social-ecological systems, ecological components may include grasslands, reefs, forests, lakes, wetlands or other types of natural resources. The social components may be the individuals, organized groups and institutional rules used to guide interactions with the ecosystem. These actions and interventions are developed to manipulate ecological systems in order to gain goods and services for the benefit of humans. In reference to sustainable development, social-ecological resilience is a major research field forming a special interest in natural resource management. A crucial point in this research area is the issue of adaptive capacity, which, generally speaking, is the design and the potential of socio-ecological elements such as institutions or management policies to change and adapt in response to altered conditions and unpredictable effects of (co)evolutionary dynamics. Given that there is neither a linear path towards any social vision, nor a possibility to eliminate surprise and uncertainty, we must request elements and functions that maintain the adaptive capacity of social-ecological systems, which involve the identification of critical thresholds and the nature of connections between the different interacting sub-systems. ‘The results are people with an affinity for the land, coupled with the resilience and stoicism needed to succeed in the face of unpredictable weather, wildly varying market conditions and the changing priorities of national and European agricultural policy’, Roberts (2008) stated in the spring of 2008 about the population of Cumbria (a region in northwestern England where the process of co-evolving has until now been coordinated by Voluntary Action Cumbria (VAC)). Territories where commons represent a core for local social-ecological systems show that flexible social networks and organizations that proceed through learning-by-doing are better adapted for long-term survival than are rigid social systems that have set prescriptions for resource use. In the face of these outside forces, Cumbria’s upland communities have been able to sustain themselves. Their robustness is a product of close-knit family and social networks, and strong, cohesive relationships that result from decades of collaboration and shared celebration. However, these communities are not immune to outside pressure and observers have long wondered when the slow and steady erosion of community and culture will reach the point of no return. Economically, upland agriculture is undermined by the decrease in market value of its

Alessandro Gretter, Ilaria Goio, and Geremia Gios 185

primary product, sheep. This affects not only the financial viability of farm holdings, but also the sense of worth of many farmers, who judge their success or failure firsthand, in the auction ring. The future role of the commons is envisaged through policy as multifunctional, but with many of the traditional benefits to rights holders being replaced by public goods, which include landscape, access and ecological diversity. However, the issue of the degree of resilience of the community of commoners is one of considerable concern to all stakeholder interests (Humphries, 2008). Conventionally, government policy and support for sustainable development have considered innovation separately from community involvement. Sustainable innovation is led by firm and market settings; community involvement encourages participation and behaviour change (Seyfang and Smith, 2008). Communities can provide niche settings, out of which grassroots innovations can flourish, scale up and be adopted into more commercial and market settings (though this process is far from automatic). Grassroots innovations for sustainable development take many different forms. Examples include furniture recycling schemes, organic food co-operatives, low impact self-housing developments, farmers’ markets, cycle networks, local car clubs and community composting schemes.

8.4

Concluding remarks

From the main findings of the MA, there is evidence that the changes that have been made to ecosystems have contributed to substantial net gains in human well-being and economic development, but these gains have been achieved at growing costs in the form of the degradation of many ecosystem services, increased risks of nonlinear changes and the exacerbation of poverty for some groups of people. These problems, unless addressed, will substantially diminish the benefits that future generations could obtain from ecosystems. In the common land, ecological functions have been preserved thanks to two favourable circumstances. The first is that traditional, extensive uses have not generated such large impacts, thus permitting the achievement of a stable (or guaranteed by human intervention) equilibrium. The second is that the necessity to have wide consensus (sometimes unanimous) within the community for the management purposes halts the introduction of vast changes. The changes in the socio-economic structure and the minor relevance of traditional production have weakened the role of common property

186

Beyond Commons

management. They have led to a clear collapse of multi-secular equilibrium and have created the opportunity for interventions with greater impact. In the first case, the return to a state of wilderness could cause a reduction in many of the non-market functions expressed from the interested areas. The greater the relevance of market-based functions and the occurrence of characteristics typical of mixed goods, the more the opportunity to focus on the latter arises. New models and forms of organization, capable of safeguarding the principles of commons rather than conserving the traditional system of management, could lead to effective solutions for new needs. Innovation on the organizational and managerial side is thus necessary, despite the fact that it is not easily found or implemented. The aim of this chapter is rather to give some guidance on the enhancement of the tools for developing policies and actions for upland communities. Two of the expected outcomes are: the enlargement of the capacity of total economic value method to express local heritage and the reinforcement of participation in creating effective planning activities. Parallel development of this research within the project initiatives and academic collaboration represents an opportunity from this perspective. From the above presented case-histories a number of principles of general interest pertinent to other mountain areas of Europe and worldwide could be identified. These are related to participative governance, management related to preservation of bio-cultural assets (based on long-term perspectives rather than on more extractive ones), sense of trust and enhancement of social capital. Regarding this later issue, the concept of payment for ecosystem services (PES) has received much attention in various countries (Jack et al., 2008) and is seen as an innovative tool for financing the sustainable management of land and water resources in watersheds. PES schemes consist of a payment or direct compensation by the users to the providers of the service for the maintenance or provision of an environmental service (Jack et al., 2008). Recent reviews of PES experiences conducted by FAO in Latin America show that such schemes can be sustainable in the long term if they are funded by local resources and if the service, the users and the providers are well defined. It is necessary to create a virtuous circle between local investment and local populations. Experiences in the Alps showed that external investments do not support the local process of development, but enforce

Alessandro Gretter, Ilaria Goio, and Geremia Gios 187

the process of depopulation, marginalization, urban-like concentration and – often – reduction of environmental quality (Zucca, 2007). There have been important innovations in other areas as well. In environmental management, there is growing support for vesting the primary property rights for forests and water sources in the local community (Baland and Platteau, 1996). It is argued that the local community has the strongest incentives for protecting the local environment and has enough resources to be able to monitor its use effectively. The challenge of reversing the degradation of ecosystems while meeting increasing demands for services can be partially met in some scenarios proposed by the MA. This degradation could grow significantly worse during the first half of this century and would be a barrier to achieving the Millennium Development Goals. It will involve significant changes in policies, institutions and practices that are not currently underway. Many options exist to preserve or enhance specific ecosystem services in ways that reduce negative trade-offs or that provide positive synergies with other ecosystem services.

Notes 1. This research was funded by the Autonomous Province of Trento within the OPENLOC research project under the call for proposals ‘Major Projects 2006’. 2. The MA research programme focuses on ecosystem change. MA is aimed at assessing the consequences of ecosystem change and the action needed to enhance the conservation and sustainable use of those systems. It was launched in 2001 with support from the United Nations.

References Andelson, R. (1991) Commons without Tragedy: Protecting the Environment from Overpopulation – A New Approach (London: Shepheard-Walwyn). Baland, J. M. and J. P. Platteau (1996) Halting Degradation of Natural Resources (Oxford: Clarendon Press). Berkes F. and C. Folke (eds) (2000) Linking Social and Ecological Systems: Management Practices and Social Mechanisms for Building Resilience (Cambridge: Cambridge University Press). Brown, K. M. (2006) ‘New Challenges for Old Commons: The Role of Historical Common Land in Contemporary Rural Spaces’, Scottish Geographical Journal 122 (2), 109–29. Carestiato, N. (2006) ‘La proprietà collettiva come opportunità di sviluppo locale sostenibile’, Quaderni del Dottorato 1 (www.geogr.unipd.it/dottorato/). Convention for the Protection of the Alps (CIPRA) (2008), www.cipra.org and www.alpconv.org.

188

Beyond Commons

Costanza, R., R. d’Arge, R. de Groot, S. Farber, M. Grasso, B. Hannon, K. E. Limburg, S. Naeem, R. V. O’Neill, J. Paruelo, R. G. Raskin, P. Sutton and M. van den Belt (1997) ‘The Value of the World’s Ecosystem Services and Natural Capital’, Nature 387 (6630), 253–60. Daily, G. C. (1997) ‘Introduction: What are Ecosystem Services?’ in D. C. Daily (ed.) Nature’s Services: Societal Dependence on Natural Ecosystems (Washington, DC: Island Press). De Groot, R. S., M. A. Wilson, and R. M. J. Boumans (2002) ‘A Typology for the Classification, Description and Valuation of Ecosystem Functions, Goods and Services’, Ecological Economics 41: 393–408, June. Dolšak, N. and E. Ostrom (eds) (2003) The Commons in the New Millennium: Challenges and Adaptation (Cambridge, MA: The MIT Press). Fankhauser, S. (1995) Valuing Climate Change: The Economics of the Greenhouse (London: Earthscan). Gios, G. and O. Clauser (2009) ‘Forest and Tourism: Economic Evaluation and Management Features under Sustainable Multifunctionality’, iForest 2: 192–7. Goio, I., G. Gios and C. Pollini (2008) ‘The Development of Forest Accounting in the Province of Trento (Italy)’, Journal of Forest Economics 14 (3) 177–96, June. Griffin, J. M. (2003) Global Climate Change: The Science, Economics and Politics (Cheltenham; Northampton, MA: Edward Elgar). Hardin, G. (1968) ‘The Tragedy of the Commons, Science, 162(3859), 1243–8. Hodge, I. (2007) ‘The Governance of Rural Land in a Liberalised World’, Journal of Agricultural Economics, 58(3), 409–32. Holling, C. S., F. Berkes and C. Folke (1998) ‘Science, Sustainability and Resource Management’, in F. Berkes and C. Folke (eds) Linking Social and Ecological Systems: Management Practices and Social Mechanisms for Building Resilience (Cambridge: Cambridge University Press). Holmgren, D. (2004) Permaculture – Principles and Pathways beyond Sustainability (Collingwood, Vic.: CSIRO Publishing). Hubacek, K., N. Beharry, A. Bonn, T. Burt, J. Holden, F. Ravera, M. Reed, L. Stringer and L. Tarrasón D. (2009) ‘Ecosystem Services in Dynamic and Contested Landscapes: The Case of UK Uplands’ in M. Winter and M. Lobley (eds) Land Use and Management: The New Debate (London: Earthscape). Humphries, A. (2008) ‘Pastoral Commoners: A Unique Social-Ecological Resource’, contribution to e-workshop ‘Resilience or Transformation? Socio-Ecological Systems in Upland Cultural Landscapes’ organized by University of Cumbria (UK) 17–19 June 2008. Jack, B. K., C. Kousky and K. R. E Sims (2008) ‘Designing Payments for Ecosystem Services: Lessons from Previous Experience with Incentive-Based Mechanisms’, Proceedings of the National Academy of Sciences (PNAS), 105 (28) 9465–70, July. Keohane, R. O. and E. Ostrom (eds) (1995) Local Commons and Global Interdependence: Heterogeneity and Cooperation in Two Domains (London: Sage). Marangon, F. and E. Gottardo (2001) ‘La valutazione del danno ai boschi del Friuli Venezia Giulia’ in F. Tempesta and F. Marangon (eds) La valutazione dei beni ambientali come supporto alle decisioni pubbliche (Ed. Forum: Udine). McCay, B. J. and J. M. Acheson (1992) The Question of the Commons: The Culture and Ecology of Communal Resources (Tucson, AZ: University of Arizona Press). MA Reports (2005) Ecosystems and Human Well-Being: Current State and Trends Chapter 24 ‘Mountain Systems’ (Washington: Island Press).

Alessandro Gretter, Ilaria Goio, and Geremia Gios 189 Meier, G. M. and J. E. Stiglitz (eds) (2000) Frontiers of Development Economics: The Future in Perspective (Washington: World Bank; New York: Oxford University Press). Nordhaus, W. D. (1994) Managing the Global Commons: The Economics of Climate Change (Cambridge, MA; London: The MIT Press). OECD (2001) Multifunctionality: Towards an Analytical Framework (Paris: OECD Publications). Ostrom, E. (1990) Governing the Commons: The Evolution of Institutions for Collective Actions (Cambridge University Press). Paletto, A. (2002) Il valore economico totale come strumento di valutazione della multifunzionalità forestale: analisi teorica e applicazioni ai boschi del comune di Oulx, PhD thesis, Department of Economics, University of Trento. Rothbard, M. N. (1982) ‘Law, Property Rights, and Air Pollution’, Cato Journal, 2(1), 55–100. Roberts, R. (2008) ‘Communities in a Cultural Landscape’ contribution to e-workshop Resilience or Transformation? Socio-Ecological Systems in Upland Cultural Landscapes organized by University of Cumbria (UK) 17–19 June 2008. Seabright, P. (1993) ‘Managing Local Commons: Theoretical Issues in Incentive Design’, Journal of Economic Perspectives 7 (4) 113–34. Seyfang, G. and A. Smith (2008) ‘Grassroots Innovations for Sustainable Development: Towards a New Research and Policy Agenda’, Environmental Politics, 16 (4), 584–603. Short, C. (2000) ‘Common Land and ELMS: A Need for Policy Innovation in England and Wales’, Land Use Policy 17 (2) 121–33. Stern, H. N. (2007) The Economics of Climate Change: The Stern Review (Cambridge: Cambridge University Press). Swanson, T. M. (ed.) (1996) The Economics of Environmental Degradation: Tragedy for the Commons? (Cheltenham; Brookfield, VT: Edward Elgar). UNESCO (2005) Operational Guidelines for the Implementation of the World Heritage Convention, World Heritage Centre, Intergovernmental Committee for the Protection of the World Cultural and Natural Heritage. Vogler, J. (2000) The Global Commons: Environmental and Technological Governance (Chichester: Wiley & Sons). Wilson, O. J. and G. A. Wilson (1997) ‘Common Cause or Common Concern? The Role of Common Lands in the Post-Productivist Countryside’, Area 29 (1) 45–8. Zucca, M. (2007) ‘Le Alpi. La Gente. Antropologia delle piccole comunità. Movimenti demografici. Condizione femminile. Prospettive di sviluppo’, Report No.36, Centro di Ecologia Alpina, Trento.

This page intentionally left blank

Part II Firms, Context and Proximity

This page intentionally left blank

9 Innovation Driven Growth: Analytical Issues and Policy Implications Pier Carlo Padoan

9.1 Innovation is changing Innovation is changing. The production and commercialization of significant innovations such as the discovery of the transistor, the invention of antibiotics, or the introduction of organizational changes in the workplace has never been a simple task, devoid of risk. What has changed is our appreciation of the process of innovation. No longer do we view innovation as a linear progression from scientific research to discovery, to technological improvements, to finished products, to their diffusion across society. Today, innovation is regarded as a much broader phenomenon and recognized as comprising more complex and interactive processes. We need to work towards the definition of a new innovation paradigm. This should rest on the following elements: (a) innovation is ‘open’ as we see more collaboration alongside with competition among innovative actors. (b) there is a new geography of innovation, where global dimensions and local linkages interact, often in complex ways to determine innovation-based comparative advantage. (c) we have to consider more carefully the role of immaterial assets and non-technological innovation, and look beyond R&D, as investment in many intangibles is rising, and so is the role of services. (d) innovation is increasingly based on technological platforms, such as information and communication technology (ICT), that are becoming just as important as, or even more important than, ‘framework conditions’, in fostering innovation. 193

194

Innovation Driven Growth

9.1.1 Innovation is increasingly open Confronted with mounting global competition and rising research and development (R&D) costs, companies are increasingly collaborating with external partners, whether suppliers, customers or universities, to stay abreast of developments, expand their market reach, tap into a larger base of ideas and technology and get new products or services to market before their competitors. Suppliers and customers are the most sought-after innovation partners. In almost all cases, this more open approach to innovation does not come for free, but rather entails entering into a partnership or exchange that can imply the (significant) payment of licence fees between companies for intellectual property. Open innovation is about increasing R&D options and complementing internal R&D investment rather than about displacing or outsourcing R&D. An OECD study of 59 companies in a dozen countries found that almost three-quarters of them devoted the bulk of their R&D budget – 80 per cent or more – to in-house R&D activities (OECD, 2008). At the same time most companies are actively involved in open innovation practices: 51 per cent of the companies allocated up to 5 per cent of their R&D budgets to research in other companies, while 31 per cent allocated more than 10 per cent outside. These aspects can be further expanded to take into account some features of the role of different innovation actors. While universities and public research institutes are generally considered an important source of knowledge for companies’ innovation activities, especially in more upstream research and exploration activities, they still represent only a small share of innovation collaborations. Larger firms innovate more openly than small firms. Innovation survey data indicate that large companies are four times more likely than small and medium-sized enterprises (SMEs) to collaborate on innovation. The degree of openness in innovation differs across firms and industries, depending on factors such as the importance of the technology, the strategy of the firm, the characteristics of the industry, and so on. Collaboration on innovation is important in manufacturing as well as in services, notwithstanding some differences among countries. Industries such as chemicals, pharmaceuticals and information and communication technology (ICT) typically show high levels of open innovation. Companies traditionally seek to retain their core capabilities and determine what to outsource or with whom to collaborate. Their core competencies (in technology and markets) are developed internally to the

Pier Carlo Padoan 195

greatest extent possible, but open innovation may be a faster, less risky alternative to in-house development when the objective is to diversify (in terms of technology and/or markets). As the practice of open innovation expands and new forms of knowledge sharing and exchange between firms, individuals and institutions occur, ‘knowledge markets’ are emerging. Using a number of different mechanisms and platforms, buyers and sellers can pool trade data, information, contacts and know-how. Intellectual property (IP) exchanges and patent pools, consortia, networking, matching or brokering services, clearing houses, knowledge warehouses and auctions are all alternative ways of managing and deriving value from intellectual assets. 9.1.2 Innovation is going global Innovation is going global, including in services. It relies on new global innovation chains, but we also know that innovation takes place in localities. Indeed geographical proximity matters in global networks as well as in collaboration as companies seem to prefer innovation partners that are geographically close. As a result, it is a challenge to understand better the interactions between these two dimensions. Open and global innovation interact. As the cost and risk of innovating has risen and the trend towards open models of innovation has grown, it has fuelled the trend towards the globalization of innovative activity that has been underway for decades. Multinational Enterprises (MNEs), in particular, have increasingly shifted R&D activities across borders within their global value chain and rely on cross-border partners for new products and processes, and access to markets and skilled human capital. While the networks may be global, the nodes of innovation – clusters of expertise – continue to be local, but are increasingly interconnected thanks to MNEs and new networking tools such as ICTs. One important implication is that the transmission channels of knowledge are several and complex. They are also often complementary as they involve trade, investment, services, skills, as well as intangible knowledge. They all contribute to progress towards global knowledge markets as well as representing a challenge for policy makers. Balancing these global and local forces is a fundamental issue that innovation policy, which is geographically rooted, has to face. 9.1.3 Intangibles and services matter Evidence shows that business services, including communication, financial services and insurance, both domestically produced and imported, grow with output and with technology reflecting the fact

196

Innovation Driven Growth

that the share of ‘advanced’ services in the economy increases with technology accumulation. At the same time services act as drivers and multipliers of innovation driven growth. The role of business services in innovation driven growth is a novel feature. The literature has so far devoted little attention to the tertiary sector as driver of technology accumulation while empirical analyses have almost entirely focused on the interaction between technology accumulation and growth of the manufacturing sector. One must also take into account the role of the composition of the manufacturing sector for producing and importing business services. This can be interpreted both as the direct stimulus coming from a higher level of intermediate demand and as the result of knowledge flows associated with forward linkages or ‘spillovers’. Moreover, with globalization, technological change leads to a ‘splintering’ process, by which services (in particular, business services) spring from the increased technical and social division of labour within production, engendering a strong interdependence between manufacturing and service activities, therefore service driven globalization of innovation is also important. The rising importance of services calls into question how innovation advances are observed and measured. Patent citations are usually considered as a ‘direct measure’ of innovation output. However, as is wellknown, traditional technological variables, such as R&D expenditures and patents do not capture entirely innovation in business services. In fact, although manufacturing sectors spend more on R&D and generate more patents than service sectors, if technological innovation is understood as affecting marketing, training and other activities, many services are more technology intensive than generally considered. At the same time the diffusion of knowledge-intensive service industries is deeply affected by the parallel diffusion and implementation of the new information and communication technology systems. The intangible and information-based nature of services gives the generation and use of ICTs a central role in innovation activities and performance that cannot be captured entirely by patents The role of ICTs as ‘enabling technologies’ is also at the basis of the ‘reverse product cycle’ model to describe the dynamics of the innovation process in services. In this view, in the first stages of the reverse product cycle, services use ICT to enhance back-office efficiency. Subsequently, learning leads to process and product innovations. Finally, the industrial sector begins to use information technologies as they increase information-intensive activities. Information and communication technologies also allow for the increased transportability of

Pier Carlo Padoan 197

service activities by making it possible for services to be produced in one place and consumed simultaneously in another. Last, but not least, non-technological innovation is growing also thanks to ICT. In recent years, interest has grown in non-technological forms of innovation and its contribution to productivity performance, especially in countries where industrial specialization and structure limit the scope for formal and technology-based R&D activities. This interest also reflects a growing understanding of the interaction between, and complementary nature of, technological and non-technological innovation, such as the key role of organizational change in the implementation of information and communication technologies. 9.1.4 General-purpose technologies and the Internet The rising role of services and intangibles in the innovation process, and more generally the new innovation paradigm, cannot be understood without considering the role of ICT and the Internet. The history of innovation can be narrated also as the history of general-purpose technologies (such as electricity, or the steam engine, or the Internet) and innovation platforms that sometimes require the interaction of several technologies. Internet is the ‘Great Facilitator’ of our times, a General Purpose Technology that has allowed the development of a number of technology platforms. We can see the effects in the data outlining three features on which Internet has been established. Convergence: the rapid decline in price of computing and communications has both contributed to and caused a shift towards the Internet which is the global platform to deliver voice, video and data services. Creativity: over a short period the Internet and its ability to network ICT has spurred an outpouring of creativity that has turned businesses upside-down and driven economic growth. Confidence: as Internet requires a minimum set of agreed regulations to protect from piracy and also make investment profitable. As networks converge and the Internet becomes a key part of the economic infrastructure, concern has grown regarding how much trust can be placed in the Internet and about its possible vulnerability to events, both accidental and malicious. As our dependence on the Internet increases, so does the need to maintain its integrity, and the work to make it a trusted system. Evidence on the contribution of Internet to profit-making is difficult to pin down. But networked innovation processes, underpinned by the spread of broadband Internet connections, enable a much larger participation in the innovation process, opening it beyond the realm of corporate R&D laboratories to include users, suppliers and consumers.

198

Innovation Driven Growth

Consequently, Internet and open and global innovation go closely together. Tapping into this source of ideas offers a potentially important new factor supporting and boosting innovation and represents an important contribution to ‘demand-side’ policies for innovation. Even more important than the ICT sector being a dynamic sector unto itself, is its importance to the broader economy and society as a platform for innovation. Because the processing, analysing and communication of information is a fundamental element of all economic activity, especially innovation, ICT advances have had a fundamental impact on the nature of innovation itself.

9.2 Challenges for modelling As innovation is changing dramatically how and to what extent the way we model innovation, and how we relate it to the broader issue of economic growth, need to be updated. At the aggregate level the way we are used to modelling innovation is to link it to the standard growth accounting model. The ‘standard’ paradigm model for a ‘national economy’ is Y  AKH (in labour units) where Y is output, K is physical capital, H is human capital, A is the residual. In this framework the relationship between innovation and growth is linear and follows one causation pattern. Inputs such as R&D spending (both private and public) and investment in human capital can lead to more innovation outputs (possibly measured by patents) and hence to increases in total factor productivity (A). This is a useful first approximation tool. Recent contributions by Aghion and Howitt (2006) expand the framework in a number of ways. According to Aghion and Howitt: New growth theory has linked productivity growth to innovation … in turn motivated by the prospect of above normal returns that successful innovators can realise. The theory suggests that innovation, and therefore productivity growth, should … be fostered by: better protection of intellectual property rights to allow successful innovators to benefit from their endeavour; financial development, as tight credit constraints will limit entrepreneurs’ ability to finance new innovative projects; better education, as this will improve the ability to innovate and/or imitate leading edge technologies; macroeconomic stability,

Pier Carlo Padoan 199

which allows for a lower, risk-adjusted interest rate that will enable entrepreneurs to invest more in growth-enhancing projects. (Aghion and Howitt, 2006) It is straightforward to extend the traditional model to take some aspects of new growth theory into account including some of the points raised earlier. This linear model can be augmented as follows: Y  AKHTIW where Y is output, K is physical capital, H is human capital, T is measurable knowledge, I is Internet investment, W is a set of global (international) factors, A is the residual, standing in for non-measurable knowledge. Such an augmented model introduces several new features, some of which are related to the new features of innovation discussed above. One element is how global (international) factors shape innovation activities. Aghion and Howitt consider different innovation and growth models for countries close to, or on, the technology frontier and countries that are catching up to the technology frontier. Again, quoting Aghion and Howitt: There are a number of ways in which a country can increase its productivity growth. One is to imitate more advanced technologies that have been invented elsewhere. Another is to make a leadingedge domestic innovation that builds on and extends the limits of international technology standards. A country that is far from the ‘technological frontier’1 can make substantial leaps forward in productivity growth each time it imitates leading technologies developed elsewhere. However, a country that lies closer to the technological frontier will need to rely primarily on new innovations, which are more difficult to generate, in order to grow further. (Aghion and Howitt, 2006) And further on: Historically, the imitation of existing technologies occurred in Japan and Europe after 1945 and more recently in the economies of the socalled Asian Tigers, such as China, Korea and Taipei China. Imitation has tended to occur where: large firms can take advantage of economies of scale; there is limited labour mobility between firms, so that

200

Innovation Driven Growth

workers’ skills remain largely specific to their firm; there is limited competition and entry, allowing large firms to survive longer and make long-term investments in capital and labour; financial systems can provide long-term bank finance. In contrast, countries that innovate at the technological frontier require: higher labour market mobility, so that innovating firms that enter new markets can more easily find workers who match their needs; more intense product market competition and low entry barriers; more focus on tertiary and, particularly, graduate education, with universities that can produce researchers and generate the basic science that firms harness to innovate; a bigger role for non-bank finance and stock markets that can help select the most promising innovative projects to finance. (Aghion and Howitt, 2006) The overall effect of competition or entry on growth at country level therefore depends on the proximity of local industries to their respective technological frontiers, and on the technological level of new entrants. 9.2.1 A systemic approach to innovation The new growth theory makes important contributions in the framework of the standard model, especially in modelling innovation and growth in countries according to their position in the global innovation system. The new features of innovation mentioned above call for further steps. In particular they require moving towards a system approach to innovation where the structure of the system and the linkages among the variables need to be considered explicitly. Needless to say, this is a very challenging task. The contribution of this chapter is to outline some of the directions this research avenue could take. The main question is: what can be modelled, and also what can be modelled in a way that is amenable to empirical testing? In doing so we must also understand which factors have a predominantly global dimension and which factors have a predominantly local dimension. Why is this distinction relevant? It would help understand how local conditions can attract mobile factors and, possibly, give rise to agglomeration effects. For the purpose of simplicity we can assume that all factors that are mobile can be defined as global factors, that is, perfect mobility is assumed, while local factors are perfectly immobile. As a result, we define as local only those variables which reflect specific institutions such as social capital, the university industry links, and

Pier Carlo Padoan 201

policies, such as framework conditions and, in some cases, regulation. Why is this distinction relevant in this context? The distinction should be taken into account, among other things, when considering possible agglomeration effects and, more generally, the role of geography. We can recall that the basic conditions for agglomeration to take place, that is, a self-sustaining concentration of production in space, as recently restated in Krugman (2009), are: • economies of scale are large, transport costs low, and enough production is mobile; • which location gets the concentration of production is arbitrary, and can be presumed to be a function of initial conditions or historical accident, so we can make the conjecture that such conditions are captured at least to some extent by the ‘local’ factors mentioned above. In what follows, variables with a local dimension will be highlighted in bold italic. To move from a single equation to a system representation we take as the starting point, again, the standard growth accounting relationship (in its augmented version): 1. Y  (A K H T I W) The next step is to endogenize the variables entering the growth equation so as to suggest how and to what extent the features of the new innovation paradigm recalled above can be related to the growth accounting framework. Let us now move to the next equation. Physical capital K depends on human capital H and on I which stands for investment in ICT. The two variables are complementary so that development of human capital is enhanced by investment in ICT and vice versa, on global; relations W, a variable which captures factors related to global value chains and to which we will return later; to ‘framework conditions’ F, including macroeconomic policy and financial market conditions, and to social capital C largely related to the role of social networks as facilitators of the production and diffusion of knowledge. This aspect partly captures open innovation effects as social capital facilitates collaboration among innovators. 2. K  K (H, I, W, F, C, …) Investment in human capital depends on physical capital (as a proxy of business requirements for skills, hence the two variables are, in principle complements rather than substitutes), on ICT investment

202

Innovation Driven Growth

(again as complement to human capital), on elements related to global factors including international skill migration, on the business/university relationship U which could be considered as largely determined by local factors, on investment in education E, largely a local policy variable. 3. H  H (K, I, W, U, E …) Intangibles are partly captured by human capital (skills) and partly by services S. Services, both domestic and imported, grow with output and with technology, reflecting the idea that they represent an important intermediate input and that the share of ‘advanced’ services in the economy increases with technology accumulation. Services are also a function of the expansion in information technology (I) and of the structure of the economy, according to how the manufacturing sector is oriented towards the use of services in production. This can be proxied by the composition of human and physical capital. Finally, regulation (R), which could depend on local factors unless determined at the supranational level (as in the case of some EU level regulations), which, if particularly tight, has a negative impact on the production of services, both domestic and imported. 4. S  S (Y, T, I, H, K, R) Measurable knowledge T (possibly identified by patents) depends on human capital, investment in R&D, (RD), intellectual property protection IP, global knowledge chains and outsourcing, ICT investment, university/business links, framework conditions, non measurable knowledge A. This very ‘sketchy’ relationship would also partly capture open innovation effects through the impact of social capital C for reasons explained above. Through output Y and physical capital K we can partly take into account user driven innovation to the extent that this reflects consumer needs and business needs. 5. T  T (H, RD, IP, W, I, U, F, A … Y, K, C) Let us now move to adoption and diffusion of ICT. As mentioned, ICT is a ‘general purpose technology’ (GPT) and, as such, it cannot be modelled simply by considering it an additional factor of production. A fully satisfactory way of modelling GPT (and ICT) driven growth requires an endogenous determination of ICT. Suggestions on how to endogenize ICT can be derived from the literature on the digital divide. There is a widespread agreement that the digital divide is mostly due to the difference in economic wealth of countries. Another factor that is widely considered in the literature

Pier Carlo Padoan 203

is human capital. The argument is that skilled (that is, educated) workers are more capable of learning how to use new technologies, and that they are more flexible with respect to their job assignment. Because the adoption of ICT often requires a reorganization of the firm, or non-technological innovation, a firm with a high percentage of skilled workers can implement information technologies more easily. The impact of regulation on the adoption of ICT has received much attention in the literature. In general, all kinds of restrictions, regulation or constraint that somehow limit the set of decisions of an economic agent, drive the economy to a sub-optimal equilibrium. Demographic factors such as the age structure of the population and the size of urban population have also been taken into account. The idea is that ICTs have larger diffusion among younger people and that the urban population tends to adopt more ICT (Internet and computer) because of network economies. Another variable that has been extensively investigated is the degree of openness of an economy. The justification is that technological spillovers due to ties with foreign countries could be an important factor in supporting the adoption of ICT. Finally, as some economic sectors use more ICT than others, the possibility that the different sectoral composition of the economies determines different rates of investment in ICT has also been investigated. A high share of the service sector on GDP is usually associated with a high rate of ICT adoption, while a large share of agriculture on GDP is associated with low rates. In conclusion, factors determining ICT diffusion and penetration include complementarity with physical and human capital, RD investment, consumer needs as captured by Y, measured and unmeasured knowledge T, A, and the regulatory stance R but also the role of social capital in determining cultural networks associated with Internet could be important here as we can capture part of open and user driven innovation effects. 6. I  I (H, K, T, RD, Y, R, C, A, …) As argued earlier, the capacity of a country to innovate increasingly depends on the capacity to interact and link up with the global system, both in term of attracting foreign activities, and projecting activities abroad. What are we modelling here? We are attempting to model the structure of a global knowledge pool, itself evolving over time. To do this, several channels of the global innovation chain make up have to be taken into account. From trade, to investment,

204

Innovation Driven Growth

to human capital, to labour flows, and intangible assets. In addition, while we tend to think of countries more or less integrated in the global innovation chains we are really looking at networks of companies, big and small. As a result, it is a tough call to identify what to measure and what determines it. Several variables matter, interestingly, both local and global: factor endowments such as physical human capital, Internet, knowledge both measurable and non-measurable, policy environment, framework conditions, intellectual property, regulatory framework and, at the aggregate level, the distance to the technology frontier (following Aghion and Howitt). 7. W  W (K, H, I, … T, A, … F, R, IP …) Finally, non-measurable knowledge depends on: factor endowment and investment in knowledge including human and physical capital, R&D, Internet, and measurable knowledge. Institutional networks represented by international links, business/university, social capital, policy conditions, including framework conditions, regulation, IP, as well as consumer behaviour as captured by output. 8. A  A (T, I, H, K, RD … W, U, C, … F, R, IP, … Y) The set of relationships (1−8) is, at best, a sketchy ‘system’. To move towards an innovation ecosystem one would have to introduce two elements (at least): dynamics, and evolution. Dynamics: one can think of a model in which variables adjust to a (partial) equilibrium value at different speeds, for example, ICT investment would, most likely, move faster than physical capital K. Thus different speeds would generate different overall system dynamics with complex outcomes in terms of convergence, divergence, or multiple equilibria. Evolution: relationships among variables, reflecting relationships among actors and institutions, evolve over time. Some get stronger, others get weaker. This further complicates the picture. One final comment on the relationship between global and local factors should be taken into account. Our framework suggests that while variables can in principle be separated into these two groups, they jointly contribute to the determination of the performance of systems of innovation, in ways that cannot be clarified here. In addition, they contribute, as mentioned, to possible agglomeration phenomena. In other words both dimensions, global and local, need to be taken into account when modelling innovation. The next challenge is the following. How can we move from a theoretical framework (and still in implicit form) to a system amenable to empirical analysis?

Pier Carlo Padoan 205

9.3 A dynamic structural model of innovation and growth One way forward is through a dynamic system approach that can be modelled and estimated rigorously to capture the systemic nature of innovation. What follows briefly describes the main features of a model (Guerrieri and Padoan, 2007; Guerrieri, Maggi and Padoan, 2009) that moves in the direction sketched above. This model develops the system approach including some of the elements of the new paradigm of innovation discussed above: international dimensions, services and, ICT. It is specified and estimated as a set of continuous time dynamic equations where Dlog stands for the derivative with respect to time and hence left hand side variables are the rate of change of the endogenous variables. Model equations: Output DlogY = f1(T, Sh, Sm, K, L) Domestic Services DlogSh = f2(Y, T, STR, ICT, REG) Imported Services Dlog Sm = f3(Y, T, STR, ICT, REG) Technology Dlog T = f4 (HK, HKR, Sh, Sm, Y, dist) Output growth Y is a function of (exogenous) labour L and capital K accumulation as well as of endogenous accumulation of technology T and business services both domestic Sh and imported Sm. Business services, including communication, financial services and insurance, both domestically produced and imported, grow with output and technology, and depend on the structure of the economy (STR). The intangible and information-based nature of services gives the generation and use of ICTs a central role in innovation activities and performance. Services and ICT interact. ICT also allows for the increased transportability of service activities by making it possible for services to be produced in one place and consumed in another. Hence provision of services is independent from proximity to the final user. This model formulation recognizes the role of a global knowledge pool. This implies that domestic technology grows with output, services, domestic human capital (HK) and, through diffusion, with foreign technology. However, the amount of foreign produced technology that

206

Innovation Driven Growth

can be used domestically is limited by distance (dist) and absorption capacity in the receiving country, proxied by human capital in such a country (HKR). The impact of distance is allowed to vary over time to the extent that technological progress brings forward a reduction in the cost of technology diffusion. Technological accumulation also depends on imports of services, another channel of knowledge diffusion. Regulation (REG) impacts in the production and import of services, and hence on growth in two different ways. Domestic regulation intensity depresses the production of services. Uniform (and low) levels of regulation across countries (a level playing field) favour production and import of services. In modelling the international transmission of technology it is assumed that technology accumulation, as measured by patents (Pat) is equal to domestic and (part of) foreign technology that flows from other countries (a 3-country example). Tt1 = Tt-11 + Pat11 + Pat21 + Pat31 Tt2 = Tt-12 + Pat12 + Pat22 + Pat32 Tt3 = Tt-13 + Pat13 + Pat23 + Pat33 DlogPat ij = f5 (HK, HKR, Sh, Sm, Y, dist) This model can provide interesting insights on the policy implications of global technology integration. For instance, policy simulations show: A persistent and significant positive impact over output is obtained through integration in the market for services, halving diffusion costs. The elimination of the effect of domestic regulation on services also produces a positive and persistent effect on the rate of growth. A higher level of human capital driven by education policy in the receiving and in the sending country raises output growth through the effect of technology accumulation and captures the role of absorptive capacity. This effect is significantly higher when combined with a larger amount of ICT spending. The model can be expanded by endogenizing ICT investment. An augmented version of the model (Guerrieri and Padoan 2007) introduces an equation for ICT investment where human capital, and investments in R&D increase ICT investments, while regulation tends to

Pier Carlo Padoan 207

depress them. Furthermore, the structure of the economy is a relevant factor for understanding the different rate of investment in ICT; in particular, countries with a higher share of the service sector usually display higher ICT investment. Another finding is that, regulation can prevent or discourage investment in ICT equipment, but also, R&D expenditure is positively correlated with ICT investment. When ICT is endogenous, both analytical and policy results are different. Simulation results confirm that services are a powerful driver of growth and that deeper integration in the market for services does significantly contribute to growth. Services and hence growth are also boosted by a reduction of diffusion costs, and the elimination of the impact of regulation. Technology accumulation is enhanced especially by human capital accumulation. The stock of technology is higher when the stock of human capital, in both sending and receiving countries is increased. If ICT is endogenous, policy can impact ICT only indirectly, although in a number of ways. More human capital is the single, most effective measure in boosting ICT, followed by higher impact of R&D on ICT, and elimination of administrative burdens on start ups. Higher investment in education, which can be considered a key public policy strategy, boosts human capital accumulation, hence ICT, and hence output growth. This last result sends an important message on the interaction between technology accumulation and growth. The ultimate driver of growth is technology accumulation and the latter is strongly supported by human capital accumulation. However, for such a mechanism to produce significant effects, a complex transmission mechanism is needed. We take this as a confirmation for the need of a systemic approach to understand the relationship between innovation and growth.

9.5 Conclusions As the process of innovation evolves and becomes more complex, our understanding of the process must also evolve. In so doing, we also need to understand better how features such as open innovation, global innovation chains and the role of technology platforms such as Internet interact, and how they can be modelled. Moving in this direction implies moving away from the traditional, growth accounting, linear relationship towards a systemic approach to modelling innovation. We have offered some initial examples on how this can be done. We have suggested how knowledge globalization can be considered, based on the recognition

208

Innovation Driven Growth

that there are multiple and interacting channels of innovation diffusion. We have offered examples of how to endogenize the role of ICT in the economic system. We have argued that in modelling innovation the interaction between global and local factors should be carefully considered. A further step would be to introduce the specific ‘local’ variables in a general model where the degree of factor mobility is high (approaching a state of ‘full globalization’) and local variables would influence the direction of knowledge flows and hence differences in growth rates. The policy simulation results offer a main message for innovation policy: we cannot rely on a single instrument to boost innovation and, through it, productivity and growth. For instance, our results show that output growth can be significantly increased if the availability of business services and the accumulation of knowledge are enhanced. These results can be obtained through an improved regulatory environment, through deeper service market integration, and through more and better human capital accumulation. Higher ICT investment, which can be boosted by a number of policy strategies – such as more investment in human capital, lower start up costs for business, more investment in R&D and appropriate regulatory framework – provides powerful additional stimuli to growth. More than this, a combined strategy of deeper integration and deregulation would boost growth through the positive interaction and complementarity among business services, knowledge accumulation, and ICT.

Note 1. The technological frontier is the existing international limit of technological capabilities in a specific sector.

References Aghion, P. and P. Howitt (2006) ‘Joseph Schumpeter Lecture – Appropriate Growth Policy: A Unifying Framework’, Journal of the European Economic Association, Vol. 4, No. 2–3, 269–314. Guerrieri, P. and P. C. Padoan (2007) Modelling ICT as a General Purpose Technology. Evaluation Models and Tools for Assessment of Innovation and Sustainable Development at the EU Level, Report for the European Commission, Collegium 35, College of Europe, Bruges. Guerrieri, P., B. Maggi and P. C. Padoan (2009) ‘A Continuous Time Model of European Growth, Integration and Technology Diffusion: The Role of Distance’, Economic Modelling, 26, 631–40. Krugman, P. (2009) The Increasing Returns Revolution in Trade and Geography, Nobel Prize Lecture, 8 Dec 2008, Stockholm University. OECD (2008) Open Innovation in Global Networks, Paris, October.

10 The Social Impact of Innovation at the Local Level: Microsoft Corporation and Grameen Bank Zoltan J. Acs, Connie L. McNeely and Joseph Sany

10.1 Introduction Entrepreneurship has been identified as one of the most important mechanisms for bringing innovation to society (Audretsch 2006; Schramm 2006; Acs and Phillips 2003), and exploring the ways by which the social impact and value of innovation can be determined is critical for understanding the contribution and broad role of entrepreneurship in society today. Accordingly, consideration of the possible social value created through entrepreneurship may prove useful for structuring investigations not only on how innovation might impact society, but also on how the social context operates as an affective factor in entrepreneurial efforts. In other words, societal considerations require and can contribute to a fuller, two-way depiction of entrepreneurship in general. However, investigating the social impact of innovation is not necessarily straightforward and represents both a challenge and an opportunity: an opportunity because of the possibilities for producing social, as well as economic, benefits and a challenge because of difficulties attached to conceptualizing and measuring those benefits. In the related entrepreneurship literature, innovation has typically been defined as ‘a process that begins with an invention, proceeds with the development of the invention, and results in the introduction of a new product, process, or service to the market-place’ (Acs and Audretsch, 1988, p. 679).1 Accordingly, associated measures have emphasized market outcomes and economic value and production. However, the social impact and value of related activities are not always as obviously conceptualized or measured. While we might think of social value in terms of common welfare and societal benefit,2 analytical specification can

209

210

The Social Impact of Innovation at the Local Level

prove somewhat elusive – especially given current gaps in related theoretical developments in studies of entrepreneurship. It is here that attention to innovations of social entrepreneurship in particular – as opposed to purely commercial entrepreneurship – might prove instructive. Arguably, social entrepreneurship is defined as such by a guiding principle of social benefit, over and above economic gain, which determines both the means and ends of associated efforts (Austin et al., 2006). The creation of social value is the raison d’être of social entrepreneurship and is usually attached to issues addressed in determining societal well-being and emphasized in depictions of social responsibility and social policy domains, for example, poverty, health, education, and so on. Having said that, it is also the case that commercial entrepreneurship and innovations also are often linked to notions of social benefit, as in the development of certain pharmaceuticals, electricity, transportation, computers, and so on. However, as an entrepreneurial activity, their social benefits – defined relative to societal well-being – have been tangential to their primary motivation and goal, that is, profit and wealth creation. Although social entrepreneurship may also encompass for-profit organizations and activities, the creation of social benefit and value is their primary goal and intention (Acs and McNeely, 2008). However, in any case, entrepreneurship does not happen in a vacuum and, without the societal link, innovation has little purpose or meaning. To explore this issue relative to the social value and impact of innovation, we suggest that a comparative examination of two types of entrepreneurship – commercial and social – might provide insight into both differences and similarities between the two relative to their roles in the broader society. We are not here engaging notions of ‘corporate citizenship’; rather, our aim is to address questions of conceptual differentiation and impact relative to entrepreneurial outcomes, both purposeful and otherwise. Again, the goal of one is principally about the accumulation of financial wealth, valued in and of itself given the primacy of the market system. The other references the common weal, with particular emphasis on social responsibility and public good. Indeed, wealth in this regard can be conceptualized in broader terms also to include value defined relative to social need and the attainment of individual and societal well-being (Acs and McNeely, 2008). That is, the conception of wealth here can be beneficially complicated as an interpretive feature which can encompass various meanings and measures of benefit and value, looking beyond narrow economic terms to include factors more generally defined as social value.

Zoltan J. Acs, Connie L. McNeely and Joseph Sany 211

Thus, as is generally invoked in discussions of entrepreneurship, the issue of scale and wealth creation applies to both commercial and social entrepreneurship. That is, we argue that both commercial and social entrepreneurship can be scalable and can create wealth, albeit with some reservations and conceptual modifications. Also, in terms of their innovations, they may have both an economic and a social impact (Acs, 2006), again, irrespective of the intentionality or target of their activities. We are, of course, well aware that arguments can be made linking economic gain to positive social opportunities and outcomes, in terms of both causality and correlation. However, especially given the lack of a unifying theoretical framework across entrepreneurial fields, we focus our lens on direct relationships for analytical clarity and theoretical weight. While definitions of entrepreneurship in general and social entrepreneurship in particular are debated, they are marked by growing interest in their contributions for addressing a variety of social problems. Moreover, with growing interest comes important financial investment, which raises questions about the need for meaningful measures of social accountability along with financial accountability. It is therefore imperative for funding institutions, promoters, policy makers, and analysts to be able to distinguish social entrepreneurship initiatives from nonsocial entrepreneurial ones, and to determine their relative capacities – whether intentional or unintentional – to effect social impact and value. Accordingly, we offer comparative case studies in an in-depth analysis of innovation in commercial and social entrepreneurial efforts. Using a case study approach (Cresswell, 1998), we explore differences and commonalities between the types of entrepreneurship. In particular, we look to two entrepreneurs, widely recognized for their innovative approaches and success in two major industries: banking and software. Their organizations were founded as for-profit businesses and have become known around the world: the Grameen Bank of Bangladesh and the Microsoft Corporation, founded by Muhammad Yunus and William Gates respectively. However, while both have created significant amounts of financial wealth, their formal motivations and goals have been quite different. One was private and more purely financial and the other, while also private and financial, was more socially motivated. Indeed, Yunus and the Grameen Bank together have become the poster child of social entrepreneurship (Mair and Marti, 2006; Peredo and McLean, 2006). Some analysts take the position that a for-profit organization cannot reflect social entrepreneurship. However, we find that to be an

212

The Social Impact of Innovation at the Local Level

unnecessarily limiting position and, instead, consider the actual mission and practice of the organization as the defining features by which to make that determination (Acs and McNeely, 2008). Indeed, rather than using non-profit organizations – which are often assumed to be examples of social entrepreneurship by definition – as our cases, we suggest that attention to for-profit organizations as innovative actors with different approaches and goals can be highly instructive and provide a more nuanced depiction of entrepreneurial social impact. Drawing upon data collected from a variety of documentation, archival records, and physical artifacts (Yin, 1989), we consider various determinant aspects of entrepreneurship in each case to develop an analysis of commercial and social entrepreneurship relative to operational contexts and to the social impact of the organization. The relevancy of the analytical discussion stems from the rationale that, to understand entrepreneurship better, it is important to consider the interaction between innovation and context; this interaction informs entrepreneurial opportunities and related outcomes. One key aspect of this debate that is often overlooked is the question of what markets do these innovations operate in. Do they operate in local or national or even global markets? It is clear that one crucial difference between Grameen Bank and Microsoft Corporation, or commercial and social entrepreneurship, is the geographic context. Grameen Bank and Microsoft both started in an emerging market. While Grameen Bank opened up new markets, sustaining the demand in deprived areas and thus indirectly widening the capability of local SMEs to develop, Microsoft, along with entering an infant market, has been seeking to monopolize a national market, and has had an indirect impact on a national market. The linked entrepreneurial activities at the local level should be considered. In effect, the social entrepreneurship and local development might be more interrelated than commercial entrepreneurship and local development especially if the commercial entrepreneurship is producing tradable goods. The two cases provide us with representative stories of wealth creation and social impact based on different practices encompassing different assumptions and driven by different motivations. What we discover through our analysis is how they vary and what they have in common, owing their success to scalable innovative approaches. Our purpose here is to use these cases as a means for better understanding the social impact of entrepreneurial innovation. Examining differences and similarities between social and commercial entrepreneurship can provide insight and aid us in that effort.

Zoltan J. Acs, Connie L. McNeely and Joseph Sany 213

To that end, after a brief discussion of the relevant conceptual and theoretical issues that frame our general inquiry, we explore the backgrounds and initial missions of the Grameen Bank and Microsoft, including the organizational and institutional environment and conditions of their creation as well as their founding motivations. Next we look more closely at the organizations, examining the innovations that they reflect and their economic impact. We then focus on the social impact of these innovations, exploring them in terms of means and ends, which are principal differentiating factors between commercial and social entrepreneurship (Acs and McNeely, 2008). We conclude by offering a general discussion and comments on our findings, along with directions for further research.

10.2 Conceptual and theoretical issues One of the primary issues fuelling the debate in the field of social entrepreneurship, and one that is important for researchers, practitioners, and policymakers alike, has been its definition. It does not suffice to say that social entrepreneurship focuses on driving social change for the benefit of society to set it apart from commercial entrepreneurship (Martin and Osberg, 2007). Moving beyond this characterization is necessary since more and more businesses are making claims to social benefit and it is imperative for the field of social entrepreneurship to distinguish itself in order to enable targeted policies and support to improve its impact. As a type of entrepreneurship, social entrepreneurship has typically been conceptualized in terms of elements of entrepreneurship as understood from different fields of study, for example, economics, sociology, psychology, organizational behaviour, and so on. The entrepreneur has been described as someone who, through innovation, transforms opportunities and organizes resources to yield economic value; in transforming innovation into commercial opportunity, the entrepreneur encourages imitation in others, thus spreading the innovation (Schumpeter, 1942). Alternatively, rather than placing innovation at the centre of entrepreneurship, the entrepreneur has also been depicted as someone who exploits ‘shortages and surpluses’, combining them in new ways in order to create economic value (Kirzner, 1973). That is, the entrepreneur ‘searches for change, responds to it, and exploits it as an opportunity’ (Drucker, 1995, p. 28). Indeed, writing in the late 1800s, French economist Jean-Baptiste Say argued the principle of value creation as being essential to the entrepreneur, who ‘shifts resources out

214

The Social Impact of Innovation at the Local Level

of an area of lower and into an area of higher productivity and greater yield. Entrepreneurs create value’.3 However, whether or not the entrepreneur is driven by profit or whether the entrepreneur is a change agent, there is a consensus that seeking and exploiting opportunities to yield economic value is at the core of commercial entrepreneurship – and this is the way that entrepreneurship in general is usually discussed. The basic context and assumptions that drive commercial entrepreneurship is the market and, in this scenario, opportunity is defined and shaped by the market. Without the possibility of free exchanges of goods and services and a price system essentially determined by supply and demand, the notion of entrepreneurship would be an empty shell. However, the market is at the centre of the economy and the economy is a sub-system of society, and it is this point that raises questions about the social impact of entrepreneurship. In fact, for purposes of the analysis here, we insist on framing social impact as a critical consideration in the value proposition of entrepreneurship, which also allows us to draw insight from notions of social entrepreneurship. Whether wealth creation is necessarily the overriding entrepreneurial motivation, social entrepreneurship points us to broader questions of social value and impact. For example, some approaches depict social entrepreneurs as operating as change agents in the social sector by adopting missions to create social value not just private value, recognizing and pursuing opportunities to serve those missions, and exhibiting accountability to the constituencies served and for the outcomes created (cf. Dees, 2001). This definition places emphasis on the mission to create social value and accountability to constituencies and, hence, the overall social impact as distinctive elements of social entrepreneurship. Accordingly, with social impact at the heart of our investigation, our initial framework, applied to both social and commercial entrepreneurship, includes three basic components: (1) mission and goals, (2) opportunities and means, and (3) outcome and social impact. Thus, the pursuit of a mission aimed at certain outcomes and impact, explored through an identification and investigation of related critical factors will look to the dynamics among various types of institutional and structural arrangements (norms, standards, stakeholders, and so on) and the interactions between markets and politics. Viewing society and culture as a system of values and beliefs through which people understand, appreciate, and adopt innovation (Acs and McNeely, 2008), we consider how social impact occurs as the organization negotiates its way through various institutional

Zoltan J. Acs, Connie L. McNeely and Joseph Sany 215

and structural layers. Our particular strategy here is to examine entrepreneurship and innovation relative to goals and impact on individual interactions and social outcomes.

10.3 Missions and opportunities Muhammad Yunus and the Grameen Bank In 1976, observing the conditions of exploitation, harassment, and disempowerment under which poor women from a small village in Bangladesh were working, economist Muhammad Yunus was moved to address their problems by establishing the Grameen Bank for the explicit purpose of providing them with access to credit. Dominant approaches to credit lending excluded such persons from the market due to their lack of collateral. However, Yunus’ venture proved highly successful and, today, the Grameen Bank has 2459 branches, providing services to 79,539 villages and covering more than 95 per cent of the total villages in Bangladesh.4 The idea of microfinance or microcredit – providing a series of small loans – lending to the poor without collateral has spread throughout the world as a legitimate banking practice. The story of the Grameen Bank actually began two years earlier in 1974 when Bangladesh was suffering a devastating famine that claimed thousands of lives. Muhammad Yunus, a professor at Chittagong University, wanted to assist people in his village of Jobra to combat the effects of the famine. To that end, Yunus and his students worked to organize the small farmers there into an agricultural cooperative to cultivate a high yielding variety of rice. However, while doing so, Yunus found himself staring at an even direr problem, the hidden face of poverty and discrimination: that of deprived, destitute, and powerless women. ‘These women, many of them widows or divorced or abandoned with children to feed, were too poor even to be share-croppers. They were landless and assetless and without hope’ (Yunus 1998, p. 68). They worked long and debilitating hours in the rice fields for which they received at most the equivalent of 40 US cents a day. While the farmer’s cooperative yielded important results, for which it received accolades and a presidential award, Yunus realized that it failed to reach the most destitute and severely impoverished people in the area, principally women. With a sense of moral indignation and a pragmatic faith in development, attacking poverty and improving the lives of these people then became his goal. His belief was that providing these women with

216

The Social Impact of Innovation at the Local Level

at least some assets would help them to improve their lives. The challenge then became how to do it. As an experiment, Yunus began by making $27 loans to a group of 42 poor women – loans which they repaid on time. ‘I could not believe one could produce so much happiness in so many people with so little money!’ (Yunus, 1998, p. 68). The challenge then became how to scale the experience. Was there a market in which women such as these without any resources could participate? They were typically excluded from the market and the social system was dysfunctional for them, imposing on them the self-perpetuating burdens of inequality and poverty. Identifying the lack of assets as a core crippling issue, Yunus worked to forge ‘a better arrangement, an institutional arrangement, so that these people could find money whenever they needed it’ (Yunus, 1998, p. 68). In other words, he aimed to introduce an innovation that would disrupt the established market equilibrium (Schumpeter, 1942), while also transforming the social system into a just and more efficient condition that would enable poor women to achieve their goals (Martin and Osberg, 2007). Yunus’ idea was to address the problem of poverty in a sustainable way that transcended charity or welfare assistance programmes, and he saw credit lending as a service that could lead them to empowerment. Credit to the poor required the development of new products and processes and, importantly, a redefinition of the standards in the credit lending industry and taking high levels of risks with high levels of uncertainties. In other words, it required a radical innovation. Indeed, by providing loans to the poor and destitute, Yunus effected a paradigm shift in the industry. The Grameen Bank – the ‘Bank of the Poor’ – was born from that aim to cause some panic in this crazy unjust system. … Because no formal institution was available to cater for the needs of the poor, the credit market had by default been taken over by the money-lenders who had found a thriving business for themselves. That business was an efficient vehicle creating a heavy rush of one-way traffic on the road to poverty.5 The establishment of the Grameen Bank was based on a theory of change, which posits that, under certain circumstances, credit can help the poor accumulate capital, provided that they invested on the basis of productive assets with a rate of return higher than the interest paid (Wahid, 1994). The key was to provide small loans with payments made

Zoltan J. Acs, Connie L. McNeely and Joseph Sany 217

in small amounts stretched over a long period of time, so as to enable equity accumulation. To address the issue of collateral, the Grameen Bank relied on trust and social capital (Abed and Matin, 2008), in which borrowers were part of a group that oversaw the behaviour of the member. However, repayment was solely the responsibility of the individual borrower, with no joint liability incurred by the group. From the outset, Yunus designed the bank as a cooperative such that ownership and control should remain in the hands of the very people who were its clients. That is, they became shareholders. Yunus focused on addressing the issue of poverty, building the Grameen Bank to expand the credit market and to create positive and systemic social change that benefited its target population. The Grameen Bank introduced new standards and services that redefined the industry. Bill Gates and Microsoft Founded in the US in Albuquerque, New Mexico, in 1975 by William Henry Gates III to develop basis software, Microsoft is now headquartered in Seattle, Washington and has risen to a multibillion-dollar business with a strong foothold in hundreds of other medium and large companies. It has become a giant in the software market and its key product, the Windows operating system, is running on almost every personal computer around the world – and it has made millionaires of many of its employees. Around the same period in 1975, when Yunus was planting the seeds of innovation thousands of miles away in Bangladesh, Bill Gates, with his friend Paul Allen, was writing ‘the coolest program [he] ever wrote’ (Lowe, 1998, p. 24). Indeed, the Altair BASIC language programme, written by Gates and Allen for the Albuquerque-based Micro Instrumentation and Telemetry Systems (MITS), would soon become the standard of the computer industry, which was experiencing tremendous growth pushed by increasing demands for information processing. Gates and Allen sold the Altair BASIC programme for $3,000 (with royalties), but, more to the point, it was a trigger for bigger things (Lowe, 1998). The young Gates, barely 20 years old at the time, saw possibilities in the new information age that could be exploited for profit (Slater, 1987). The technological change brought by progress in computer technology created new possibilities for the software industry, new ways to combine resources for more productivity with the potential for yielding profit (Casson, 1995). For Gates, Altair BASIC was proof of that potential;

218

The Social Impact of Innovation at the Local Level

it was a window to a world of opportunities through which he saw ‘a computer on every desk and in every home’.6 The challenge was then to find the strategy to exploit the opportunity. In order to exploit the opportunities brought forth by the technological and economic changes that were happening in the software industry, Gates and Allen opted to design a new means-ends framework. In 1976, just one year after the sale of Altair BASIC, the trade name ‘Microsoft’ was registered with the Office of the Secretary of the State of New Mexico with the purpose of developing and identifying ‘computer programs for use in automatic data processing systems, pre-programming processing systems, and data processing services including computer programming services’.7 Microsoft relentlessly sought new opportunities and, thanks to the technology breakthroughs in personal computers represented by IBM PC, the organization was able to consolidate its lead on software development. When IBM wanted an operating platform for its new IBM PC 386, it turned to Microsoft, which then delivered MS-DOS.8 The decision by IBM to run MS-DOS as an open source programme replicable by other companies acted to transform the industry radically and provide Microsoft with a critical edge over the competition. Microsoft became a major trendsetter in software, inundating the market with innovative products that would continuously redefine the industry and productivity across sectors. The essence of Microsoft’s innovation machine is commercialization: the commoditization of technology, partner empowerment, and the delivery of new products and capabilities to the global mass market. This occurs through our partner ecosystem that continually innovates or invents new ways to solve customer problems.9 By aggressively pursuing innovation, Microsoft increased its ‘lead time’ in the industry, that is, the period between the introduction of an innovation and its successful imitation by the competition. Microsoft seized every opportunity to commercialize its inventions, increase the lead-time and yield profit, which also meant building strategic partnerships with hardware constructers, and recruiting and retaining talent. As recounted by Gates, even though it was not under financial pressure, Microsoft decided to go public as a way to open up ownership to its employees: ‘We are using ownership as one of the things that ties us all together’ (Stross, 1996, p. 24). This was essentially the same argument used by the Grameen Bank in providing shares to poor women in Bangladesh. However, the motivating rationale was quite different.

Zoltan J. Acs, Connie L. McNeely and Joseph Sany 219

For the Grameen Bank it was a form of empowerment for the poor; for Microsoft it was a business strategy for retaining talent. Gates saw in the development of computer technology and the accompanying software boom an untapped opportunity. He brought in creativity, innovation, and vision to develop one of the leading organizations in the IT and software development industry.

10.4 Scale and wealth creation As previously mentioned, scale and wealth creation are two primary features marking conceptions of entrepreneurship. However, these notions have typically been framed according to a narrow conception of wealth, defined particularly in limited terms of financial gain and investment. Thus, it is not surprising that most discussions of entrepreneurial outcomes tend to focus on economic impact over and above other kinds of value. However, we argue that such a perspective restricts the development of a fuller understanding of entrepreneurial possibilities and of the significant role that entrepreneurship might play in society today (Acs and McNeely, 2008). In any case, even privileging a more limited approach, a starting point for insight into our cases is that both were characterized by innovations that created wealth and were scalable; both innovations transformed their respective industries; and both entrepreneurs started for-profit organizations that have grown into major corporations in their own right. Grameen Bank As described above, in less than 30 years, Yunus and the borrowers had moved the Grameen Bank from a local social experiment in Jobra, Bangladesh, to a viable and thriving nationwide corporation, employing more than 16,000 people. Total assets in 2005 included approximately $700 million, along with more than $400 million in gross total outstanding loans.10 Note also that the borrowers actually became bank members who together held 94.34 per cent of Grameen Bank shares. The remaining 5.66 per cent was held by the Government of Bangladesh (Ahmad et al., 2006). Research has shown a high correlation between this kind of microfinance and increased household consumption, and a positive impact on local economies (Khandker, 2005). Such large inflows of money in the form of credit – microcredit – as produced by the Grameen Bank can impact economies and overall perspectives on development. To track its performance relative to its mission of poverty reduction, the

220

The Social Impact of Innovation at the Local Level

Grameen Bank has used ten criteria for assessing whether a member can be considered to be out of poverty. The criteria include factors such as children’s school attendance, sanitation practices, savings, and so on.11 Interestingly, while the poverty line is indicated in financial terms,12 such criteria incorporate broader attention to social well-being and value. Since 1997 when the Grameen Bank began tracking the progress of its members, 54 per cent of its borrowers have thus crossed over the poverty line and another 27 per cent are very close to it (Goldberg 2005). It is noteworthy that the impact of microcredit as an innovation extends far beyond the original idea and location, which is one of the main characteristics of radical innovation. Indeed, according to the Microcredit Summit Campaign (2007): As of December 31, 2006, 3,316 microcredit institutions reported reaching 133,030,913 clients, 92,922,574 of whom were among the poorest when they took their first loan. Of these poorest clients, 85.1 percent, or 79,130,581, are women. Assuming five persons per family, the 92.9 million poorest clients reached by the end of 2006 affected some 464,612,870 million family members, according to the Microcredit Summit Campaign. Microsoft In less than 30 years, as did the Grameen Bank in microfinance, Microsoft had become an icon in the information technology (IT) sector, particularly in the software market, where its products had become the industry standard. Moreover, it arguably shaped the outlook of the sector by continually pushing new ideas and products through massive investment in research and development and through the use of its networks of partners to reach new markets and customers. In 2005, Microsoft reported net revenue of $40 billion and a net income of $12.25 billion, with 61,000 employees. IT companies play an important role in the performance of businesses and other organizations in general and, directly and indirectly, they contribute a large share to the wealth of nations and individuals (Economist Intelligence Unit, 2008; Jorgenson and Vu, 2005; Brynjolfsson and Hitt, 2003). In fact, Microsoft generates directly and indirectly through its ‘ecosystem’ – which includes companies that sell products that run with or on Microsoft software, or that service and distribute Microsoft software – at least 42 per cent of jobs in the IT sector, representing about 14.7 million jobs in 2007 (IDC 2008).

Zoltan J. Acs, Connie L. McNeely and Joseph Sany 221

The innovations of the Grameen Bank and of Microsoft have not only transformed their own industries, they have succeeded in building corporations that have reached unprecedented heights in global scale and reproduction, as well as creating wealth with spillover effects on other sectors and layers of the economy.

10.5 The social impact of innovation The social impact of an innovation can be seen in changes that occur in communities or social groups as the result of the innovation, referring here particularly to positive effects relative to entrepreneurial goals and practices. One focus of our query is on the impact that innovations can have on the way people relate to one another, engage in society, and build alliances to effect some social action – that is, on social capital – relative to social benefits and responsibilities (Coleman, 1988). Social capital has been described as critical to the quality of life, with variations in the quality of life in some communities attributed to variations in their levels of social capital (Putnam, 1993, 2000), and is based on group relationships that facilitate action. ‘Unlike other forms of capital, social capital inheres in the structure of relations between actors and among actors. … It is not lodged either in the actors themselves or in physical implements of production’ (Coleman, 1988, p. 98). Thus, social action reflects the social context, norms, and values, and shapes social capital according to social factors such as obligations, expectations which depend on the trustworthiness of the social environment, information flow and capacity of the social structure, and norms accompanied by sanctions. Hence, one way that the social impact of innovation can be revealed is by the degree to which it facilitates the creation of social capital, for example, in the form of obligations and expectations, norms and sanctions; and information. From this perspective, we can now consider the social impact of the Grameen Bank and of Microsoft, looking to how they affect social capital, interaction, and benefit. Grameen Bank: Empowering women and strengthening communities An understanding of the social impact of the Grameen Bank requires attention to the assumptions and mission driving its activities. Three basic assumptions guided Grameen Bank action: (1) poverty is not due to a lack of skills, but rather to inefficient social and economic institutions (Acemoglu and Johnson, 2005); (2) the poor have skills that have been unrecognized or under-utilized; and (3) the poor are creditworthy.

222

The Social Impact of Innovation at the Local Level

Therefore, as Yunus explained, ‘Grameen created a methodology and an institution around the financial needs of the poor, and created access to credit on reasonable terms enabling the poor to build on their existing skills to earn a better income in each cycle of loans.’ By so doing, the Grameen Bank has been able to fulfil its mission, which is ‘to help the poor families to help themselves to overcome poverty. It is targeted to the poor, particularly poor women.’13 Over and above economic gains stood the goal of social transformation, changing norms and creating new ways of relating in the form of empowerment and social capital. Through Grameen Bank programmes, women who were once socially excluded and marginalized have become empowered and engaged in their communities; they have found the means to challenge norms and social structures that were mechanisms of oppression. In fact, there exists a high correlation between the time that they spend in Grameen Bank programmes and levels of empowerment (Hashemi et al., 1996). These women also display increased civic engagement and participation. For example, in a 2003 local government (Union Parishad) election, 3059 Grameen Bank members ran for and were elected to seats reserved for women, constituting 24 per cent of the total members elected to the reserved seats.14 In addition to empowering women and encouraging their community participation and decision-making, the Grameen Bank has also acted to challenge cultural norms and transform the social system. The bank programmes and lending requirements are aimed at raising awareness and providing resources and opportunities for establishing individual and group networks, building solidarity and trust among members, that is, increasing their social capital. For example, as part of their loan agreements, the women are requested to respect and act in accordance with the Grameen Bank’s ‘Sixteen Decisions’ (which are recited at the beginning of group meetings).15 The ‘Sixteen Decisions’ are the foundation for social transformation and provide the moral framework and ideology for life changing experience and empowerment. The social value and impact of the Grameen Bank are translated through these decisions, which encompass the social entrepreneurial mission. As Peter Goldmark, former president of the Rockefeller Foundation, once commented, Grameen Bank is not based on transactions. It is based on commitment. It deals in something more than contracts. It builds on a compact and business sense. … It’s the only bank in the world with its own birth control policy. Its members make this pledge: ‘We shall plan to keep our families small.’ It’s the only bank in the world with

Zoltan J. Acs, Connie L. McNeely and Joseph Sany 223

its own marriage policy. Its members make this pledge: ‘We shall keep the center free from the curse of dowry. We shall not practice child marriage.’16 Furthermore, while the main stakeholders of the Grameen Bank are poor women, the social impact of Grameen Bank is felt throughout their communities via the groups of borrowers that are created around the Grameen Bank innovative credit system and their extended networks. Also, the programmes and meetings held in the villages by Grameen Bank credit agents give women the opportunities to learn, share ideas, and relate in ways that build trust and solidarity, that enhance social capital (Grameen Bank and Embassy of Norway, 1999). These in turn provide the women with the credibility (creditability) and trustworthiness that increases their capacity to attain loans and accumulate assets (Grootaert, 1999). Microsoft: Effecting technological and societal change Examining the social impact of Microsoft presents a different and complex challenge. For analytical purposes, it will be useful here to separate the company from its product innovations. On the one hand, we consider the social impact created by the different innovative software attributed to Microsoft, on which it has ridden the rails of success. On the other hand, the impact of Microsoft as a corporate entity arguably has provided socially relevant services to its clients and society at large. As a corporation, Microsoft has contributed to several communitybased and broader social initiatives, from assisting law enforcement in the fight against online predators with the Child Exploitation Tracking System to enabling people with disabilities to develop various job skills. Microsoft claims to have improved the skills and opened up new opportunities to more than 135 million people around the world. Although the depth of the impact and even the scale relative to the wealth in billions of dollars generated by Microsoft certainly can be questioned, it is undeniable that, for example, the education of millions of students and the functional lives of thousands of persons with disabilities have been assisted or improved by Microsoft products and programmes. Thus, while Microsoft as a corporate entity is not organized around a social problem and its primary mission is not the creation of social value, it has arguably had a positive social impact – the achievement of which it trades upon to increase its market capacity. In fact, one could claim that, as commented by Barro (2007),

224

The Social Impact of Innovation at the Local Level

[b]y any reasonable calculation Microsoft has been a boon for society. … A conservative estimate, in a model where software serves as a new variety of productive input, is that the social benefit of Microsoft’s software is at least the $44 billion Microsoft pulls in each year. When capitalized with the same ratio (22) that the market applies to earnings, this flow corresponds to a valuation of $970 billion. Thus, through Microsoft’s future operations, Gates is creating a benefit to the rest of society of about a trillion dollars. … And this counts only the likely future benefits, giving no weight to the past. The impact of technological innovations driven by Microsoft clearly goes beyond the organization itself to include the social impact resulting from software advances in general. With more than 50 per cent of the software market share (in conservative measure) and contributing to the employment (directly and indirectly) of about 42 per cent of the IT workforce, Microsoft clearly has played a leading role in the impact of IT innovations. In one way or another, Microsoft innovations, in terms of software development, have had a broad – and transformative – impact on human endeavours in the world today, from the way we work to the way we play, communicate, and relate to one another. Software development has enormously affected not only the one billion people who use computers, but also those who have never seen one. True, Microsoft is not principally or directly guided by a principle of social value; its overriding motivation and mission is profit, not social value and, as previously mentioned, it is not organized around a social problem. Yet, again, the fact that it is not defined explicitly as a social entrepreneurial venture does not deny the potential for social impact, irrespective of intent. However, we also must mention that there is a general lack of consensus on whether some software innovations have had a positive or negative impact on society, particularly as regards impact on quality of life and social interaction. For example, some analysts have argued, in part due to electronic entertainment, that there has been a breakdown in social capital, with some studies showing that, while information technologies have enabled communication to an unprecedented degree, those advances have come at the expense of the time people spend interacting and they have led to isolating individuals (Putnam, 2000). Yet, others have claimed that such innovations have provided new possibilities and means for people to interact and build social capital. Still others posit that, even if there is an association between the Internet and the quality of individual interactions, it is not a causal relationship.17

Zoltan J. Acs, Connie L. McNeely and Joseph Sany 225

Such arguments and findings are symptomatic of controversies surrounding questions of the ‘digital divide’. Communities and individuals who are positively impacted by the information technologies are those with the capacity to engage and harness the potential advantages provided by these technologies, that is, the ‘haves’, as opposed to the ‘havenots’ whose access and relative capacities are blocked or severely impaired (Norris, 2001). Accordingly, the social impact of information technologies can be a double-edged sword. On the one hand, there are those who posit that it has meant an improved quality of life. On the other hand, there are those who experience the adverse effects of the digital divide – or of the social divide. The focal matter in terms of social capital is the propensity for individuals and groups, based on related aptitudes and capacities, to interact with others and participate in society (Nie, 2001). As Microsoft advanced its innovations, it shaped standards in the IT industry, introduced new products, and created new opportunities for millions. However, exploitation of those opportunities by communities and individuals required particular qualities, aptitudes, resources, and organizations. Microsoft’s innovations have arguably contributed to the ‘democratization’ of information technologies, giving millions of people access to new technologies and capabilities. However, that democratization operates as a market strategy, not as an expression of ethical boundaries. Microsoft is a for-profit organization, motivated and defined as such; profit has been the guiding principle of its entrepreneurial activities and market shares have been its overriding goal – and, clearly, it has had a large social impact.

10.6 Social entrepreneurship and local development Does social entrepreneurship have more of a local impact than commercial innovation? This might depend on whether we are interested in the input producer or the consumer. If one thinks of Microsoft, or other such commercial entrepreneurs, they all have a local impact in their communities. Microsoft has a profound impact on Redwood, Washington where the firm is headquartered. However, it had a minimal local impact in other parts of the country. Its main impact was on the commercial computer industry. Grameen Bank, on the other hand, while perhaps having an impact in its hometown, it clearly had a local impact in the communities that it provided loans to. In fact, part of the purpose of social entrepreneurship is to help local communities to build better lives for the customers they serve. This is true for many social entrepreneurs. The focus is on community and therefore local development.

226

The Social Impact of Innovation at the Local Level

10.7 Conclusion In establishing the Grameen Bank and Microsoft, both Muhammad Yunus and William Gates, respectively, evinced common traits attributed to entrepreneurs: they were creative and innovative, they were risk-takers, they took direct action toward the pursuit of their objectives, and they were able to frame their visions clearly and exploit related opportunities. They both introduced radical innovations that created paradigm shifts and systemic transformations in their respective industries. Fundamentally, both Yunus and Gates and their respective organizations shared in common the notion of change and innovation. They both created highly successful for-profit organizations and they welcomed and created change through innovation and scale. Both the Grameen Bank and Microsoft have had undeniably important economic and social impacts. Yet, despite these commonalities, there are important contrasts that differentiate them as entrepreneurial actors, particularly in terms of missions, opportunities, and outcomes. As we have argued, while both organizations have generated market and social value, they have given different priority to these two notions, and that prioritization defined the ways that they operated, grew, assessed their performance, developed their innovations, and interacted with society. Microsoft was organized with the principal goal of enabling commercial growth and market presence. However, the Grameen Bank gave primacy to social value, over and above market value. Thus, for example, when given the opportunity, Yunus did not pursue his original rice production project for the bank, even though it clearly promised to be quite profitable, because he determined at the time that it would not add social value to the bank’s impoverished target population. Social value, in terms of alleviating poverty and empowering the poor, was its driving force and raison d’être, and market value was viewed primarily in instrumental terms for sustainability, not as an end unto itself. This has affected their differentiated impact on local development. While Microsoft undoubtedly has had a social impact, the Grameen Bank, relative to social change as the value proposition, has had a systemic and transformative social impact. Not only adding social value, the Grameen Bank has operated with the explicit goal of effecting social change that renders obsolete old oppressive structures and institutions, and that establishes new arrangements for the benefit of a targeted group and for the improvement of society overall. It is this motive that distinguishes the Grameen Bank under the rubric of social entrepreneurship; the social value proposition is embedded in its mission.

Zoltan J. Acs, Connie L. McNeely and Joseph Sany 227

By comparing and contrasting the experience of two renowned examples of entrepreneurial innovation, we have brought forth critical similarities and differences between commercial and social entrepreneurship, recognizing that the impact of innovation does not happen, scale, or diffuse in a vacuum. Entrepreneurial innovation is the result of dynamic interactions among a variety of institutions and structures, such as markets, political institutions, and culture. Those interactions create openings, opportunities, and challenges that affect the nature and effect that the innovation might have on society. That is, social impact is created as the organization negotiates its way through various institutional and structural layers and relationships. So, where does this leave debates on the economic impact of innovation? It is clear that the developed world, and increasingly, the developing world have been transformed, and that both societies and individuals have been affected by innovations in information technology, which have been responsible for the majority of productivity gains in the last fifteen years. What part did Microsoft play in this? That is difficult to answer directly, but we can venture to say that it was not trivial. Microfinance, clearly a radical innovation, has had important impacts on the poor by providing credit and banking services. Even the Grameen Bank clients who are still below the poverty line are not as destitute as before microfinance was introduced; their lot has clearly improved in terms of relative deprivation. The social impact of innovation is an even more difficult question. Microfinance clearly has the potential for major social impact on the poor of the world. Indeed, ‘ten years ago, the probability of an idea from Bangladesh affecting a community in Brazil, Poland, or the US was very limited. Now it is common … and becoming more common every year’ (Drayton, 2006, p. 82). In the same vein, Microsoft has had a profound effect around the world, impacting the billions of people using computers today. However, is this social value? What is the actual social impact of such organizations in general? How have they impacted the ways in which we relate to one another? Although Yunus introduced the microfinance innovation to achieve a social mission and the Grameen Bank has operated in pursuit of related goals, microfinance itself need not have such goals; it may be principally commercial in focus. While it has spread as a means for credit lending to the poor and may ultimately have a broadly transformative social impact, the motivation for many such ventures in the field may be primarily an identification and appreciation of the means by which this niche can be exploited for profit. Similarly, computer and IT advances

228

The Social Impact of Innovation at the Local Level

have certainly introduced new ways to create and use social capital, as evidenced by the vast array of social networking programmes available via the Internet today. However, what are the ultimate effects of such innovations in terms of overall societal relations and well-being? We are not arguing here that these are good or bad, but rather that they are certainly social and their broader impacts and implications are subjects that require further investigation.

Notes 1. A similar definition is also dominant in complexity studies (Rycroft and Kash, 1999). 2. Social value is distinct from welfare economics where allocative efficiency within an economy and the income distribution associated with it are determined; in welfare economics there is no ‘social welfare’ apart from that associated with its individual units. Here, ‘welfare’ in its most general sense refers to societal well-being. 3. Quoted in Gregory (1998). 4. From http://www.grameen-info.org/bank/index.html, date accessed 15 January 2008. 5. Leifer et al. 2000, pp. 80, 82. 6. Microsoft’s initial slogan. 7. From http://www.thocp.net/companies/microsoft/microsoft_company. htm#3, date accessed 15 January 2008. 8. Microsoft transformed Q-DOS (Quick and Dirty Operating System) which was developed by a freelance developer into MS-DOS. 9. From Daniel Lewin, Vice President of .Net Business Development at Microsoft, in ‘The democratization of technology’, http://alwayson.goingon. com, date accessed 15 January 2008. 10. From http://www.grameen-info.org/infoharvus$.html, date accessed 18 January 2008. 11. These indicators are as follows: 1. The family lives in a house worth at least Tk. 25,000 (about $380 at current exchange rates) or a house with a tin roof, and each member of the family is able to sleep on a bed instead of the floor. 2. Family members drink pure water of arsenic free tube-wells, boiled water or purified water. 3. All children in the family over six years of age are all going to school or have finished primary school. 4. The minimum weekly loan instalment of the borrower is Tk. 200 or more. 5. The family uses a sanitary latrine. 6. Family members have adequate clothing for every day use, warm clothing for winter, and mosquito nets to protect themselves from mosquitoes. 7. The family has sources of additional income, such as a vegetable garden, fruit-bearing trees, and so on, so that they are able to fall back on these sources of income when they need additional money.

Zoltan J. Acs, Connie L. McNeely and Joseph Sany 229 8. The borrower maintains an average annual balance of Tk. 5000 (about $75) in her savings accounts. 9. No member of the family goes hungry any time of the year. 10. The family can take care of its health. If any member of the family falls ill, the family can afford to take all necessary steps to seek adequate healthcare. 12. People living with more than $ US 1 a day in purchasing power parity (PPP). 13. TheseYunus quotes were posted on www.grameen-info.org, date accessed 12 January 2008. 14. Reported on http://www.grameen.com/bank/GBGlance.htm, date accessed 12 January 2008. 15. The Sixteen Decisions: 1. We shall follow and advance the four principles of Grameen Bank – Discipline, Unity, Courage, and Hard work in all walks of our lives. 2. Prosperity we shall bring to our families. 3. We shall not live in dilapidated houses. We shall repair our houses and work towards constructing new houses at the earliest. 4. We shall grow vegetables all the year round. We shall eat plenty of them and sell the surplus. 5. During the plantation seasons, we shall plant as many seedlings as possible. 6. We shall plan to keep our families small. We shall minimize our expenditures. We shall look after our health. 7. We shall educate our children and ensure that they can earn to pay for their education. 8. We shall always keep our children and the environment clean. 9. We shall build and use pit-latrines. 10. We shall drink water from tube-wells. If it is not available, we shall boil water or use alum. 11. We shall not take any dowry at our sons’ weddings, neither shall we give any dowry at our daughters’ weddings. We shall keep our centre free from the curse of dowry. We shall not practice child marriage. 12. We shall not inflict any injustice on anyone, neither shall we allow anyone to do so. 13. We shall collectively undertake bigger investments for higher incomes. 14. We shall always be ready to help each other. If anyone is in difficulty, we shall all help him or her. 15. If we come to know of any breach of discipline in any centre, we shall all go there and help restore discipline. 16. We shall introduce physical exercise in all our centres. We shall take part in all social activities collectively. (www.grameen-info.org) 16. In the Microcredit Summit Report (2007). 17. For example, studies conducted in 2000 by the Stanford Institute for the Quantitative Study of Society, the National Public Radio, Kaiser Family Foundation, and the Kennedy School of Government; and by the PEW Internet and American Life Project.

230

The Social Impact of Innovation at the Local Level

References Abed, F. H. and I. Matin (2008) ‘Beyond Lending: How Microfinance Creates New Forms of Capital to Fight Poverty’, Innovations/World Economic Forum Special Issue, Davos, 13–27. Acemoglu, D. and S. Johnson (2005) ‘Unbundling Institutions’, Journal of Political Economy, 113(5): 949–95. Acs, Z. J. (2006) ‘How is Entrepreneurship Good for Economic Growth?’ Innovations, 1(1): 97–107. Acs, Z. J. and D. B. Audretsch (1988) ‘Innovation in Large and Small Firms’, American Economic Review, 78(4): 678–90. Acs, Z. J. and C. L. McNeely (2008) ‘Social Entrepreneurship and the Creation of Social Value: A Conceptual Prolegomenon’, School of Public Policy Working Paper, George Mason University. Ahmad and Ahmad, Ahmad & Co. (2006) ‘Grameen Bank: Notes to the Financial Statements for the year ended, 31 December 2006’, Grameen Bank. Austin, J., H. Stevenson and J. Wei-Skillern (2006) ‘Social and Commercial Entrepreneurship: Same, Different or Both’, Entrepreneurship Theory and Practice, January, 1–22. Barro, J. R. (2007) ‘Philanthropy: Earned Fortune’, Hoover Digest, 4 (available online at http://www.hoover.org/publications/digest/10678111.html, date accessed 18 January 2008). Casson, M. (1995) Entrepreneurship and Business Culture (Aldershot; Brookfield: Edward Elgar). Coleman, S. J. (1998) ‘Social Capital in the Creation of Human Capital’, The American Journal of Sociology, Vol. 94, Supplement: Organizations and Institutions: Sociological and Economic Approaches to the Analysis of Social Structure: S95–S120. Cresswell, W. J. (1998) Qualitative Inquiry and Research Design: Choosing Among Five Traditions, (Thousands Oaks, CA: Sage Publications). Dees, J. G. (2001) ‘The Meaning of Social Entrepreneurship’, available online at www.gpnet.com/perspective/social_entrepreneurship.htm, date accessed 12 October 2009. Drucker, F. P. (1995) Innovation and Entrepreneurship (New York: Harper Business). Goldberg, N. (2005) Measuring the Impact of Microfinance: Taking Stock of What We Know (Washington, DC: Grameen Foundation). Grootaert, C. (1999) ‘Social Capital, Household Welfare and Poverty in Indonesia’, Local Level Institutions Working Paper No. 6, Environmentally and Socially Sustainable Development Network, Social Development Family, World Bank, April. Washington DC. Hashemi, S., R. Schuler, S. Sidney and A. P. Riley (1996) ‘Rural Credit Programs and Women’s Empowerment in Bangladesh’, World Development, 24, 4: 635–53. Khandker, S. R. (2005) ‘Microfinance and Poverty: Evidence Using Panel Data from Bangladesh’, The World Bank Economic Review, 19, 2: 263–86. Leifer, R., C. M. McDermott, G. Colarelli O’Connor, L. S. Peters, M. Rice and R. W. Veryzer (2000) Radical Innovation: How Mature Companies can Outsmart Upstarts (Boston, MA: Harvard Business School Press).

Zoltan J. Acs, Connie L. McNeely and Joseph Sany 231 Lowe, J. (1998) Bill Gates Speaks: Insights from the World’s Greatest Entrepreneur (New York: John Wiley and Sons). Martin, R. L. and S. Osberg (2007) ‘Social Entrepreneurship: The Case For Definition’, Stanford Social Innovation Review, Spring 2007. Microcredit Summit Campaign (2007) The State of the Campaign Report 2007. Forthcoming. Norris, P. (2001) Digital Divide: Civic Engagement, Information Poverty, and the Internet Worldwide (Cambridge: Cambridge University Press). Peredo A. M. and M. Mclean (2006). ‘Social Entrepreneurship: A Critical review of the concept’, Journal of World Business, Vol. 41: 56–65. Putnam, R. (2000) Bowling Alone (New York: Simon And Schuster). Putnam, R. (1993) Making Democracy Work: Civic Tradition in Modern Italy (Princeton, NJ: Princeton University Press). Schumpeter, J. (1942) Capitalism, Socialism, and Democracy (New York: Harper). Schramm, C. J. (2006). ‘Entrepreneurial Capitalism and the End of Bureaucracy: Reforming the Mutual Dialog of Risk Aversion’, American Economic Association, 6 January 2006, Boston, MA. Wahid, Abu N. M. (1994) ‘The Grameen Bank and Poverty Alleviation in Bangladesh: Theory, Evidence and Limitations’, The American Journal of Economics and Sociology, Vol. 53, no. 1. Yin, R. K. (1989) Case Study Research: Design and Method (Newbury Park, CA: Sage Publications). Yunus, M. and A. Jolis (1998) Banker to the Poor: The Autobiography of Muhammad Yunus, Founder of the Grameen Bank (Dhaka: The University Press).

11 The Public Interest in Economic Development and Creativity: A Knowledge Governance Perspective Silvia Sacchetti and Roger Sugden

11.1 Introduction This chapter considers economic development from the perspective of the organization of production. The basis for our argument is a synthesis of two previously distinct analyses of the theory of the firm, namely: the competence-based and strategic choice approaches. That synthesis makes creativity – that is, the use of ideas and imagination so as to make things happen – a central issue in understanding production. From that we hypothesize that the treatment of creativity is a significant determinant of the prospects for economic development at local, regional, national and indeed global levels. The structure of the chapter is as follows. Section 11.2 explores the organization of production and Section 11.3 highlights the significance of creativity, contrasting our analysis with much of the currently topical concern with so-called creative industries. Section 11.4 deepens the analysis by introducing the interests of publics as a criterion for assessing economic relations, behaviours and activities. This takes us in Section 11.5 to a depiction of the reality and prospects for economic development, hence to further comments on people’s creativity. We conclude with some brief remarks about the challenges facing societies, communities and territories.

11.2 The organization of production We view the essence of the problem of organizing production as the creation and use of knowledge so as to make choices over the strategic direction of activity (which may then facilitate the further creation and use of suitable knowledge).1 232

Silvia Sacchetti and Roger Sugden 233

The concern with knowledge follows Richardson (1972) and Penrose (1959), who identify it as the essence of capabilities and see capabilities as defining what a firm can do. The link with strategic choice is inspired by a critique of the competence-based approach (inter alia Prahald and Hamel, 1990; Teece and Pisano, 1994); this stresses the commitment, transmission and reproduction that are necessary for the effective creation and use of knowledge, but underplays the critical significance of the governance of knowledge processes. In contrast, governance – defined in terms of the power to determine strategic direction – is the principal concern of the strategic choice approach to the theory of the firm (Cowling and Sugden, 1998). It contends that the critical determinant of what does or might occur in production activity is strategic choice; that each and every type of economic process, system and organization is characterized by a particular type of strategic choice, that is, governance process; and that different types of governance are associated with different outcomes (in terms of efficiency, distribution and well-being). In particular, the strategic choice approach to the theory of the firm identifies a spectrum of governance possibilities (Sacchetti and Sugden, 2003), the two extremes of which are as follows: 1. Direction: A hierarchical system to plan activities according to the exclusive aims of a core, with or without the agreement of others; strategy making is dominated by the core, which directs resources. 2. Mutual dependence: An ideal type, characterized by the absence of hierarchy and of a strategic decision-making core; strategies are determined through a process of diffused co-ordination amongst partners, each of which is allowed and encouraged to contribute to strategic choice through communication and deliberation. To illustrate, consider Hymer’s (1972) analysis of uneven development, which can be applied to economic development at local, regional, national and indeed global levels. His concern is a stylized version of the US economy, and in particular its evolution from a system in which small firms are especially influential into one in which certain forms of large corporation ‘penetrate almost every nook and cranny’ (48). The analysis focuses on a hypothetical situation: what the world economy would look like, if it were to be dominated by a ‘regime’ (38) of such corporations. Hymer argues that the governance by direction in the corporations would be reflected in governance by direction of the world economy. Hymer’s analysis focuses on layered decision making in transnational corporations, most interestingly on two extremes: (a) the lowest levels

234

The Public Interest in Economic Development and Creativity

of management, responsible for the coordination of day-to-day activities; (b) the most senior levels of management, concerned with goal determination and planning, that is, strategy. He argues that while the lowest level would be spread throughout the world ‘according to the pull of manpower, markets and raw materials’ (50), the strategic planning activities would be concentrated in a handful of major cities, the likes of London, New York and Tokyo: One would expect to find the highest offices of the [transnational] corporations concentrated in the world’s major cities. … These … will be … major centres of high-level strategic planning. Lesser cities throughout the world will deal with the day-to-day operations of specific local problems. These in turn will be arranged in a hierarchical fashion: the larger and more important ones will contain regional corporate headquarters, while the smaller ones will be confined to lower level activities. (50) What Hymer also argues is that such an extreme system of governance by direction would have significant welfare consequences: ‘income, status, authority and consumption patterns would radiate out from [the major] centres along a declining curve’ (38), and ‘the “best” and most highly paid administrators, doctors, lawyers, scientists, educators, government officials, actors, servants and hairdressers’ (50) would agglomerate around those centres. His ultimate conclusion is that such governance has a systemic tendency to produce poverty as well as wealth, underdevelopment as well as development.

11.3 Creativity A clear implication of our focus on the creation and use of knowledge so as to make strategic choices is that creativity is a central concern in the organization of production. There are three dimensions to this relevance: 1. The creation of knowledge: the use of ideas and imagination so as to cause an alteration in knowledge, for instance increasing the stock or changing its distribution. 2. Creativity in the use of that knowledge. 3. Creativity in choosing a strategy: the use of ideas and imagination so as to make things happen by opting for particular directions in production.

Silvia Sacchetti and Roger Sugden 235

This perspective is in stark contrast to the attention given to creativity in recent analyses of ‘industries supplying goods and services that we broadly associate with cultural, artistic, or simply entertainment value’ (Caves, 2000: 1). Topical though the analysis of these ‘creative industries’ has become, not least in terms of prospects for economic development (see, for example, Cooke and Lazzeretti (2008) on cities and other localities), it is largely unconcerned with creativity as essential to the organization of industry in general. Rather, the literature considers sectors of industry that have been previously ignored, applying to the new-found sectors more or less traditional analytical methods (Caves, 2000). Moreover, there is typically no concern with creativity among people in general, instead there is consideration of restricted groups; see especially Florida (2002) on the notion of a creative class. These considerations lead to a number of interesting questions: • Who is and who is not using their imagination and ideas in the creation and use of knowledge so as to make choices over the strategic direction of production? • Whose interests are being pursued when those strategic choices are being made, and whose interests are being ignored? To find an answer to these questions, we turn to Dewey (1927) on the interests of publics and thereby deploy a particular criterion for assessing socio-economic relations, behaviours and activities (Sacchetti and Sugden, 2009a).

11.4 Interests, notably public interests For Dewey (1927), an act might have significant consequences both for those directly engaged in it, and for others. The direct participants are said to have private interests in the act, whereas the others have public interests. Dewey (1927) is also clear in acknowledging that an act might bring into existence more than one public, each of which, according to Long (1990: 171), has ‘a shared concern with consequences’ of the act. Referring to this literature – and recognizing that the making of a strategic choice is an act – Branston et al. (2006: 195) identify ‘the public interest in a corporation’s activities in general and in its strategies in particular as the agreed upon, evolving concerns amongst all of those indirectly and significantly affected by those activities and strategies (wherever they live, whatever their nationality)’. For example, the consumers purchasing a corporation’s outputs would form a public, as

236

The Public Interest in Economic Development and Creativity

would (at least the mass of) the corporation’s employees (that is, all of those not actually making its strategic decisions). To illustrate more specifically, consider the economic crisis that broke across much of the world in 2008. Strategic choices in the banking and finance sector in London, New York and other leading centres impacted on interested parties in all sectors and in all corners of the world. Stiglitz (2008) refers to a global crisis and to ‘families whose life dreams are destroyed as they lose their homes, their jobs, and their life savings’. Very few of the people losing their employment had a direct input to the strategic choices being made, but each clearly had an interest. When Bell and Blanchflower (2009) refer to the crisis impacting on youth unemployment and warn of the ‘permanent scars’ (26), they are identifying young people as an interested public.

11.5 Economic development: Reality and prospects Drawing these lines of analysis together, Figure 11.1 depicts reality under currently prevalent processes of economic development, in line with the aforementioned analysis of Hymer (1972). It focuses on the

Mutual dependence

Interests of publics

Governance possibilities

Accommodated interests The reality of economic development – local, regional, national, global

Direction

Private interests

Figure 11.1 Governance of, and interests in, economic development

Silvia Sacchetti and Roger Sugden 237

parallel spectra of interests and governance possibilities that we have been discussing. On the left hand side of the Figure we map governance, ranging from direction to mutual dependence. Parallel to this, on the right hand side we map the accommodation of interests. The idea underlying the parallel spectra is as follows: • One extreme is governance by direction, associated with the pursuit of specific private interests and the exclusion of publics • The other extreme is governance by mutual dependence, associated with an awareness and accommodation of the interests of publics • Between these two extremes are degrees of direction, corresponding with degrees to which specific private interests override the interests of publics (or, viewed from the opposite end of the spectrum, corresponding with degrees to which there is an awareness and accommodation of the interests of publics). As for the current reality of economic development, the sort of concentration of power and unevenness envisaged by Hymer (1972) is in many respects well recognized in the literature (inter alia Dicken, 1992; Cowling and Sugden, 1994; Sugden and Wilson, 2002 on economic development; Sugden and Wilson, 2005 on globalization). For example, Henderson et al. (2001) review analysis of uneven development across and within countries. For them, ‘the most striking fact about the economic geography of the world is the uneven distribution of activity’ (81), reflected in 54 per cent of world’s GDP being produced by countries occupying 10 per cent of the land mass. Similarly Coe and Yeung (2001), assert that uneven development is ‘the single most visible structural outcome of globalization processes’ (370). Moreover, they relate development variations across territories to the ‘uneven power relations underlying most global production chains such that some segments of these chains have disproportionately greater power and control over other segments’ (371). This recognition of concentrated power applies not only to the power associated with particular localities, regions and nations, but also to that of particular firms. Consider for example Fold (2001), highlighting the impacts of large producers in the chocolate industry in Europe on cocoa production in West Africa, and linking those with the influences of the structural adjustment programmes stimulated by the World Bank and International Monetary Fund (IMF). More generally, Rothschild (2005: 445) views the large transnational corporations as having ‘become – nationally and internationally – an especially powerful interest group’.

238

The Public Interest in Economic Development and Creativity

In short, on the basis of the theoretical and empirical evidence, we would argue that the world’s economies have been driven by large and powerful firms that essentially follow their own, private interests, with comparatively less regard for the publics upon which they impact. Hence we show the current reality of economic development – local, regional, national and global – in the space towards the extreme lower ends of the governance and interests spectra in Figure 11.1. Furthermore, an implication of this analysis is that most people are constrained in their creativity. In part, the private interests governing economic development processes have, as a corollary, excluded interests that comprise a mass of people who are not directly or significantly involved in creating and using knowledge so as to make choices over the strategic direction of production. These excluded people are simply denied what Schumpeter (1912: 93) refers to as ‘the joy of creating, of getting things done, or simply of exercising one’s energy and ingenuity’. We would also assert that even among those not denied, most are constrained so that the fruits of their creativity can be harvested for the narrow, private gain of those governing production. In terms of organizational design, the departure from hierarchy (and the values associated with it, that is, the exclusive use of creative abilities) requires an increase in the complexity of the rules governing the organization. Such change would be framed by the development of new ‘habits of thought’ and routines, which are themselves an expression of creativity. Several factors, however, may hinder change, for example, power imbalances (Cowling and Sugden 1998a), lock-in effects and path dependence from previous choices (David 1985), risk, lack of alternative institutional frameworks, resistance against change (Hirschman 1970), loss of critical abilities in people, acceptance of the status quo (Sacchetti, Sacchetti and Sugden 2009). Yet, if following early institutionalists, critical inquiry and curiosity are at the roots of change, creativity maintains a paramount position. This is consistent with the Veblenian inclination of people to exert their inquisitiveness and curiosity, the critical and the creative proceeding in one piece, ‘placed as they are between openness and decisiveness’ (Christensen, 2009: 725; Veblen 1998/1898). The case for a diffused, rather than concentrated, use of creativity is essentially related to people being able to shape production consistently with multiple, emerging values and needs. Fundamentally, this requires that at an upper level, there exists a variety of governance structures which are the expression of different sets of values (See Ianes and Tortia, 2009). Recalling a Veblenian argument, a multiplicity of institutional solutions is necessary if production governance is conceived in evolutionary terms.

Silvia Sacchetti and Roger Sugden 239

Again, this is an argument for focusing on creativity, as the spark which conveys variety and change within and across localities.

11.6 Concluding remarks Viewed from another perspective, we have identified a critical challenge for societies, communities and territories: the possibility of evolving a model of economic development that better serves the interests of publics. Quite how this might be achieved, if in fact it could be achieved, would require further analysis and considerable thought. For example, we would need to explore precisely what is meant by ‘public’. We would need to understand how publics might identify both themselves and their interests; analysing what acting in public interests entails, Dewey (1927: 327) reasons that ‘the prime difficulty’ is discovery of ‘the means by which a scattered, mobile and manifold public may so recognize itself as to define and express its interests’. Especially important is that we would need to think about the importance of values in socio-economic activity (on which see Sacchetti and Sugden, 2009a). Do people look to impose one on another? Do they focus on personal consumption for personal gratification? Do they value mutual respect, sharing, critical awareness, some notion of socioeconomic democracy? Another concern would be consideration of varied types of enterprise, and indeed socio-economic systems comprising different mixes of enterprise types. Using Hymer’s analysis, this chapter has offered criticism of a stylized form of large corporation, but that is not to argue that large corporations or large firms more generally do not have a place in a socio-economic system serving the interests of publics. It might be that we need to consider systems in which there are both large and small firms, as well as firms that seek profit and those that are non-profit. Perhaps we need to give particularly close thought to the role of so-called social enterprises and the third sector.

Note 1. This perspective is explored and explained in detail in Sacchetti and Sugden (2009b).

References Bell, D. N. F. and D. G. Blanchflower (2009) What Should be Done about Rising Unemployment in the UK? mimeo (University of Stirling).

240

The Public Interest in Economic Development and Creativity

Branston, J. R., K. Cowling and R. Sugden (2006) ‘Corporate Governance and the Public Interest’, International Review of Applied Economics, 20(2): 189–212. Caves, R. E. (2000) Creative Industries, Contracts between Art and Commerce (Cambridge, MA: Harvard University Press). Christensen, J. (2009) ‘Reframing Economic Development: Thing or Mystery?’ International Review of Applied Economics, 23(6): 723–41. Coe, N. M. and H. W. Yeung (2001) ‘Geographical Perspectives on Mapping Globalisation’, Journal of Economic Geography, 1: 367–80. Cooke, P. and L. Lazzeretti (2008) Creative Cities, Cultural Clusters and Local Economic Development (Cheltenham: Edward Elgar). Cowling, K. and R. Sugden (1994) Beyond Capitalism: Towards a New World Economic Order (London: Pinter). Cowling, K. and R. Sugden (1998) ‘The Essence of the Modern Corporation: Markets, Strategic Decision-Making and the Theory of the Firm’, The Manchester School, 66(1): 59–86. David, P. A. (1985) ‘Clio and the Economics of QWERTY’, The American Economic Review, 75(2): 332–7. Dewey, J. (1927) The Public and its Problems. Page numbers refer to the reproduction in J. A. Boydston (1988) John Dewey: The Later Works Volume 2: 1925–1927 (Carbondale and Edwardsville: Southern Illinois University Press). Dicken, P. (1992) Global Shift: The Internationalization of Economic Activity (London: Paul Chapman). Florida, R. (2002) The Rise of the Creative Class (New York: Basic Books). Fold, N. (2001) ‘Restructuring of the European Chocolate Industry and its Impact on Cocoa Production in West Africa’, Journal of Economic Geography, 1: 405–20. Henderson, J. V., Z. Shalizi and A. J. Venables (2001) ‘Geography and Development’, Journal of Economic Geography, 1: 81–105. Hirschman, A. O. (1970) Exit, Voice, and Loyalty (Cambridge, MA: Harvard University Press). Hymer, S. H. (1972) ‘The Multinational Corporation and the Law of Uneven Development’ in J. N. Bhagwati (ed.) Economics and World Order: From the 1970s to the 1990s (London: Macmillan). Page numbers refer to the reproduction in H. Radice (ed.) (1975) International Firms and Modern Imperialism (London: Penguin). Ianes, A. and E. Tortia (2009) ‘Creativity and Institution Building: The Case of Italian Social Cooperatives’ in S. Sacchetti and R. Sugden (eds) Knowledge in the Development of Economies: Institutional Choices Under Globalisation (Cheltenham: Elgar). Long, N. E. (1990) ‘Conceptual Notes on the Public Interest for Public Administration and Policy Analysts’, Administration and Society, 22: 170–81. Penrose, E. T. (1959) The Theory of the Growth of the Firm (Oxford: Blackwell). Prahalad, C. K. and G. Hamel (1990) ‘The Core Competence of the Corporation’, Harvard Business Review, 68(May–June): 79–91. Richardson, G. B. (1972) ‘The Organization of Industry’, The Economic Journal, 82: 883–96. Rothschild, K. W. (2005) ‘New Worlds – New Approaches: A Note on Future Research Strategies’, Kyklos, 58(3): 439–47. Sacchetti, F., S. Sacchetti and R. Sugden (2009) ‘Creativity and Socio-Economic Development: Space for the Interests of Publics’, International Review of Applied Economics, 23(6): 653–72.

Silvia Sacchetti and Roger Sugden 241 Sacchetti, S. and R. Sugden (2003) ‘The Governance of Networks and Economic Power: The Nature and Impact of Subcontracting Relationships’, Journal of Economic Surveys, 17: 669–91. Sacchetti, S. and R. Sugden (2009a) ‘The Organization of Production and Its Publics: Mental Proximity, Markets and Hierarchies’, Review of Social Economy, 67(3): 289–311. Sacchetti, S. and R. Sugden (2009b) Knowledge Governance and Creativity in the Organisation of Production: What is in the Interests of Publics? mimeo, (University of Stirling). Schumpeter, J. A. (1912) Fundamentals of Economic Development (Cambridge, MA: Harvard University Press). Stiglitz J. E. (2008) ‘Global Crisis – Made in America’, Spiegel Online International, http://www.spiegel.de/international/business/0,1518,590028,00.html, date accessed 14 December 2008. Sugden, R. and J. R. Wilson (2002) ‘Economic Development in the Shadow of the Consensus: A Strategic Decision-Making Approach’, Contributions to Political Economy, 21: 111–34. Sugden, R. and J. R. Wilson (2005) ‘Economic Globalisation: Dialectics, Conceptualisation and Choice’, Contributions to Political Economy, 24: 1–20. Teece D. J. and G. Pisano (1994) ‘The Dynamic Capabilities of Firms: An Introduction’, Industrial and Corporate Change, 3(3): 537–56. Veblen, T. (1998) [1898] ‘Why is Economics not an Evolutionary Science?’ Quarterly Journal of Economics, July, 373–97. Reprinted in Cambridge Journal of Economics 22: 403–14.

12 Global Sourcing and Business and Social Networks: Quality Heterogeneity and Firms’ Efficiency Giuseppe Vittucci Marzetti, Maria Luigia Segnana and Chiara Tomasi

12.1 Introduction1 A distinct feature of globalization is the pivotal role played by the internationalization of production processes (Feenstra and Hanson, 1996; Hummels et al., 2001). A growing empirical literature provides evidence on the effects of global sourcing on firms’ efficiency via specialization, learning, variety and quality upgrading mechanisms. Following this literature, the chapter develops a model to analyse the costs and efficiency gains entailed by firms’ global sourcing strategies in the case of suppliers’ heterogeneity. Indeed, one of the mechanisms through which global sourcing may actually affect firms’ productivity is the quality upgrading of intermediate inputs. However, given the quality heterogeneity of suppliers, outsourcing firms incur some screening costs, that is, fixed costs related to the need of acquiring the relevant information on the different suppliers and testing their products, in search of the best one. The larger the quality range of suppliers, the higher these screening costs. By expanding suppliers’ heterogeneity, the internationalization of production processes may actually boost firms’ screening costs. In this way, the efficiency enhancing effects of global sourcing via quality upgrading can be reduced by the increase of screening efforts. Within this setting, we show that the increasing size of the market for the outsourcing firms is efficiency-enhancing for two reasons: the economies of scale arising from the fixed costs of searching for a partner and the increasing average quality of the chosen supplier. Moreover, as recently emphasized by the literature (Rauch, 2001; Rauch and Casella, 2001), Business and Social Networks (BSN) can make 242

Vittucci Marzetti, Segnana and Tomasi 243

it easier to collect information, thus being another source of efficiency gains. We indeed confirm that, assuming quality heterogeneity of suppliers and screening costs, such networks can make firms’ production and profitability increase via the reduction in the unit screening cost. In addition, we show that there are cumulative beneficial effects at work in case of BSN. This suggests that a well established network is itself an incentive for firms to invest in its further development. The chapter is organized as follows. The first section briefly summarizes the main theoretical and empirical background. We then set up the theoretical model and discuss the main results. We follow with a section that sketches a possible extension of the model to deal with the problem of location of external sourcing: local vs. foreign. The final section concludes.

12.2 Theoretical and empirical background The increased resort of firms to global sourcing strategies and the internationalization of production processes in the last two decades has spurred a growing number of studies – empirical (Feenstra and Hanson, 1996; Hummels et al., 2001) and theoretical (Grossman and Helpman, 2005; Antràs and Helpman, 2004) – aimed at assessing the actual extent of the phenomenon, together with its main determinants and effects. Empirical studies have been hampered so far by a lack of systematic statistics, a lack partly due to the absence of shared definitions.2 Economists have adopted different approaches and used several different data: trade statistics in intermediate inputs and in parts and components (Feenstra and Hanson, 1996; Hummels et al., 2001; Yeats, 1998); intraindustry trade measures (Jones and Kierzkowski, 2001); data referring to specific kinds of trade in intermediates, such as the US offshore assembly program (OAP) (Feenstra et al., 1999; Yeats, 1998) or the EU outward processing traffic (Baldone et al., 2001). These imperfect and different measures notwithstanding, the studies provide strong evidence of a sustained growth of global sourcing in several industries, such as textiles and footwear; apparel; machinery and electrical equipment; transportation equipment; and chemicals. As for the effects of such practices, economists have analysed mainly their impact on domestic labour markets and firms’ productivity and efficiency. In particular, the effects of global sourcing on relative wages are determined by the possible downward pressure exerted by foreign sourcing on the wages of unskilled workers in skilled labour-abundant countries, because of the reallocation of the unskilled labour-intensive phases of

244

Global Sourcing and Business and Social Networks

production processes in unskilled labour-abundant countries (Feenstra and Hanson, 1996; Grossman and Rossi-Hansberg, 2008). Other studies have instead dealt with the effects of global sourcing on firms’ productivity and efficiency. They provide different theoretical arguments for the productivity enhancement effect of global sourcing, namely: increased specialization, learning, innovation, increased variety and quality upgrading. By relocating outside the inefficient parts of the production process, firms may indeed specialize in the phases where they have a comparative advantage. The change in the workforce composition determines an increase in the average productivity of the remaining workers (Amiti and Wei, 2006). Gains may also arise from learning effects related with the foreign technology embodied in the imported intermediate inputs (Acharya and Keller, 2007; Eaton and Kortum, 2001). In addition, outsourcing firms might benefit from accelerating the pace of innovative products and services. According to Glass and Saggi (2001), by lowering the marginal cost of production, global sourcing enhances the incentives for innovation. Researchers have also considered the possible positive effects due to the increased variety of available intermediates, which allows better matching between needed inputs and available ones (Kasahara and Rodrigue, 2005). Finally, imported inputs can increase productivity via quality upgrading: global sourcing may in fact allow firms to purchase higher quality inputs abroad (Grossman and Helpman, 1991; Markusen, 1989).3 One of the channels through which global sourcing can actually enhance productivity is thus quality upgrading. This argument however entails an assumption of heterogeneity among suppliers, which has been recently introduced in economic modelling in the so-called new new trade theory of international trade (Melitz, 2003; Baldwin and Robert-Nicoud, 2008). The rapid expansion of global sourcing and the enlargement of the market for intermediates has determined a raise in the number of suppliers and a high heterogeneity in the quality of this supply. Because of such quality heterogeneity, a firm outsourcing a phase of the production process or a service incurs some screening costs. Indeed, even if firms can estimate the quality of the supplied inputs, they face some costs related to the needs for: searching for the supplier (Grossman and Helpman, 2002, 2005); collecting all the relevant information on it; testing its products.4 The larger the quality range of intermediates, the higher these screening costs. By expanding quality heterogeneity, global sourcing may thus boost firms’ screening costs. But unit screening costs are negatively affected by the density and efficiency of Business and Social Networks (BSN) operating across

Vittucci Marzetti, Segnana and Tomasi 245

national borders. Such networks have recently come to the forefront of economic analysis as a means to overcome informal trade barriers (Rauch, 2001; Rauch and Casella, 2001; Rauch and Trindade, 2003). They convey information to distinguish suppliers and thus can reduce unit screening costs. In what follows, we build up a simple model to analyse the interplay between these three factors: the enhancing of the potential quality; the boost of the screening costs entailed by the increased heterogeneity of the quality of suppliers; and the role of BSN in reducing such costs.

12.3 The model Let us consider a monopolistic firm h producing a final good and outsourcing the production of the needed intermediate input. For the sake of simplicity, let us assume further that there is no other cost involved in the production of the final good but the cost of the intermediate, and that both the internal cost of its production and the cost of local sourcing for h are always greater than the cost of foreign sourcing. Assume a unit measure of foreign suppliers m producing the intermediate, uniformly distributed according to the quality of the latter and indexed in descending order according to such quality. Let us suppose that there is a one-to-one relation between this quality and the probability that the intermediate will eventually break down when employed in the production of the final good. Let us denote this breakdown probability with . Apart from this, all the supplied intermediates are homogeneous and their cif cost is the same (c). The quality and the related breakdown probability are not freely observable. In particular, at the beginning of the production period, the firm h bears screening costs, s. Such costs are related to the need to search for a good partner and to test its supplied intermediate. We assume that these costs are directly proportional to the number of the considered potential partners, n (n  1): S  n

(1)

where  is the unit cost of screening, which includes the costs entailed in the search for the supplier and the test of its product, encompassing also the costs for collecting all the relevant information on it. After n screenings, the firm outsources the production of the intermediate to the supplier with the best quality among those actually con– ). Given that the firm cannot freely obtain information on the tacted (m

246

Global Sourcing and Business and Social Networks

suppliers and because of the assumption on the distribution of suppliers, each screened supplier can be considered by h a random draw from a uniform distribution of µ ranging from 0 to 1. Thus, after n screenings, – is characterized by the probability that the intermediate provided by m – breakdown probability  is equal to: g ( μ ) = nF ′( μ )(1 − F ( μ ))n−1 = n(1 − μ )n−1

(2)

where F() is the cumulative distribution function of . Expected profits of firm h are given by: E(p(q)q  C)  p(q)q  E(C)

(3)

where p is the price of the final good produced by h, q is the quantity sold of the final good and C denotes firm’s total costs, whose expected value is: E(C ) = s + E( c )q = s + E( E( c | μ ))q

(4)

In Equation (4), s denotes h’s screening costs and c its marginal cost. The latter is simply equal to the cost of the intermediate, given the simplifying assumption that h incurs no production cost.5 Assuming that, in case of breakdown, the firm has to reacquire the – is: input, the expected value of the variable unit costs conditional on  E( c | μ ) = (1 − μ )c + (1 − μ )μ 2c + (1 − μ )μ 2 3c + ... = ∞

∞

∞

i=0

i=0

i=0

= c(1 − μ )∑ μ i (1 + i ) = c(1 − μ )( ∑ μ i + ∑ μ ii ) = ⎛ 1 μ ⎞⎟ μ ⎟⎟ = c = c= = c(1 − μ ) ⎜⎜⎜ + 1− μ ⎝1 − μ 1 − μ 2 ⎟⎠ =

c 1− μ

(5)

Hence, their unconditional expected value is: 1 c c )= ∫ g ( μ )d μ = 0 1− μ 1− μ 1 n = cn ∫ (1 − μ )n−2 d μ = c 0 n −1

E( c | μ ) = E(

(6)

Vittucci Marzetti, Segnana and Tomasi 247

whereas the average quality of the chosen supplier is: 1

1

E( μ ) = ∫ μ g ( μ )d μ = ∫ μ n(1 − μ )n−1 d μ = 0

0

1 n +1

(7)

Assuming that h maximizes its expected profits by freely setting q and n,6 its profit function is: π = max p (q )q − q ,n

n cq − αn n −1

(8)

If we assume further that h faces an isoelastic demand function:7 q(p)  Ap

(9)

with  1, from the first order conditions of the maximization problem (8) it follows: ⎛ e -1⎞⎟e ⎛ n - 1⎞⎟e 1 ⎜ q = A ⎜⎜ ⎜⎝ e ⎟⎟⎠ ⎜⎜⎝ n ⎟⎟⎠ c e

n = 1+

cq α

(10)

(11)

and therefore: e

n e ( n - 1)2- e =

A ⎛⎜ e - 1⎞⎟ 1 ⎟ ⎜ α ⎜⎝ e ⎟⎠ c e -1

(12)

Although the objective function is not concave, it is quasiconcave in – ) is a singleton (see the relevant subset and the set of maximizers (q–, n Appendix). We can therefore analyse the effects of parameter changes on the screening efforts of the firm, its profits and the average quality of the chosen supplier. In particular, we consider two parameters: the market size of h (A) and the unit cost of screening (), which is negatively related to the density and efficiency of BSN. Let us note first that, given the presence of fixed costs directly proportional to the number of screened suppliers and the decreasing effect of

248

Global Sourcing and Business and Social Networks

an increase in the screening efforts of the firm on the reduction of the expected marginal cost, the supplier actually chosen will produce on average a product whose quality is not maximal. Equation (7) implies this average quality is positively related to the optimal number of – ), which is in turn related to A and . screened suppliers (n As for A, from Equation (12) it follows that, the higher the demand faced by h, the greater the optimal number of screened suppliers, and hence the quality of the intermediate. Moreover, the marginal effect of an increase of the market size on firm’s profits by the envelope theorem is: ∂π 1 ⎛⎜ q ⎞⎟ = ⎜ ⎟ ∂A e ⎜⎝ ⎟⎠

e -1 e

e -1 e -1 1 ⎛ e - 1⎞⎟ ⎛⎜ n - 1⎞⎟ 1 = ⎜⎜ ⎟ ⎟ ⎜ ⎟ ⎟ e ⎜⎝ e ⎠ ⎜⎝ n ⎠ c e -1

(13)

which turns out to be positively related to n–. Therefore, given that a big–, the positive effect of marginal increases of A on ger A entails a greater n firm’s profits becomes larger the larger the initial level of A. Hence, in presence of quality heterogeneity of suppliers and screening costs, the differential efficiency gains from market expansions tend to increase with the initial level. This leads to our first result:8 Proposition 1 Big firms can better exploit the potential gains from quality upgrading and have an advantage in the international arena. Let us consider now the effects of changes in the unit cost of screening (). From Equation (12) it follows that a decrease of  makes q–, n– and the quality of the chosen suppliers all increase. Thus, our model predicts that ‘thicker’ transnational networks, via the increase in the effectiveness of the screening efforts, can entail an increase of a firm’s efficiency, which comes from the increase in the average quality of the intermediate, and an expansion of production. Proposition 2 Denser and more efficient transnational BSN improve firms’ efficiency and make production increase. Moreover, given that the effect of a marginal increase of  on a firm’s profits is simply equal to: ∂π = −n ∂A

(14)

Vittucci Marzetti, Segnana and Tomasi 249

this effect interacts with the previous one creating cumulative incentives for firms to invest in the development of transnational BSN. In particular, given that, the more the initial thickness of the network, the greater the optimal number of screened suppliers, then the higher the cost saving the firm would obtain by reducing further  and thus its incentive to invest in the network. Proposition 3 Developed transnational BSN are themselves incentive for firms to invest in their further development. Hence, our model predicts that transnational BSN increase the overall production and firms’ profitability. Moreover, it shows that a developed transnational network constitutes in itself an incentive for firms to invest in its further development.9

12.4 A possible extension: Foreign vs. local sourcing The benchmark model can be easily modified to analyse the mutually exclusive strategies of external sourcing: local vs. foreign, by considering the differences between local and foreign suppliers and investigating how these differences, in terms of costs, heterogeneity and degree of embeddedness in networks, can affect final strategies of firms and their efficiency. Such extension allows us to focus upon the linkages between the characteristics of local systems and firms’ sourcing strategies. In particular, by assuming that local business networks are more developed than transnational ones and that the heterogeneity of local suppliers is less pronounced, we can investigate the firms’ choice between local and global sourcing and how they interact with the previous factors determining the firms’ overall efficiency. In so doing, let us suppose that, along with the foreign providers (m*), there is a supply of local providers (m) that firm h can alternatively resort to for the provision of the intermediate. The unit cost of screening of local suppliers for firm h () are smaller than the corresponding costs in the case of foreign suppliers (  *). This is the result of, on the one hand, the geographical and cultural proximity between h and its local suppliers; on the other, the existence of local BSN usually more developed than transnational ones.10 Moreover, because local providers are more spatially and technologically concentrated, we assume that they are less heterogeneous in terms of quality than the suppliers on international markets. In particular, we

250

Global Sourcing and Business and Social Networks

suppose that, like foreign suppliers, there is continuum of local suppliers producing the intermediate suitable for h, which are uniformly distributed according to its breakdown probability , but, unlike foreign suppliers, in case of local providers the latter ranges from tm to tM, where 0 tm tM 1. Finally, we assume that local providers sell the intermediate at a price (c), not smaller than the c.i.f. price of intermediate on international markets: c c *. Firm h can do either local or foreign sourcing. In particular, h will decide to do foreign sourcing if and only if: π * ( A, α * , c * ) > π( A, α , c , t m , t M )

(15)

where  * and  are the expected profits in case of, respectively, foreign and local sourcing. The interplay between the differences in the previous features of local and foreign providers, also in terms of the different BSN they are embedded in, determines the location of the supplier chosen by firm h. Such differences can impact in opposite directions on the relative profitability of local vs. foreign sourcing strategies. For instance, the higher unit costs for screening foreign suppliers rather than local ones makes ceteris paribus local sourcing more profitable. And the same happens because of the ceiling threshold in the distribution of local suppliers in terms of breakdown probability of the intermediate (tM). On the contrary, the higher cost of the intermediate supplied locally (c) and the floor threshold (tm) both make foreign sourcing a more efficient strategy. Thus, we can assume that there exists a firm h to which the two strategies give on average the same profit and we can thus analyse the impact of changes in the parameters on these expected profits.

12.5 Conclusions The chapter analyses the effects of global sourcing on the efficiency of final firms via quality upgrading of intermediates, entailed by the increased availability of suppliers, also taking into account the role of Business and Social Networks (BSN) in facilitating supplier-user relations and improving information diffusion. Indeed, when new sourcing opportunities arise, the increased quality range of suppliers may allow firms to acquire higher quality inputs, but it also increases the extent of screening efforts. Global sourcing is thus

Vittucci Marzetti, Segnana and Tomasi 251

a potential efficiency enhancing strategy for firms, but the potential gains may be partly offset by the boost of screening costs produced by the increased heterogeneity of suppliers. Within this setting, we show that big firms have an advantage in the international arena since they can exploit better the potential gains of the increased availability of suppliers. Moreover, BSN have cumulative beneficial effects in reducing these costs: thicker networks imply higher cost saving and thus further incentives to invest in network linkages, making them thicker and thicker. In a sketched extension of the model, we frame the problem of external sourcing at a local vs. foreign level as a problem of supplier-user matching, by considering the differences between local and foreign suppliers in terms of costs, heterogeneity and degree of embeddedness in networks. Because of the potentially greater heterogeneity of foreign suppliers, transnational BSN are usually more effective in enhancing firms’ efficiency than local BSN, but thicker local BSN can help reduce the probability of firms to source globally and therefore reduce the ‘negative’ impact of globalization on local production systems.

Appendix The Hessian of the objective function of (8) is: ⎞⎟ ⎛ c ⎜⎜2 p ′( q ) + p ′′( q )q ⎟ ⎜ ( n − 1)2 ⎟⎟⎟ ⎜ ⎜ ⎟ H=⎜ ⎜⎜ 2cq ⎟⎟⎟ c ⎟ − ⎜ ⎜⎝ ( n − 1)2 ( n − 1)3 ⎠⎟⎟ ⎞⎟ ⎛ e - 1 1/ e −( e +1)/ e c ⎜⎜− A q ⎟ ⎜⎜ e2 ( n − 1)2 ⎟⎟⎟ ⎟ = ⎜⎜ ⎜⎜ c 2cq ⎟⎟⎟ ⎟ − ⎜ ( n − 1)2 ( n − 1)3 ⎟⎟⎠ ⎝⎜

(16)

Given that the upper left element of H is negative, if its determinant is positive the matrix is negative definite. The condition is therefore: 1

2c( e1) ⎛⎜ A ⎞⎟e c2 >0 | H(q , n ) = 2 ⎜⎜ ⎟⎟ − 3 ( n − 1)4 e ( n1) ⎜⎝ q ⎟⎠ – ) becomes: This condition valued at (q–, n

252

Global Sourcing and Business and Social Networks 1

e − 1 n − 1 ⎛⎜ A ⎞⎟e e ⎜ ⎟⎟ > c ⎜⎝⎜ q ⎠⎟ 2 e e −1 n −1 e p> e c 2 Given that: p=

e n c e −1 n −1

it follows that the condition for a critical point (q–, n– ) to be a local maximum is: 2n >e

(17)

Let us denote the left hand side of Equation (12) with r(n). Taking the logarithm of this function and differentiating it with respect to n we obtain: d log r ( n ) d 2n − e = ( e log n + (2 − e ) log( n − 1)) = dn dn n( n − 1)

(18)

which is stricly positive provided that condition (17) is satisfied. The limits of r(n) are: e ⎛ n ⎞⎟ lim r ( n ) = ⎜⎜ lim ⎟⎟ lim ( n − 1)2 = lim ( n − 1)2 = +∞ ⎜ n→+∞ n→+∞ ⎝n→+∞ n − 1⎠ n→+∞

if e ≤ 2 ⎪⎧0 lim r ( n ) = ⎪⎨ ⎪⎪⎩+∞ if e > 2

n→1+

Hence, we can have two cases. If 1    2, then r(n) is a strictly increasing monotonic function approaching 0 when n tends to its inferior limit. Thus, there is one and only one possible value of n (with the associated value of q) for which Equation (11) is satisfied and such value also satisfies condition (16). On the contrary, if  2, then r(n) is a convex function reaching its minimum at n  /2. Within reasonable values of

Vittucci Marzetti, Segnana and Tomasi 253

ne (n−1)2−e

A a

( ( e−1 e

e

1 c e−1

n Figure 12.1 Critical points of n when  2

the parameters, the situation will be the one depicted in Figure 12.1. Hence, in this case there are two critical points, but the only one that satisfies condition (16) is the largest one.11

Notes 1. We would like to thank, for their useful suggestions, Andrea Fracasso and the participants of the International Conference on ‘Apparent Antithesis: Globalization and Local Development’ (Trento, 9–11 October 2008) organized by the School on Local Development (University of Trento) in collaboration with the OECD LEED Programme and UNDP. Giuseppe Vittucci Marzetti also gratefully acknowledges support for this research from the PAT (Provincia Autonoma di Trento, post-doc scholarship 2006). The usual disclaimers apply. 2. Despite the diffuse perception of its huge increase, there is no common definition of global sourcing (Feenstra, 1998). Indeed, the term global (or international) sourcing has been used: as a synonym of delocalization (or offshoring) (for example, Hummels et al., 1998; Glass, 2004), it being due to external sourcing from abroad – where the production stage crosses both the country’s and the firm’s boundary – or vertical FDI – where instead the phase crosses the national boundary but not the firm’s one; to refer broadly to the international trade in intermediate inputs (for example, Feenstra and Hanson, 1999); for international partnerships, thus assuming a minimum level of durability in the supplier-user relation (for example, Van Long, 2005); or only in the case of external service provision (Bhagwati et al., 2004). In what follows, we use the

254

3.

4.

5. 6. 7.

Global Sourcing and Business and Social Networks expression global sourcing in a broad sense, thus including all subcontracting relationships between firms and their suppliers at an international level. Not many studies have empirically tested the impact of global sourcing on productivity. Among the few, some employ industry level data to investigate its productivity effects on manufacturing and service sectors (Amiti and Wei, 2006; ten Raa and Wolff, 2001; Fixler and Siegel, 1999). In particular, by using data on all US manufacturing industries over the 1990s, Amiti and Wei (2006) find that service and material foreign sourcing is positively correlated with labour productivity; and similar results are reached by Görg et al. (2004) at a micro level. The perspective here adopted is slightly different with respect to Bartel et al. (2005, 2008), where the fixed costs entailed by outsourcing practices are related to the adjustments to be implemented in the in-house production and the outsourced phase, because of the less than perfect matching between the internal production process and the external inputs produced by misunderstandings, frictions, delivery lags or quality differences. Removing this assumption does not alter any of the results of the model. For simplicity, we neglect the integer ‘problem’ and treat the discrete number of screened suppliers (n) as a continuous variable. This demand function can be seen as the result of a maximizing representative consumer with a CES utility function as: I

U = ∫ β(i )q(i ) 0

e−1 e di

and whose walrasian demand function for good j is therefore:

q( j ) =

q( j ) =

W I

∫0

β (i )e

p(i )1−e di

W I

∫0

β (i )e

p(i )1−e di

p( j )−e

p( j )−e

where W denotes the wealth of such consumer. With N consumers in the market the aggregate demand function faced by h is thus Equation 9, where A is given by:

A=

WN I

∫0 β(i )e p(i )1−e di

8. It is instructive to consider what happens instead in the more standard case of a monopolistic firm incurring costant marginal costs (c) and facing an isoelastic demand curve like (8). In this case, although the effect of a marginal increase of the market size on firm’s profits is clearly still positive:

Vittucci Marzetti, Segnana and Tomasi 255

∂π 1 ⎛⎜ q ⎞⎟ = ⎜ ⎟ ∂A e ⎜⎝ A ⎟⎠

e−1 e

=

1 −1−e >0 p e

it remains costant across different initial market sizes: 1−c e−1 ∂π 1 ⎛⎜ e ⎞⎟ 1 ⎛ e − 1⎞⎟ 1 = ⎜ c ⎟⎟ = ⎜⎜ ⎟ e ⎜⎝ e ⎟⎠ c e−1 ∂A e ⎜⎝ e − 1 ⎠

9. The previous effects could be dimmed by pronounced decreasing returns to scale in the investments made for network developments. They are instead emphasized assuming seemingly increasing returns of such investments. 10. This greater development of local networks compared to transnational ones can be itself the result of the above proximity. Notwithstanding, it should be properly retained as an independent factor that contributes towards reducing the unit costs of screening in case of local suppliers. 11. Quasiconcavity in the relevant subset can be proved by looking at the bordered Hessian.

References Acharya, R. and W. Keller (2007) ‘Technology Transfer through Imports’, Working Paper 13086, NBER. Amiti, M. and S. J. Wei (2006) ‘Service Offshoring and Productivity: Evidence from the United States’, Working Paper 11926, International Monetary Fund. Antràs, P. and E. Helpman (2004) ‘Global Sourcing’, Journal of Political Economy 112(3): 552–80. Baldone, S., F. Sdogati, and L. Tajoli (2001) ‘Patterns and Determinants of International Fragmentation of Production. Evidence from Outward Processing Trade between the EU and the Countries of Central-Eastern Europe’, Weltwirtshaftliches Archiv, 80–104. Baldwin, R. E. and F. Robert-Nicoud (2008) ‘Trade and Growth with Heterogeneous Firms’, Journal of International Economics 74 (1): 21–34. Bartel, A., S. Lach, and N. Sicherman (2005) ‘Outsourcing and Technological Change’, Working Paper 11158, National Bureau of Economic Research. Bartel, A., S. Lach, and N. Sicherman (2008) ‘Outsourcing and Technological Innovations: A Firm-Level Analysis’, Discussion Paper 3334, IZA. Bhagwati, J., A. Panagariya, and T. N. Srinivasan (2004) ‘The Muddles over Outsourcing’, Journal of Economic Perspectives 1 (4): 93–114. Eaton, J. and S. Kortum (2001) ‘Trade in Capital Goods’, European Economic Review 45, 1195–235. Feenstra, R. C. (1998) ‘Integration of Trade and Disintegration of Production in the Global Economy’, Journal of Economic Perspective 12(4): 31–50. Feenstra, R. C., G. Hanson, and D. L. Swenson (1999) ‘Offshore Assembly from the United States: Production Characteristics of the 9802 Program’, Working Paper 98-10, UC Davis. Feenstra, R. C. and G. H. Hanson (1996) ‘Foreign Investment, Outsourcing and Relative Wages’ in R. C. Feenstra, G. M. Grossman, and D. Irwin (eds) The

256

Global Sourcing and Business and Social Networks

Political Economy of Trade Policy: Papers in Honor of Jagdish Bhagwati (MIT Press) pp. 89–127. Feenstra, R. C. and G. H. Hanson (1999) ‘The Impact of Outsourcing and HighTechnology Capital on Wages: Estimates for the United States, 1979–90’, Quarterly Journal of Economics August, 907–40. Fixler, D. J. and D. Siegel (1999) ‘Outsourcing and Productivity Growth in Services’, Structural Change and Economic Dynamics 10: 177–94. Glass, A. J. (2004) ‘Outsourcing under Imperfect Protection of Intellectual Property’, Review of International Economics 12(5): 867–84. Glass, A. J. and K. Saggi (2001) ‘Innovation and Wage Effects of International Outsourcing’, European Economic Review 45: 67–86. Görg, H., A. Hanley, and E. Strobl (2004) ‘Outsourcing, Foreign Ownership, Exporting and Productivity: An Empirical Investigation with Plant Level Data’, Research Paper 2004/08, Globalisation, Productivity and Technology. Grossman, G. and E. Helpman (2005) ‘Outsourcing in a Global Economy’, Review of Economic Studies 72: 135–59. Grossman, G. and E. Rossi-Hansberg (2008) ‘Trading Tasks: A Simple Theory of Offshoring’, American Economic Review 98(5): 1978–97. Grossman, G. M. and E. Helpman (1991) Innovation and Growth in the Global Economy (Cambridge, MA: MIT Press). Grossman, G. M. and E. Helpman (2002) ‘Integration versus Outsourcing in Industry Equilibrium’, The Quarterly Journal of Economics 117(1): 85–120. Hummels, D., J. Ishii, and K. Yi (2001) ‘The Nature and Growth of Vertical Specialization in World Trade’, Journal of International Economics 54(1): 75–96. Hummels, D., D. Rapoport, and K.-M. Yi (1998) ‘Vertical Specialization and the Changing Nature of World Trade’, Federal Reserve Bank of New York Economic Policy Review 4: 79–99. Jones, R. W. and H. Kierzkowski (2001) ‘A Framework for Fragmentation’ in S. W. Arndt and H. Kierzkowski (eds) Fragmentation: New Production Patterns in the World Economy (New York: Oxford University Press) pp. 17–34. Kasahara, H. and J. Rodrigue (2005) ‘Does the Use of Imported Intermediates Increase Productivity?’ Technical Report Working Paper 20057, RBC Financial Group Economic Policy Research Institute. Markusen, J. (1989) ‘Trade in Producer Services and in other Specialized Intermediate Inputs’, American Economic Review 79(1): 85–95. Melitz, M. J. (2003) ‘The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry Productivity’, Econometrica 71(6): 1695–725. Rauch, J. E. (2001) ‘Business and Social Networks in International Trade’, Journal of Economic Literature 39(4): 1177–203. Rauch, J. E. and A. Casella (eds) (2001) Networks and Markets (New York: Russell Sage Foundation). Rauch, J. E. and V. Trindade (2003) ‘Information, International Substitutability, and Globalization’, The American Economic Review 93(3): 775–91. Ten Raa, T. and E. N. Wolff (2001) ‘Outsourcing of Services and the Productivity Recovery in US Manufacturing in the 1980s and 1990s’, Journal of Productivity Analysis 16: 149–65. Van Long, N. (2005) ‘Outsourcing and Technology Spillovers’, International Review of Economics & Finance 14(3): 297–304. Yeats, A. J. (1998) Just How Big is Global Production Sharing? (Washington: World Bank).

13 Does Outsourcing Increase Labour Productivity? Evidence for a Local Production System in Emilia Romagna (Italy) Sandro Montresor, Davide Antonioli, Massimiliano Mazzanti and Paolo Pini 13.1 Introduction Empirical evidence shows that outsourcing of both intermediate inputs and business production services has risen dramatically in the last two decades (Kirkegaard, 2005; Spencer, 2005). This has spurred a substantial interest in the issue, ranging from the economics of the firm, through industrial organization, to international trade. In particular, attention has focused on the analysis of outsourcing determinants, leading to the formulation and empirical test of a number of theories of the so-called ‘vertical scope of the firm’. Standard transaction-cost-economics (TCE) based explanations (Grossman and Helpman, 2002) have thus been both contrasted (Mahnke, 2001) and integrated (Jacobides and Winter, 2005) with capabilities and competences based ones and, more recently, with an entrepreneurship kind of perspective (Zander, 2007). These explanations have found several specifications and integrations when they have been applied to the very special case of international outsourcing, or offshoring. Such phenomena as ‘international fragmentation of production’ (Jones and Kierzkowski, 2001), international trade in intermediate commodities and in services, and MNC networks (Kleinert, 2003) actually add to the picture and make the international analysis of outsourcing more complicated. Quite surprisingly, this large interest in the outsourcing determinants of the firms has not been accompanied by as large an attention on its effects on their economic performances. Indeed, most research on the outsourcing effects has rather focused on the labour market, trying to investigate the potential negative impact of it on such ‘hot issues’ as employment losses, wage and skill biases. The recent OECD Report on 257

258

Does Outsourcing Increase Labour Productivity?

‘Offshoring and Employment: Trends and Impacts’ (OECD, 2007) is just one of the indications of this attention. What is more, very little of the empirical research has been carried out by retaining the firm ‘embeddedness’ in specific local production systems (LPS henceforth), while greater attention has been dedicated to big companies’ externalization strategies. This is quite unfortunate, given that several studies in the field of regional economics have shown that outsourcing is, although with distinguishing features, a competitive strategy also for small and medium-sized enterprises co-located in the territory, within particular socio-economic and institutional setups (Taymaz and Kilicaslan, 2005). It is the purpose of this chapter to contribute to filling this gap. In particular, by providing some evidence on the impact that outsourcing has on the labour productivity of firms ‘embedded’ in a LPS characterized by idiosyncratic techno-economic and organizational features. In so doing, the chapter aims at testing whether this local embeddedness might make the productivity impact of outsourcing dependent on factors, which are not usually considered in the analysis of big companies, such as the specialization pattern of the LPS, its labour division and organization, and its innovative profile. More precisely, a diachronic cross-section econometric model of the productivity impact of outsourcing is applied to a sample of firms based in a LPS of the Italian region of Emilia Romagna (Reggio Emilia province), for which survey-based outsourcing and balance-sheet data have been collected in the period 1998–2005. Its results are quite interesting: the main conclusions drawn by the theoretical and empirical literature in a big-company context end up being mitigated, if not even reversed, in a LPS environment, suggesting new and original strategic implications. The chapter is organized as follows. The first section outlines the issue and briefly presents the ‘ambiguous’ link between outsourcing and firm performance (productivity, in particular) which emerges from the literature. The second section briefly describes the dataset and presents the econometric model. The third section comments on the main empirical results. Some final remarks close the chapter.

13.2 Background literature At the risk of becoming another ‘buzz-word’, outsourcing is nowadays used by different scholars and professionals to denote different phenomena, and is often used interchangeably with similar words such as offshoring, insourcing, and the like. Accordingly, clarifying the meaning we attach to it here is necessary at the outset.

Montresor, Antonioli, Mazzanti and Pini 259

By referring to the OECD conceptual framework (OECD, 2007: 15), with outsourcing we here generally mean ‘the use of goods and services produced outside the enterprise’: no matter if this is also outside the national boundaries of the firm or not, providing it is outside the firm’s boundaries. In other words, our outsourcing encompasses both domestic and international outsourcing. Of course, we are aware of the fact that the two phenomena overlap only partially in terms of determinants and implications. However, also for the sake of consistency with the empirical application we will carry out – whose dataset reports the two indistinguishably – in the following we will refer to their ‘least common multiple’ and differentiate their analysis whenever it will be necessary and possible. The theoretical literature on outsourcing at the firm level is really massive, and mainly concentrates on the outsourcing determinants (Mazzanti et al., 2007b). Quite surprisingly, the relative contributions rarely encompass among these determinants, at least directly, a prospective increase in the performance of the outsourcing firms, either in terms of productivity or profitability. Indeed, firms are usually recommended to shift from ‘make’ to ‘buy’ in order to save on their internal administration costs (Grossman and Helpman, 2002), providing the relative ownership re-allocation does not threaten asset specific investments (Grossman and Hart, 1986) or the ensued agency relationship does not pose asymmetric-information problems (Aghion and Tirole, 1997). Recently, outsourcing has also been envisaged as a tool for firms to specialize on their core competences, escape ‘learning-traps’, tap into the providers’ knowledge (Mahnke, 2001; Jacobides and Winter, 2005), if not discover and implement new entrepreneurial opportunities (Hsieh et al., 2007), especially in terms of innovation (Mazzanti et al., 2007a). In all these contributions, a positive impact on the outsourcing firm’s performance is envisaged only indirectly, if not just implicitly, although to a variable extent depending on the specific approach. However, if one wants to find a more explicit theoretical account of the firm performance impact of outsourcing, one has to integrate the literature at the firm level with that at a more aggregate level, mainly sectoral and intersectoral, and, what is more, support purely theoretical predictions with empirical ex-post rationalizations (Olsen, 2006). Although a generalization of the theoretical results is hard to draw, it seems to us that the ‘dominant’ view is a positive one. Theoretically, firms should be expected to gain from outsourcing, both in terms of productivity (labour and total) and profitability, both in the short and in the long run.

260

Does Outsourcing Increase Labour Productivity?

Starting with productivity gains, in the short run they should accrue mainly in the form of labour productivity increases: either because external inputs become available at lower costs – exploiting economies of scale of national external suppliers (Grossman and Helpman, 2005) or cost differentials in international labour markets (Kohler, 2004; Kim, 2003) – or because specialist suppliers provide inputs of higher quality (Markusen, 1989; Heshmati, 2003) and larger variety (Kasahara and Rodrigue, 2005). In the long run, further increases in labour productivity could be due to changes in factor shares, namely to the externalization of less skill-intensive tasks and to the reallocation of labour toward more skill-intensive ones (Feenstra and Hanson, 1999). More generally, firms can change their specialization patterns and exploit their comparative advantages (Amiti and Wei, 2006). Over time outsourcing could also be expected to affect total factor productivity positively, along with its growth and that of labour productivity itself. Indeed, by outsourcing firms could focus on their core competencies and thus increase their innovativeness (Mazzanti et al., 2007a; Glass and Saggi, 2001), as well as learning from those innovations which are embodied in their imported inputs (Acharya and Keller, 2007). Although less thoroughly investigated the impact that outsourcing should theoretically have on firms’ profitability also appears generally positive. This is due, in particular, to the organizational competitiveness they gain by focusing on those internal resources and competences which are relatively scarce and durable (Sharpe, 1997). While the main theoretical, or ‘quasi-theoretical’, view is positive, a number of negative views on the performance impact of outsourcing are emerging, especially in the form of ex-post rationalizations of empirical studies. This is particularly so when productivity is considered in the short run, as labour market rigidities could initially hamper the reskilling of the workforce in the aftermath of outsourcing. Furthermore, cultural and linguistic barriers to an efficient exploitation of foreign providers could be considered a negative in the case of international outsourcing (Egger and Egger, 2006). Productivity and productivity growth, both labour and total, might be negatively affected by outsourcing in the long run too: for example, because by decoupling production (outsourced) from R&D (in-house) activities, outsourcing lessens the feedback from the former to the latter and thus the firm’s innovation capabilities (Naghavi and Ottaviano, 2006). Similar outsourcing losses have also been theorized, this time more extensively than the positive counterpart, in terms of profitability: both

Montresor, Antonioli, Mazzanti and Pini 261

in the short run, due to the managers’ underestimation of its transaction costs (Young and Macneil, 2000; Benson, 1999), and in the long run, given the emergence of imitative behaviours of successfully outsourcing firms (Gorzig and Stephan, 2002). Although relatively less established, these negative positions deserve particular attention when compared with the positive view. In particular, it becomes interesting to establish whether the two views hold alternatively, or rather simultaneously with respect to different time horizons, a task the empirical evidence should deal with.

13.3 Dataset and empirical model The previous insights are explored empirically using survey based data on manufacturing firms localized in Reggio Emilia (RE henceforth). The LPS of RE is analysed by combining two different datasets. The first, used to build up our outsourcing indicators and to draw the relevant controls from, is based on the results of a wide firm-level survey carried out in 2002, with respect to the period 1998–2001, on the manufacturing firms located in RE. Out of a population of 257 firms with at least 50 employees in 2001 (Pini, 2004),1 a sample of 166 has been extracted which has replied to both of two questionnaires addressed to management and union representatives, respectively. The second dataset, used to build up our productivity measurements, is represented by a collection of coherent balance sheet data for (as much as possible) the surveyed manufacturing firms covering the period 1994–2005: that is, a period which spans from the time of the survey (1998–2001) to the most recent year for which comparable datasheets are available (2005). The two datasets overlap only marginally in terms of surveyed firms, allowing for two research strategies: working with an unbalanced sort of ‘panel’, possibly looking for entry-and-exit phenomena between the two periods, or with a balanced one, covering the same firms in the two datasets. Out of the two, as a first step, this chapter follows the latter, and works with a merged dataset which determines a substantial collapse of the final working sample. The merged dataset, encompassing firms with complete questionnaires and balance sheets available for the years of interest, reduces to a working sample of 116 firms2 (Montresor et al., 2008, for more details on the dataset). In terms of the empirical model, apart from some studies estimating total factor productivity (TFP) and carrying out TFP growth breakdowns and ANOVA analysis, the majority of the studies estimate the impact

262

Does Outsourcing Increase Labour Productivity?

of outsourcing on productivity by referring to a production function framework (Olsen, 2006, p. 9). Given its limitation, we adopt instead a ‘knowledge-production function’ framework (Griliches, 1979) such as the following: LABPRODi ,t = β0 + β1OUTi ,t −1 + β2PRODINPUTi ,t −1 + β3CONTi ,t −1 + εi ,t

(1)

where LABPRODi,t stands for the logarithm of labour productivity at time t, OUTi,t⫺i is an indicator of outsourcing at time t⫺1, PRODINPUTi,t⫺1 refers to the firm’s inputs at time t−1 (that is, physical capital per employee and number of employees), while CONTi, t⫺1 refers to a suitable array of controls (i is the usual firm subscript). Equation 1 defines the reduced form which attempts to explain the productivity impact of outsourcing by exploiting a theoretically consistent set of covariates. Furthermore, as a first attempt to deal with potential endogeneity, a diachronic cross-section econometric model is used, with a temporal lag on the outsourcing measurement.3 Moreover, we distinguish the different results obtained with respect to different time horizons. The regressions are carried out by using, at first, the average labour productivity of the 116 firms over the period 2002–5, then the productivity shown by them in 2002 – that is the closest year to the period for which outsourcing has been detected (1998–2001) – and, finally, the firms’ productivity in 2005 – that is the most distant year from the same period. In spite of the absolute closeness of the years, this econometric strategy will allow us to distinguish, at least in relative terms, short run from medium long run productivity effects, as one of the most important points to emerge from empirical studies (Gorzig and Stephan, 2002). In order to address the firm-specificity problem, the set of the controls, CONT, retains simultaneously a wide number of variables which refer to – in addition to such standard structural elements as size, sector and the like – idiosyncratic techno-economic and institutional elements which are shared by firms co-located in a specific LPS (Tables 13.4 and 13.5). In particular, on the basis of the results of the empirical literature, and of the studies we have carried out ourselves on the outsourcing determinants of the RE firms, additive structural controls will be progressively extended from quite standard structural ones (Specification 1), through innovation related variables (Mazzanti et al., 2007a) (Specification 2), to

Montresor, Antonioli, Mazzanti and Pini 263

industrial relations based ones (Mazzanti et al., 2007b) (Specification 3). Multiplicative interaction terms will be instead built up in order to capture sector specificities à la Pavitt (Pavitt, 1984) (Specification 4) and, above all, the internationalization degree of the outsourcing firm (Specification 5), here proxied with the firm belonging to an international rather than national business group. As a major point of originality, we try to provide an accurate measurement of outsourcing by using, rather than balance sheet outsourcing proxies, a number of direct indicators of it. To start with, we use standard dummy-like outsourcing variables, controlling for the simple presence of at least one outsourcing operation for each of three kinds of activity, j, into which an ‘ideal’ value chain can be broken down: (i) ancillary activities – namely, low value added activities, in particular services (for example, janitorial ones), which are so to say accessory to the production process as such (j = 1); (ii) production supporting activities (for example, engineering), not primarily productive, but contributing to the production process more directly than those in (i) (j = 2); (iii) production activities, that is transformation activities as such (for example, supply of intermediate products) (j = 3). As a second outsourcing variable, we will refer to what we call the outsourcing intensity of certain kind of activities j, OUTi,j, defined as the number of the same kind of activities j which are actually outsourced by firm i (ni,j) out of a certain total of activities j identified with respect to a theoretical value chain OUTi , j =

ni , j

(2)

Nj

Far from being pure technical devices in search of superior significance, the dummy and the intensity measurements have a substantially different nature. Indeed, while the former account for the simple choice of resorting to outsourcing, being a sort of proxy of the make-or-buy decision, the latter also controls for the extent to which, according to the production specialization of the firm itself, outsourcing is used. Considering both of them is therefore more than opportune.

13.4 Results When discussing the main results of the regressions, an interesting point should be stressed at the outset. The productivity analysis of outsourcing requires us to distinguish the activities which are outsourced: manufacturing or services, ancillary or core, low or high value added.4

264

Does Outsourcing Increase Labour Productivity?

As a first step in this direction, let us consider, as independent variables, simple dummy variables accounting for the presence of at least one externalization in each of the three groups of outsourced activities that is: production (OUTPRODDum), encompassing what is usually called material outsourcing (for example, intermediate inputs), productionsupporting (OUTSUPRODDum), mainly referring to high-valued added services (for example, R&D), and ancillary activities (OUTANCDum), within which we find low-valued added service outsourcing (for example, of cleaning and janitorial services). In other words, let us start by disregarding the intensity of outsourcing of each of these activities and estimate the productivity impact of being fully or non-fully vertically integrated with respect to each of them. Quite interestingly, in this case the average labour productivity over the 2002–5 period is only affected by the externalization of service outsourcing: positively, by that of high-value added services (OUTSUPRODDum) and negatively, although not fully significantly, by that of low-value added ones (OUTANCDum) (Table 13.1). This appears consistent with what Olsen (2006) called the ‘law of diminishing returns from outsourcing’, according to which the potential gains from outsourcing low value-added activities are exhausting, while a strategy of outsourcing high value-added activities still provides margins of gain. In a manner consistent with other empirical results which do not have the territorial specification of the present study, the interactive terms with the firm’s belonging to an international business group are strongly significant, for all the three kind of activities, and with a positive sign with respect to production ones (OUTPRODDum): although by retaining the approximation of such a dummy, this suggests that those firms which are more open to international trade and investments are also more prone to benefit from the advantages of outsourcing and, possibly, of offshoring. Given the confirmation this result finds in the other specifications of the model, we need to emphasize that it is not due to the presence of a bias in the superior productivity of multinational firms. Indeed, in the estimates which include the simple dummy variable capturing the belonging of the firm to an international group, such a dummy is never significant (the results are not reported but are available upon request). Thus, we may say that it is not the belonging to an international group per se which results in being positively related to higher productivity, but it is such belonging interacted with some kinds of outsourcing (production supporting activities, in our case) that matter.

Table 13.1 Regression results: Outsourcing dummies per activity, 2002–5; 2002; 2005 LnVA/Emp0205 Dependent

Spec. 1

Spec. 2

LnVA/Emp02

Spec. 3

Spec. 1

LnVA/Emp05

Spec. 2

Spec. 3

Spec. 1

Spec. 2

Spec. 3

yes n.s. n.s. n.s.

yes n.s. n.s.

yes n.s. n.s. −2.25**

yes n.s. n.s. −2.32**

yes n.s. n.s.

n.s. n.s.

2.37** 3.66***

2.30** 3.58***

1.99* 3.53***

n.s. 2.00** −2.26**

2.09** 1.68* −2.47**

n.s.

−2.30**

Covariates Controls Sector Dummies SKILL ENTR GROUP

yes n.s. −2.10** n.s.

yes n.s. −1.88* n.s.

yes 1.70* n.s.

yes n.s. n.s. n.s.

Past Balance Sheets Variables lnPhysCap/Emp9801 LnEmp9801

3.28*** n.s.

2.82*** n.s.

3.24*** n.s.

4.53*** n.s.

4.18*** n.s.

Outsourcing OUTPROD-Dum OUTSUPROD-Dum OUTANC-Dum TECINNO

n.s. 2.00** n.s.

n.s. 2.13** n.s.

n.s.

−2.04**

n.s. n.s. n.s. n.s. n.s. n.s. Innovation Activities n.s. n.s. −2.67***

n.s.

n.s. (continued )

265

266

Table 13.1 Continued LnVA/Emp0205 Dependent

Spec. 1

Spec. 2

LnVA/Emp02

Spec. 3

Spec. 1

LnVA/Emp05

Spec. 2

Spec. 3

10.70*** 116 0.00 0.40 2.52

n.s. n.s. 1.94* −1.98* 12.60*** 116 0.00 0.41 2.94

Spec. 1

Spec. 2

Spec. 3

7.68*** 116 0.00 0.30 2.46

−2.42** n.s. 1.94* −4.25*** 7.81*** 116 0.00 0.29 2.96

Interaction Terms OUTANC-NAT-Dum OUTPROD-INT-Dum OUTSUPROD-INT-Dum OUTANC-INT-Dum _cons N F R2 VIF

13.08*** 114 0.00 0.32 3.42

12.08*** 114 0.00 0.34 3.09

n.s. 1.70* 2.83*** −4.20*** 14.06*** 114 0.00 0.38 3.57

10.49*** 116 0.00 0.37 2.59

7.60*** 116 0.00 0.28 2.59

Notes: (a) as we are not interested in elasticities, t ratios only are shown with the following notation: significant at 10%*; 5%**; 1%***; (b) an empty cell means the variable is not included in the specification; n.s. means not significant but included in the specification; (c) VIF: Variance Inflation Factor measure of the degree of multicollinearity (threshold for multicollinearity: 10); (d) heteroskedasticity is addressed using robust standard errors; (e) as a rule of thumb, we have discarded those covariates having a t ratio lower than 0.5 in order to end up with a parsimonious specification through a process going from general to particular.

Montresor, Antonioli, Mazzanti and Pini 267

The analysis of the productivity impact of the outsourcing dummies in 2002 and 2005 (Table 13.1) provides another apparent confirmation of what we know from the investigations of big companies’ externalization strategies, that is the importance of the time horizon. On the one hand, the gains from outsourcing production supporting activities are not immediate, as a workforce re-skilling seems to be needed in order to reap the potential benefits of high value added outsourcing on labour productivity. On the other hand, the negative sign in the productivity of externalizing ancillary activities emerges over time too. Those firms which outsource these activities apparently do it in order to cut down production costs, without planning further or contextual high value added outsourcing activities. So far, then, the LPS of RE seems to confirm those results the empirical literature finds by looking at the big-company model of outsourcing. However, such a confirmation has been obtained under the implicit assumption that the marginal propensity to outsource is invariant across the three kinds of activity. Were this the case, RE would confirm what we already know about outsourcing and its impact on firm productivity. However, this is not realistic as the actual propensity of externalizing each group of activities should be retained as an idiosyncratic feature of the context outsourcing firms are embedded in, an aspect that many empirical studies seem to ignore. If we re-run the regressions with outsourcing intensity indexes, the picture of the results changes substantially. First of all, outsourcing significantly affects the average productivity of the period 2002– 2005 (Table 13.2) only in the case of production activities as such (OUTPROD): in all the first three specifications, that is irrespectively from the covariates utilized, such as innovation indexes (Specification 2) and industrial relations variables (Specification 3). The externalization of inner phases of the production process thus seems to be the only one with a positive impact on the RE firms’ performance, while that of service outsourcing, both low (OUTANC) and high (OUTSUPROD) valueadded, apparently vanishes. Quite at odds with the ‘generic’ empirical literature on the topic, this result instead appears consistent with the district nature of this LPS. Here, firms also typically increase their productivity by tapping into the superior competences of external, (possibly) geographically closer, manufacturing suppliers. The embodied nature of the knowledge of this kind of activity, along with the same district atmosphere of the RE province, both work in mitigating the risk of knowledge leakage which usually hampers its effects.

268

Table 13.2 Regression results: Outsourcing intensity per activity, 2002–5 LnVA/Emp0205 Spec. 1

Spec. 2

Sector Dummies ENTR

yes −2.32**

yes −2.09**

lnPhysCap/Emp9801

3.14***

Dependent

Spec. 3

Spec. 4

Spec. 5

yes −2.88***

no −1.90*

yes n.s.

Past Balance Sheets Variables 2.72*** 3.40***

4.3***

2.87***

n.s.

n.s.

−1.77*

−1.69*

n.s. n.s. n.s.

n.s. n.s. n.s.

Covariates Controls

OUTPROD

1.83*

1.94*

Innovation Activities −2.31**

TECINNO UNION FORMINDREL RELMANUNI

Outsourcing 2.26**

n.s. n.s. n.s.

Industrial Relations n.s. n.s. n.s. n.s. n.s. n.s. Interaction Terms

OUTPROD-RI OUTSUPROD-INT OUTANC-INT -cons N F R2

VIF Note:fn See notes in Table 13.1.

3.64***

14.36*** 114 0.00 0.32

13.42*** 114 0.00 0.35

11.71*** 101 0.00 0.37

14.11*** 114 0.00 0.35

2.20*** −2.08*** 13.88*** 114 0.00 0.34

3.45

3.08

2.46

1.99

3.22

Montresor, Antonioli, Mazzanti and Pini 269

Looking at the two specifications containing the interaction terms with the firm’s internationalization and with its sector of activity, more specific relationships emerge (Table 13.2). On the one hand, the resource-intensive firms that outsource production activities are those that gain more from such a strategy (Specification 4). This appears consistent with our previous interpretation, as this kind of firm, usually ‘low-knowledge intensive’ (Foss and Laursen, 2005), might need to look beyond the firm boundaries to find the competences enabling them to deal with changes in production activities required by the market. On the other hand, and more important, the interaction with the internationalization degree of the outsourcing firm (Specification 5) yields back the general result we got by working with the relative dummies: the outsourcing of high value added services (that is, our OUTSUPROD) positively affects the firm’s productivity, but of international firms only. Belonging to any kind of national or international group, instead, makes significant and negative the productivity impact of the outsourcing of low value added services (that is, our OUTANC). This is another extremely interesting result, which suggests that the ‘high-road’ to the benefits of outsourcing high-level services requires firms to draw on international markets and is thus possibly reserved to multinational corporations through offshoring and global sourcing strategies. The last empirical exercise assesses the relevance of the time horizon. As expected, when the indexes of outsourcing intensity per activity are regressed against the simultaneous productivity of the investigated firms, that is for 2002, not one of them appears significant, apart from production activities (OUTPROD), which is just marginally significant when innovation related variables (Table 13.3, Specification 2) are considered. If we also exclude the cases of labour intensive and specialized supplier firms, for which reorganization problems do not seem to be large enough to prevent an immediate productivity impact of production supporting and production activities, respectively (Specification 4), working with outsourcing indexes confirms the general result, in turn confirmed by working with outsourcing dummies: a temporal delay for outsourcing to affect labour productivity is needed. In general, then, the productivity impact of outsourcing is not a short-run phenomenon; this also holds when the reference is to specific LPS such as that of RE. Such a general result is confirmed by an important exception, as the interaction terms involving the dummies national/ international group and the outsourcing indexes obtain the same results we did using the average productivity over the period 2002–5

Table 13.3 Regression results: Outsourcing intensity per activity, 2002 and 2005 LnVA/Emp02 Spec. 1

Spec. 2

Spec. 3

Spec. 4

Spec. 5

Spec. 1

Spec. 2

Spec. 3

Spec. 4

Spec. 5

yes n.s. n.s. n.s. n.s.

yes n.s. n.s. n.s. n.s.

yes n.s. n.s. n.s. n.s.

yes n.s. n.s. −1.72* n.s.

yes n.s. n.s. −1.79* −1.80*

yes −2.21** n.s. n.s. n.s.

no n.s. n.s. −1.80* −1.83*

yes n.s. n.s. n.s. n.s.

4.31*** n.s.

3.95*** 1.66*

n.s.

1.70*

Past Balance Sheets Variables 5.02*** 5.27*** 3.81*** 2.25** n.s. n.s. n.s. 2.75*** Outsourcing n.s. n.s. n.s. 2.09**

2.16** 2.69***

1.74* 2.29**

2.82*** 3.05***

1.97* 3.13***

−2.92***

Innovation −2.41** −2.69***

2.33**

2.03**

n.s.

n.s.

−2.11**

n.s.

Covariates Sector Dummies ENTR MAN GROUP FIRMAGE lnPhysCap/Emp9801 LnEmp9801 OUTPROD TECINNO

Controls no n.s. −1.78* n.s. n.s.

yes n.s. n.s. n.s. n.s.

−2.25**

Industrial relations UNION OUTSUPROD-LI OUTSUPROD-SS OUTPROD-RI OUTPROD-SI OUTPROD-SS OUTSUPROD-INT OUTANC-INT -cons N F R2 VIF

−1.91*

11.49*** 116 0.00 0.37 2.63

Note: See notes in Table 13.1

11.89*** 116 0.00 0.41 2.56

10.90*** 101 0.00 0.32 2.16

n.s. Interaction terms 2.08** n.s. n.s. n.s. 1.67* 1.74* −1.71* 13.89** 11.25** 116 116 0.00 0.00 0.35 0.43 2.20 2.81

n.s. 1.84* 2.83*** 2.61** n.s.

7.78*** 116 0.00 0.26 2.62

7.84*** 116 0.00 0.29 2.50

9.17*** 102 0.00 0.29 2.22

9.06*** 116 0.00 0.33 1.52

2.00** 2.24** 6.31*** 116 0.00 0.25 2.56

270

Dependent

LnVA/Emp05

Montresor, Antonioli, Mazzanti and Pini 271

(Specification 5). This is somehow unexpected, when one considers the larger difficulties that firms working on international markets have in reorganizing in the aftermath of outsourcing. However, it is also true that our estimated proxy might hinder other counteracting factors, such as a superior efficiency imposed by international vs. national markets. When productivity is considered as far as possible from the occurrence of outsourcing, that is, in 2005, the outsourcing intensity of production activities (OUTPROD) turns out to be significant in all of the first three specifications. Overall, this suggests that the sign and the level of significance of the impact of OUTPROD on the average productivity of the period 2002–5 are driven by the last years of the period over which the performance variable is computed: and this provides a further evidence of the temporal dimension of the phenomenon we have investigated. The positive and significant sign of this kind of outsourcing is confirmed also by the results of the two other specifications with interactive terms (Specification 4 and 5). Furthermore, these last specifications confirm the sectoral and geographical qualifications which mediate the productivity impact of the outsourcing of the high value added services (OUTSUPROD): indeed, this occurs only for firms which belong to an international group and mainly for those which are specialized suppliers, an aspect that appears consistent with the nature of the intersectoral flows of the Pavitt taxonomy.

13.6 Conclusions Although limited to a specific LPS, the analysis of outsourcing in RE has brought us a number of different results. Indeed, only few general conclusions can be drawn. First of all, the productivity impact of outsourcing in RE (and possibly in other LPSs) is not a short run phenomenon: benefits seem to accrue from the labour reorganization and innovation opportunities outsourcing offers in the long run, rather than from the cost savings of the short run. Second, the internationalization degree of the firms generally amplifies (extensively) and magnifies (intensively) the productivity impact of outsourcing: in brief, the LPS of RE seems to benefit more from a kind of outsourcing that, overcoming the national boundaries, enables it to enter into global value chains. The other facts we know from the (scanty) empirical evidence on the issue are only partially confirmed, and require us to be very cautious

272

Does Outsourcing Increase Labour Productivity?

in drawing strategic implications. On the one hand, that outsourcing manufacturing activities has actually entered a phase of diminishing returns – in RE as in other contexts – and that it is mainly (if not even only) the externalization of high value added (production supporting) activities which might still guarantee productivity margins, are corroborated only when the firms of the LPS are assumed to have an equal propensity to outsource different kinds of activities. However, when the actual extent to which the different kinds of activities are outsourced is retained, as a distinguishing feature of the context in which the outsourcing firms are embedded, the RE picture appears less supportive of the general evidence and rather shows some important exceptions to it. First of all, the analysis of outsourcing intensity seems to make the productivity impact of service outsourcing vanish – both low and high value added – and instead promotes the emergence of the positive one of the externalization of inner phases of the production process. A second related result is that the internationalization degree of the outsourcing firm, not only does strengthen, but actually also conditions the productivity impact of the outsourcing of production supporting activities. The strategic implications these results suggest to the firms of this LPS are therefore quite at odds with those one can recommend to big companies. While externalizing low value added services might actually not be worthwhile anymore, outsourcing high value added services might not be worthwhile yet. In other words, while ancillary activities have possibly already reached the ‘periphery’ of the LPS, productionsupporting ones are still in its core, and their externalization works only through competent foreign suppliers. Outsourcing has widespread positive results only when it overlaps with the system of relationships of which the LPS is made. That is, when it refers to production activities which embody and transfer a kind of knowledge that social embeddedness and territorial proximity help in making more productive.

Size (Number of Employees)

Firm population: 257 firms Istat Ateco91 Sectors (2 digit) Food and beverage Other industries Paper and printing Chemicals, fibres, rubber & plastic Wood products Metal products & equipment, mechanical machinery, office equipment, transport equipment and others Non metal minerals Textiles & clothing Total

50–99

100–249

250–499

500–999

> 999

Total

2 2 4 8 0 72

5 0 0 7 2 41

3 0 3 2 0 13

2 0 0 0 0 7

2 0 0 1 0 9

14 2 7 18 2 142

25 4

17 4

5 7

7 0

2 1

56 16

117

76

33

16

15

257

50–99

100–249

250–499

500–999

> 999

Total

0 0 1 5 0 33

3 0 0 2 0 24

Appendix

Table 13.4 Reggio Emilia: Representativeness of the sample

Final working sample: 116 firms Istat Ateco91 Sectors (2 digit) Food and beverage Other Industries Paper and printing Chemicals, fibres, rubber & plastic Wood products Metal products & equipment,

0 0 1 1 0 9

0 0 0 0 0 4

0 0 0 0 0 7

3 0 2 8 0 77 273

(continued )

274

Table 13.4 Continued Final working sample: 116 firms Istat Ateco91 Sectors (2 digit)

50–99

mechanical machinery, office equipment, transport equipment and others Non metal minerals Textiles & clothing Total

100–249

250–499

500–999

> 999

Total

6 3

7 1

3 0

5 0

1 0

22 4

48

37

14

9

8

116

Cochran Test

N = 257 and n = 116

Margin of error ␪*

θ=

N 1 − = 0.068 ( N − 1)n N − 1

Note: * Restrictive test for small population: the smaller N is, the lesser the distance between N and n has to be in order to generate an acceptable ␪. A margin of error ␪ lower than 0.10 can be thought as acceptable given our small population.

Table 13.5 Descriptive statistics and variable construction (116 observations) Variable Dependent Labor productivity LnVA/Emp0205 LnVA/Emp02 LnVA/Emp05

Description

Mean of the log ratio between value added and employees over 2002–5 Log ratio between value added and employees in 2002 Log ratio between value added and employees in 2005

Past Balance Sheets Variable LnPhysCap/Emp9801 Log ratio between physical capital and employees (1998– 2001 average) LnEmp9801 Log of the employment (1998–2001 average) Outsourcing OUT OUTPROD-Dum OUTSUPROD-Dum OUTANC-Dum OUTPROD OUTSUPROD OUTANC OUTPROD-SI;-LI;-RI;-SS* OUTSUPROD-SI;-LI;-RI;-SS* OUTANC-SI;-LI;-RI;-SS* OUTPROD-NAT(-dum) OUTSUPROD-NAT(-dum)

Min

Max

3.92

3.14

5.06

3.94 3.91

3.12 2.38

5.37 5.20

3.26

0.05

4.96

4.88

2.90

7.03

0.29 0.59 0.60

0 0 0

0.882 1 1

0.88 0.23 0.18 0.41 — — — 0.05

0 0 0 0

0

1 0.75 1 1 — — — 0.75

0.05

0

1

0.08

0

1

— — —

(continued )

275

OUTANC-NAT(-dum)

General outsourcing intensity Dummy for outsourcing at least one production activity Dummy for outsourcing at least one production-supporting activity Dummy for outsourcing at least one ancillary activity PROD outsourcing intensity SUPROD outsourcing intensity ANC outsourcing intensity OUTPROD multiplied by Pavitt sector dummies OUTSUPROD multiplied by Pavitt sector dummies OUTANC multiplied by Pavitt sector dummies OUTPROD multiplied by the national group (dum if the outsourcing dummy is used) OUTSUPROD multiplied by the national group (dum if the outsourcing dummy is used) OUTANC multiplied by the national group (dum if the outsourcing dummy is used)

Mean

Variable

Description

Min

Max

OUTPROD-INT(-dum)

OUTPROD multiplied by the international group (dum if the outsourcing dummy is used) OUTSUPROD multiplied by the international group (dum if the outsourcing dummy is used) OUTANC multiplied by the international group (dum if the outsourcing dummy is used)

0.02

0

0.5

0.007

0

0.33

0.03

0

0.86

Two-digit classification from ISTAT ATECO91 Dummy for belonging to a business group Skill ratio between qualified employees and total employees Log of (2002 – set-up year of the firm) Dummy for firm managed by managers Dummy for firm managed by owner Geographical diversification for the revenues location: regional, national, EU and international markets Sector Pavitt dummies: Labour Intensive (LI), Resource Intensive (RI), Scale Intensive (SI) and Specialized Suppliers (SS)

— 0.29 37.37 3.40 0.21 0.43 0.48

OUTSUPROD-INT(-dum) OUTANC-INT(-dum) Controls Sector dummies GROUP SKILL FIRMAGE MAN ENTR GEODIV LI,RI,SI,SS Innovation TECINNO ORGINNO FLEXINNO TRAIN Industrial Relations FORMINDREL§ RELMANUNI§ UNION

Synthetic Synthetic Synthetic Synthetic

index index index index

Mean

of of of of

technological innovation new organizational practices flexibility indicators training activities

Synthetic index of formal industrial relations Index of relations between management and union representatives Union density

Note: *For scope constraints we do not report each single value; §104 observation

—

0 0 0 1.61 0 0 0

1 1 77.07 4.95 1 1 0.95

0

1

0.64 0.50 0.30 0.61

0 0 0.06 0

1 1 0.46 0.90

0.58 0.31

0.04 0

0.96 0.79

0.38

0

0.74

276

Table 13.5 Continued

Montresor, Antonioli, Mazzanti and Pini 277

Notes 1. Several official sources were used to construct the firm population: Reggio Emilia Chamber of Commerce, Istat Census, Aida data bank, Impero data bank, balance sheets data bank of the Reggio Emilia Camera del Lavoro Territoriale. 2. As shown by the Cochran (1977) test the working sample size is coherent with the population size excluding problems of under-coverage (Table 13.4). 3. A rigorous endogeneity test, and an actual integration with previous studies that we have carried out on the outsourcing determinants of the same firms of the application, are instead postponed to our future research agenda. 4. The use of a general composite measure of outsourcing intensity that incorporates the three different outsourced activities, both weighted and unweighted, is not significant, in any of the specifications used. The relative results have been omitted for scope constraints and are available from the authors on request.

References Acharya, R. and W. Keller (2007) ‘Technology Transfer through Imports’, working paper, NBER No. W13086. Aghion, P. and J. Tirole (1997) ‘Formal and Real Authority in Organizations’, Journal of Political Economy, 105, 1–29. Amiti, M. and S. J. Wei (2006) ‘Service Offshoring and Productivity: Evidence from the United States’, working paper 11926, International Monetary Fund. Benson, J. (1999) ‘Outsourcing, Organisational Performance and Employee Commitment’, Economic and Labour Relations Review, 10, 1–21. Cochran, W. (1977) Sampling Techniques (New York: John Wiley and Sons). Egger, H. and P. Egger (2006) ‘International Outsourcing and the Productivity of Low-Skilled Labour in the EU’, Economic Inquiry, 44, 98–108. Feenstra, R. and G. H. Hanson (1999) ‘The Impact of Outsourcing and HighTechnology Capital on Wages: Estimates for the United States, 1979–1990’, Quarterly Journal of Economics, 114, 907–40. Glass, A. J. and K. Saggi (2001) ‘Innovation and Wage Effects of International Outsourcing’, European Economic Review, 45, 67–86. Gorzig, B. and A. Stephan (2002) ‘Outsourcing and Firm-Level Performance’, Discussion Paper 309, German Institute for Economic Research. Griliches, Z. (1979) ‘Issues in Assessing the Contribution of Research and Development to Productivity Growth’, Bell Journal of Economics, 10, 92–116. Grossman, G. M. and E. Helpman (2002) ‘Integration versus Outsourcing in Industry Equilibrium’, The Quarterly Journal of Economics, 117, 85–120. Grossman, G. M. and E. Helpman (2005) ‘Outsourcing in a Global Economy’, Review of Economic Studies, 72, 135–60. Grossman, S. and O. Hart (1986) ‘The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration’, Journal of Political Economy, 94, 85–120. Heshmati, A. (2003) ‘Productivity Growth, Efficiency and Outsourcing in Manufacturing and Service Industries’, Journal of Economic Surveys, 17, 79–112.

278

Does Outsourcing Increase Labour Productivity?

Hsieh, C., J. Nickerson and T. Zenger (2007) ‘Opportunity Discovery, Problem Solving and a Theory of the Entrepreneurial Firm’, Journal of Management Studies, 44, 1255–77. Jacobides, M. J. and S. G. Winter (2005) ‘The Co-Evolution of Capabilities and Transaction Costs: Explaining the Institutional Structure of Production’, Strategic Management Journal, 26, 395–413. Jones, R. W. and H. Kierzkowski (2001) ‘A Framework for Fragmentation’ in S. W. Arndt and H. Kierzkowski (eds) Fragmentation: New Production Patterns in the World Economy (Oxford: Oxford University Press). Kasahara, H. and J. Rodrigue (2005) ‘Does the Use of Imported Intermediates Increase Productivity?’ Technical report, RBC, Financial Group Economic Policy Research Institute. Kim, B. (2003) ‘Dynamic Outsourcing to Contract Manufacturers with different Capabilities of Reducing the Supply Cost’, International Journal of Production Economics, 86, 63–80. Kirkegaard, J. F. (2005) ‘Outsourcing – Stains on the White Collar?’ working paper, Institute for International Economics, n. 27. Kleinert, J. (2003) ‘Growing Trade in Intermediate Goods: Outsourcing, Global Sourcing, or Increasing Importance of MNE Networks?’ Review of International Economics, 11, 464–82. Kohler, W. (2004) ‘Aspects of International Fragmentation’, Review of International Economics, 12, 793–816. Mahnke, V. (2001) ‘The Process of Vertical Dis-Integration: An Evolutionary Perspective on Outsourcing’, Journal of Management and Governance, 5, 353–79. Markusen, J. (1989) ‘Trade in Producer Services and in other Specialized Intermediate Inputs’, American Economic Review, 79, 85–95. Mazzanti, M., S. Montresor and P. Pini (2007a) ‘Outsourcing and Innovation: Evidence for a Local Production System of Emilia Romagna’, Innovation: Management, Policy, Practice, 9, 324–43. Mazzanti, M., S. Montresor and P. Pini (2007b) ‘Outsourcing and Transaction Costs in “Real” Time and Space: Evidence for a Province of Emilia-Romagna (Italy)’, The ICFAI Journal of Industrial Economics, IV, 7–23. Montresor, S., D. Antonioli, M. Mazzanti and P. Pini (2008) ‘Outsourcing and Firm Productivity: Evidence for an Italian Local Production System’, available at SSRN http://ssrn.com/abstract=1194322. Naghavi, A. and G. Ottaviano (2006) ‘Offshoring and Product Innovation’, CEPR Discussion Papers 6008. OECD (2007) Offshoring and Employment: Trends and Impacts, OECD, Paris, July. Olsen, K. B. (2006) ‘Productivity Impacts of Offshoring and Outsourcing: A Review’, OECD Science, Technology and Industry Working Papers, 2006(1). Pavitt, K. (1984) ‘Sectoral Patterns of Technical Change: Towards a Taxonomy and a Theory’, Research Policy, 13, 343–73. Pini, P. (ed.) (2004) Innovazione, Relazioni Industriali e Risultati d’Impresa (Milan: FrancoAngeli). Sharpe, M. (1997) ‘Outsourcing, Organizational Competitiveness, and Work’, Journal of Labor Research, 18, 535–49. Spencer, B. J. (2005) ‘International Outsourcing and Incomplete Contracts’, working paper 11418, NBER.

Montresor, Antonioli, Mazzanti and Pini 279 Taymaz, E. and Y. Kilicaslan (2005) ‘Determinants of Subcontracting and Regional Development: An Empirical Study on Turkish Textile and Engineering Industries’, Regional Studies, 39, 633–45. Young, S., and J. Macneil (2000) ‘When Performance Fails to Meet Expectations: Managers’ Objectives for Outsourcing’, Economic and Labour Relations Review, 11, 136–68. Zander, I. (2007) ‘Do You See What I Mean? An Entrepreneurship Perspective on the Nature and Boundaries of the Firm’, Journal of Management Studies, 44, 1141–64.

Index Acemoglu, D. 29, 221 administrative borders 19, 158 advantage absolute 18 comparative 17–18 agglomeration 48, 154–6, 159, 170, 200–1, 204 of economic activity 113 urban 59 agglomerative economies 104 Aghion, P. 198–9 Amin, A. 28 anti-corruption strategy 150, 152 apartheid 49–50, 63–5, 75–6, 80–3, 87–8 approaches competence-based 232–3 cumulative causation spatial econometric 22 evolutionary 2, 17–18, 23 heterodox 2, 17, 21–2 industrial clusters 19 industrial districts 22 milieux innovateurs 19 new industrial spaces 19, 21–2 orthodox 17 regional innovation systems 19, 23 regulation 20 strategic choice 232–3 systems of innovation 78 see also schools Arthur, W. B. 23 Audretsch, D. B. 156, 209 Aydalot, P. 21 Bagnasco, A. 15, 21 Bangladesh 215, 219 bantustan 81, 83 Barabasi, A. L. 23 Baumol, W. J. 30 Beccattini, G. 15 Bellandi, M. 21

Berg, van den, L. 155 Boschma, R. 18–19, 25, 28 Brandenburger, A. M. 156 bribery 134, 136, 152–3 Business and Social Networks (BSN) 242–5, 248–51 business environment 29 Camagni, R. 16, 18 China 95 Chinese counties Changshu 100 Jiangyin 100 Wuxian 100 Zhangjiagang 100 Chinese regions Hang-Jia-Hu 100 Yangtze River Delta 95, 102, 107–10 Christaller, W. 26 Ciccone, A. 156 climate change 176, 178 cluster 113–18, 120–4, 126, 128–9 activities in clusters 155, 164, 167 affiliation 155, 164 dynamic 116 identification 157, 161–2 industrial 102, 104–6, 113 mapping 113, 115, 121–4, 128 membership 166, 170 organizations 113–4, 120, 123, 126 collective management 183 Combes, P. P. 163 commons 175–9, 181–6 competition direct market 15 competitiveness 1–2, 114, 116 national 2 of firms 3, 15, 21, 30, 114 regional 16, 18–21, 23–5, 114 relative 25 280

Index concentration 155, 162 regional 114 convergence 46, 197, 204 beta convergence 53–6 sigma convergence 54 Cooke, P. 22–3, 235 cooperation 113–20, 154–6, 159, 163–70 co-opetition 156, 164 Corruption Research Centre 6, 134 costs screening 242–6 search 242, 244–5 courtyard economy 100 creativity 10, 197, 232, 234–5, 238 Cumbria, see England customer-supplier-relationships 154, 158 Davenport, T. R. H. 82 Dei Ottati, G. 21 delocalization 253 development economic 232, 236–8 local 2, 5, 15–16, 19–20, 30, 95–6, 175, 178, 183, 212, 225 local economic 45–7, 50–1, 66, 69, 92 regional 16–17, 19–20, 22, 24 spatially balanced development 16 sustainable 177, 184–5 uneven 233, 237 dimension global 193, 200 local 200–1 distribution, spatial 3, 6, 25, 46 district, magisterial 55, 68–9 Dixit, A. K. 27 Djankov, S. 29 Doing Business (DB) 30 Drucker, P. 213 Du Plessis, S. 48 Duranton, G. 163 Easterly, W. 29 economics mainstream 2, 16, 18, 25, 27 neoclassical 25 urban 62

281

economies of scale 27, 60, 62, 66 economies, localization 60, 62–3, 155 economy integration 3–4, 16, 46–7, 66 see also integration, economic local 3, 16–18, 30–1 openness of 1, 25, 30, 47 ecosystem services 176–7, 179–81 payment for 186 Edquist, C. 23 efficiency 11, 16–18, 24, 242–4, 248–9 Emilia Romagna, see Italy England 181 Cumbria 177, 183 entrepreneurship commercial 210, 212–14 social 210–14, 225–7 equity, spatial 3, 16, 31 European Commission (EC) 16, 24, 113 European Metropolitan Region (EMR) 154, 159, 164–6, 170 export 68–9 diversification 66–7 specialization 66–7 external economies 22, 27 local 26, 31 negative 17 positive 17 externalities 15, 60 context specific 15 coordination 28 physical 18 positive 182 soft 20 family firms 95, 97–9, 104–6 Feenstra, R. 243 Fei, X. 96, 98 Feldman, M. 156 Feser, E. J. 155 firm culture 154–5, 164, 168 foreign direct investment (FDI) 107–8, 113–15, 117–18 foreign investment enterprises (FIE) 116, 128 Fosfuri, A. 163

282

Index

Fratesi, U. 18, 20 Frenken, K. 18, 28 Fujita, M. 25–7, 155 Gates, W. 217–19, 226 General Purpose Technology (GPT) 197, 201–2 Gengcui model 100 Germany 154, 159 Central Franconia 154, 159–60 Nuremberg 6, 154, 159–61, 163–5, 169–70 geography first-nature 48, 50 New Economic Geography 3, 16, 27, 66, 156 relational 20 Glaeser, E. 59–61 Global Insight Southern Africa 52 globalization 45–8, 75–7, 90–2 government corruption, local 134, 137, 145, 150 causes 148 consequences 135, 148 corruption cases 136–8, 144–5 institutionalization 144 network system 142 governance 233–4, 237–8 local 3, 19 Grameen Bank 9, 211–13, 215–20 greenfield investments 117–19 Gross Domestic Product (GDP) 50, 55–7, 67–9, 83 Gross Geographic Product (GGP) 83–4 Groupement de Recherche Européen sur les Milieux Innovateurs (GREMI) 21 growth, economic 4, 15–17, 28, 46, 48, 50–1 Guerrieri, P. 204 Hall, R. E. 156 Hardin, G. 8, 175 history 15, 24–6, 29 home market effect 68–9 Howitt, P. 198 human capital 59, 76, 79, 87–8, 195, 198–9, 201–8

Human Development Index (HDI) 87 human resources 96–7, 104 Hungary 6, 113–29, 134, 137–44 Hymer, S. H. 233–4 industries banking 211, 215, 227 creative 232, 235 software 211, 217–19 industry affiliation 154, 158 inequality, spatial 3–4, 16, 46–8, 50–2 information and communication technology (ICT) 193, 197–8, 201–8 information technology (IT) 220, 224, 227 infrastructure 61, 63, 68, 70 institutional 108 innovation 8–10, 17–23, 76–7, 114, 116, 181, 185, 193, 209–20 actors 194 collaboration 193, 195, 201 global 195, 198, 200, 203–4 paradigm 8, 193, 197 modelling 198, 200, 208 non-technological 193, 197, 203 open 194, 201–2 partners 194–5 policy 195, 208 process and product 196 Institute of Employment Research (IAB) 6, 161, 169 institutions formal 20–1, 76 informal 20–1, 77 institutional framework 1, 4 networks 76, 78 integration, economic 3–4, 16, 46–7, 66 interdependencies 19 untraded 20–1, 23 interlinkages 169 vertical, horizontal and diagonal links 158 International Monetary Fund (IMF) 237 international trade 4, 17, 66, 257, 264

Index Internet 197, 203–4 Isard, W. 27 Italy 175, 180, 257 Emilia Romagna 257–8 Reggio Emilia (RE) 2, 11, 258, 261 Trentino 177, 180 Kanbur, R. 16, 69 kernel density analysis 4, 53, 55 Khandker, S. R. 219 Kirkegaard, J. F. 257 knowledge, creation and use of 232–5 markets 195 Krugman, P. 17, 25, 27, 201 labour market pooling 162–3 Lambsdorff, J. 152 La Porta, R. 29 Levine, R. 29 liberalization 3, 29, 47, 59 Lipietz, A. 20 Lopez-de-Silanes, F. 29 Lösch, A. 26 Maggi, B. 204 Magubane, B. M. 82 Maillat, M. 21 markets auction 104 emerging 212 global 45, 91, 114, 212 local 212 national 212 real estate 104 specialized 99, 102, 104–6 technology 104 Markov chain analysis 56 Marshall, A. 113 microcredit 215, 219–20 Microcredit Summit Campaign 220 microfinance 215, 227 Microsoft Corporation 9, 211–13, 217–20, 223–7 migration 79, 87–9, 91 milieu 19, 21 Millennium Ecosystem Assessment (MA) 177, 180

283

models Dixit-Stiglitz 27 econometric 258, 262 Gengcui 100 local spillover (LS) 16–17 see also New Economic Geography principal-agent-client 137 South Jiangsu 95–101, 104, 108 territorial innovation 19–20 Wenzhou 95, 97–101, 104, 106, 108 multinational enterprises (MNEs) 120, 195 Myrdal, G. 16, 20 Nalebuff, B. J. 156 network activities 7, 160, 162, 166 networks, global 119, 195 Nunn, N. 29 Nuremberg, see Germany OECD 76, 194, 257–9 Olsen, K. B. 259 original equipment manufacturers (OEMs) 117–18, 120 Ostrom, E. 175–6 outsourcing 11–2, 242, 244–5, 257–64, 267, 269, 271–2 Pannon Automotive Cluster (PANAC) 120 path dependence 13, 20, 23 policy, economic 157, 163 political economy cultural 20 of regional development 20 Porter, M. 22, 24, 114 poverty 59, 63, 215–17, 220–2, 226 reduction of 219 privatization 29, 118, 178 production, organization of 9, 22, 232, 234 production systems, local (LPS) 258, 267, 271–2 productivity 5, 11–2, 24 of firm 242, 244, 267 of labour 258, 260, 262, 267 public and private goods 176 public procurement 145, 150

284

Index

Quah, D. 55 quality upgrading 242, 244, 250 quotient, locational 122 radical geographers 20 rationality perfect 27 Rauch, J. E. 242, 245 reforms second-generation institutional 29 Reggio Emilia (RE), see Italy Regional Economic Explorer (REX) database 3, 52 research & development (R&D) 119, 194–8, 207 returns to scale 27, 62 Rodrik, D. 25–9 Rønde, T. 163 Rose-Ackermann, S. 151 rule of law 30 Saxenian, A. 22, 114 school California 21 evolutionary 2, 17–18, 23 French School of disequilibriated spatial development 20 German Historical 20 heterodox 18 institutional 2, 18, 20 Yongjia school of thought 98 see also approaches Schumpeter, J. Alois 213, 216, 238 Sforzi, F. 21 Shleifer, A. 29 Smit, B. 48 social capital 175, 177, 186, 217, 221–5 social-ecological systems 175, 181, 183–4 Solow, R. 53 sourcing foreign 243, 250, 254 global 11, 242–4, 249–50 local 245, 249–50 South Africa 2, 45–70, 75–92 South African provinces Eastern Cape 82 Free State 82, 92

Gauteng 82–4, 87, 89, 92 KwaZulu-Natal 82, 92 Limpopo 82–3 Mpumalanga 82 North West 82, 84 Northern Cape 84 Western Cape 82–4, 87, 89, 92 South Jiangsu model 95–101, 104, 108 specialization functional 7, 154, 156–8, 161–2 Spencer, B. J. 257 spillover effects 5, 115, 221 spatial 67 spillovers technological 23, 116, 203 stability, macroeconomic 30, 198 stakeholder 185 Stiglitz, J. E. 27 Storper, M. 16, 20–2 structural change 160 supplier network 117, 120–1 supply chains 7, 154–6, 158, 161 Sylos Labini, P. 15 systems of innovation 75–8, 92 definition 75 local 77, 91 national 76, 79–80 provincial 75–92 viability 75, 78, 82 technology and knowledge transfer 116, 118, 120 theory location 25–6 network 20 transaction-cost-based theory of the California school 21 Thisse, J. F. 27, 155 Thrift, N. 28 total economic value 8, 186 transaction-cost-economics (TCE) 257 transaction costs 104–5 transition 117–18, 128 transition and transplantation 95, 106 Transparency International Hungary Foundation 137

Index Trentino, see Italy TVEs (township and village collective enterprises) 95–102, 105–6, 108 unemployment 63, 65, 80, 236 Universities 164–6, 170, 194 urbanization economies 60, 62, 155 utility flows 176, 181–2 value chain 156–7, 162–3 Venables, A. J. 16, 66 Wenzhou model 95, 97–101, 104, 106, 108

285

willingness-to-pay 179 women empowering 221–2 poor 215–16, 218, 222–3 powerless 215 World Bank (WB) 3, 16, 30, 46, 237 World Trade Organization (WTO) 95, 108 Yongjia school of thought 98 see also schools Yunus, M. 215–17, 226–7 Zipf’s law

26, 61–2