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Clusters as an Instrument for Industrial Policy. Xiaobo Zhang (IFPRI). Conventional Thinking on Industrialization.
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Clusters as an Instrument for Industrial Policy Xiaobo Zhang (IFPRI)
Conventional Thinking on Industrialization • Financial development is regarded as a key instrument for industrial development because pooled resources are necessary to build factories and purchase machineries (Goldsmith, 1969; McKinnon 1973; Banerjee and Newman 1993; King and Levine 1993; Rajan and Zingales, 1998, Ayyagari et al. 2006). • Building a sound legal system is also crucial for ensuring the functioning of market economy (contract enforcement) (North, 1990; Acemoglu and Robinson, 2012). Page 2
However, not so easy to do • It may take long time to develop a sound financial and legal system and the process is wrought with challenges. • Microfinance institutions (MFIs) are a telling example. • One useful instrument; • But they are not miraculous as widely thought (Banerjee et. al., 2010; Karlan and Zinman, 2010). Page 3
A Counter Example from China • China’s rapid industrialization in the past three decades seems to defy the conventional wisdom. • MFIs have never been formally promoted. • State banks didn’t extend any credit to SMEs in the early stage of reform (Lin and Li, 2001). • One possible channel is informal financing (Allen, Qian, and Qian 2006). However, considering that at the onset of China’s reform, a large proportion of rural people were poor, the amount of local savings available for informal financing would have been rather limited. • Private ownership was not formally recognized by constitution until 2004. Page 4
Role of Clustering • Without denying the importance of financial development, the China growth puzzle suggests there must be additional factors in play. • “Localization is one method of increasing the economic size of an industry and achieving the gains of specialization.” (page, 192, Stigler, 1951 JPE article “The division of labor is limited by the extent of the market”) Page 5
Huzhou, just down the road from Zhili, is noted for its bamboo products. The city of Wenzhou is famous for manufacturing a large share of the world's supply of cigarette lighters. What they all have in common is a reliance on the low-cost labor that is in increasingly short supply. "The cluster-based model is labor-intensive. The real question is whether it can survive in the new environment of Huzhou, just down the road from Zhili, is noted for its bamboo products. The city of Wenzhou is famous for manufacturing a large share of the world's supply of cigarette lighters. What they all have in common is a reliance on the low-cost labor that is in increasingly short supply. "The cluster-based model is labor-intensive. The real question is whether it can survive in the new environment of Major Industrial Clusters in China Page 6
Production Organizers Page 7
Market Page 8
Family workshops Page 9
Workers/entrepreneurs Page 10
Initial Capital Investment in Puyuan Cashmere Sweater Cluster
Working Capital • While clustering deepens the division of labor and lowers the entry barriers, firms in the clusters still encounter credit constraints in the course of daily operation. • With a lack of access to formal finance, how do the numerous SMEs in a cluster overcome the constraints of working capital? --- informal borrowing and trade credit.
The Most Important Financing Source When Facing Working Capital Problems Ruan and Zhang (EDCC 2009)
Almost No Formal Contracts Sample receipt Page 14
Lower Effective Tax Rates in Clusters Note: Calculated by the author based on China Economic Census 2004. The tax rate is the average rate among firms in locations corresponding to each percentile of the cluster measure.
More Firms in Clusters Note: Calculated by the author based on China Economic Census 2004. The number of firms is the total number of firms in locations corresponding to each percentile of the cluster measure.
Is China Unique? • Clusters were widely observed in the early stage of Industrial Revolution in developed countries, as shown in the famous gun-making cluster in Birmingham in the 19th century cited by Stigler (1951): The manufacture of guns, as of jewelry, was carried on by a large number of makers who specialized on particular processes, and this method of organization involved the frequent transport of parts from one workshop to another. The master gun-maker—the entrepreneur—seldom possessed a factory or workshop …. Usually he owned merely a warehouse in the gun quarter, and his function was to acquire semi-finished parts and to give these out to specialized craftsmen, who undertook the assembly and finishing of the gun. He purchased materials from the barrel-makers, lock-makers, sigh-stampers, triggers-makers, ramrod-forgers, gun-furniture makers, and, if he were engaged in the military branch, from bayonet-forgers. All of these are independent manufacturers executing the orders of several master gun makers…. Once the parts had been purchased from the “material-makers,” as they were called, the next task was to hand them out to a long succession of “setters-up,” each of whom performed a specific operation in connection with the assembly and finishing of the gun. Cited in Stigler (1951), originally in Allen (1929).
Cluster in History • Putting-out system was widespread in the UK according to Adam Smith’ Wealth of Nations. • Marshall’s emphasized three advantages of industrial districts in his Principle of Economics: • Technology spillover; • Market linkage; • Labor pooling
Ethiopian Handloom Cluster Page 19
Why have the Clusters in China Reached such a Scale? • More compatible incentive of local governments in developing the local economy. • Better infrastructure. Without electricity and road, it would be difficult for a cluster to expand (see our handloom cluster study in Ethiopia). • The presence of these markets and other essential public goods in a cluster enables individual producers to keep the scale of production small and specialize in fewer tasks. Page 20
Role of Local Governments • Roadside sweater stands blocked traffic: • Built cashmere sweater marketplaces (with roof) through private-public partnership to formalize the informal business. • Fights among different private logistic centers and transport companies: • Set up a unified logistic center by re-organizing dozens of private logistics and transport companies and auctioning out the rights of transport routes • Increasing crimes as a result of more merchants and migrant workers: • Increased street security patrol to ensure a safe environment • A large fraud by a woman trader using fake name: • Established information system to link hotels with police stations to check fake Ids to chase out cheaters Page 21
Crises and Provision of Public Goods • Reputation crises due to low quality product: • Enacted decrees on the quality requirement of cashmere products; • Set up quality inspection centers and quality control offices; • Established an industrial park to attract cashmere firms with brand names to Puyuan from all over the nation by preferable land, tax, and credit policies • Short of skilled labors and inadequate trainings: • Built technical training centers/schools to train employees at the township level • Land shortage: • Replaced the scattered farmers’ residential houses with town houses. Using the saved land to build factories and industrial park (in which famers hold shares). Page 22
Conclusions • China's cluster-based rapid industrialization suggests an important role of localization in industrial policy. • In addition to the advantages highlighted by Marshall, clustering helps firms overcome financial and institutional constraints. • Cluster-based model fits well to countries with high population density and weak financial institutions. • However, most of the small and informal enterprises in clusters are largely outside the radar of official statistics.
Electrified versus Nonelectrified Handloom Clusters in Ethiopia Zhang et al. (2011, JDS)
Opportunities for Clusters in Bangladesh h High pop density Limited capital Hard working Entrepreneurship Flying geese from China
Dyeing Cluster in Bangladesh More than 400 in three villages
