Capabilities and Clusters

1. Capabilities and Clusters Topics 3 & 4: Some New Developments in International Trade National Graduate Institute For Policy Studies IDPTP Fall 2012 John Page

2. Why Are We Interested in Capabilities? • Recall the “new” stylized facts about firms: • TFP levels vary more across firms in the same industry in poor countries than in high income countries. • Average TFP levels among firms in the same industry are lower in poor countries than in high income countries • If we could raise productivity in developing country firms we could close the income gap

3. Why Are We Interested in Capabilities?The Firm Level Distribution of TFP

4. Why Are We Interested in Capabilities?Average firm labor revenue productivity across countries, 2005GDP per capita from the IMF 2005 in $PPP. Sales/Employee in current $, across all firms in the ORBIS

5. Why Are We Interested in Capabilities? • What might explain these differences? • Differences in Technology (firms are on different production functions) • Differences in plant level productivity (Technical efficiency) • Differences in managing indirect costs (supply chain management) • Differences if quality • The last three are determined by capabilities

6. Why Are We Interested in Capabilities?Differences in Technology and Technical Efficiency

7. Why Are We Interested in Capabilities? • Recent research suggests that more of the difference in TFP between firms in low income countries and high income countries is due to differences in capabilities than to differences in technology (Sutton) • Technology can be purchased • Differences in designed productivity are small among suppliers • There is evidence that firms in low income countries adopt new technologies

8. Why Are We Interested in Capabilities? • Recent research also suggests that firms in low income countries are less well managed than those in high income countries (Bloom, et al.) • Particularly important in larger firms (100+ employees) which are operationally complex • Owners tend to make almost all major management decisions because of fears of expropriation by their manager • Owner-managers only have the capacity to make decisions for firms up to a certain size • Inability to delegate constrains growth • May be equally important in small firms (Otsuka and Sonobe)

9. What are Capabilities? • Capabilities are the tacit knowledge and working practices needed for production and product development • New products • Improved production • Management of the supply chain • Marketing • They are linked to people not equipment • Management is important but it is not the only thing that determines capabilities, the whole workforce of the firm is relevant

10. How are Capabilities Acquired? • Capabilities can be transferred from high to low capability settings • FDI (Sutton finds that 50% of the top 50 firms in Ethiopia had foreign owners) • Supply chain links • Demanding buyers • Equipment suppliers • Repeated relationships with input suppliers • Knowledge of the supply chain is a critical element of firm performance • In Ethiopia 50 percent of the domestically owned firms in the top 50 were started by traders in the same products without prior industry experience

11. How are Capabilities Acquired? • Capabilities can spill over to other firms • Little econometric evidence of productivity increases arising from foreign investment in the same industry (why?) • More persuasive evidence of productivity increases in linked industries (Javoric; Harrison) • Very little understanding of the mechanisms by which these spill overs take place

12. Can Public Policy Play a Role in Capability Building?Attracting capabilities • Building effective FDI agencies • International best practice from the Irish Experience • Organizational characteristics are important • Full commitment of the chief executive • Small, elite and highly paid staff • Private sector experience • Must excel at three stages of the investment cycle • Recruitment • Embedding • After-care • Little evidence of effective implementation in Africa or MENA

13. Competing in capabilities:Inward FDI Flows (1990-2010)* *US Dollars at current prices and current exchange rates in millions Source: UNCTAD

14. Can Public Policy Play a Role in Capability Building?Building Capabilities • Creating knowledge networks • Knowledge as a public good • Collective action and Public-Private Partnerships • Management training • Content likely to differ with firm size • Some indication of positive returns (but statistical significance is low) • Questions of incentives to adopt and persistence • Making capability building a “practice area” for aid • JICA/World Bank training experiments

15. Can Public Policy Play a Role in Capability Building?Diffusing Capabilities • Supporting vertical supply chains • The pitfall of “domestic content” • Can a “first best” approach work? • What should governments ask of Foreign Direct Investors? • Linking to geography and skills • Can Special Economic Zones play a role (Penang)? • What complementary investments would be needed in skills?

16. Why Do Firms Cluster? • Common needs for inputs and access to markets • “Thick” labor markets lower costs of search, and improve availability of specialized skills. • Proximity to input suppliers and customers may allow closely related firms, including backward- and forward-linked industries, to realize economies of scale and resolve coordination problems. • Close proximity between suppliers and purchasers may also help to ensure timely delivery, lower inventory costs and enhanced quality. • Co-location may facilitate sharing of indivisible goods and facilities, such as infrastructure, and joint actions by producers, including advocacy and advertising, and private-public partnership • Clusters may also attract traders and reduce the costs for firms to market their goods

17. Why Do Firms Cluster? • Learning may be easier when firms are located close together • High capability firms prefer to locate near other high capability forms • When firms in the same industry are located close to each other, it is easier to monitor what the neighbours do and learn from their successes and mistakes • industry-specific knowledge flows and spill overs • sharing of technological or marketing knowledge • knowledge of improved management techniques. • The drivers of location may differ between cities and industrial clusters and with income level

18. Why Do Firms Cluster?High Income Country Evidence • Agglomeration effects strongly encourage firm entry and employment growth • Clustering seems to be more pronounced in high-technology, high-skill industries than in medium and light industries • Electrical and electronic equipment and transport equipment tend to be more concentrated than metal products, machinery and equipment • Own-sector externalities are much stronger than those generated by other sectors

19. Why Do Firms Cluster?Middle Income Country Evidence • Agglomeration variables affect employment growth and firm entry • Heavy and transport industries (metals, chemicals and transport equipment) are concentrated in specialized locations. • Light industries (food and textiles) are more dispersed • Diversity of the agglomeration raises productivity for high- technology industries, but not in more standardized, light industries (food, textiles, and apparel)

20. Clusters and CapabilitiesThe Case of Penang

21. Geography and Public Policy • Agglomerations confer significant productivity gains, even in low income countries (Siba, et. al. Sonobe and Otsuka). • These clusters are often focused on the domestic market and lack dynamism. • Starting a new industrial agglomeration is a form of collective action problem • The “first mover” disadvantage • A rationale for public intervention • Africa has few dynamic, modern industrial clusters because it has not solved the collective action problem

22. Geography and Public PolicySpatial Industrial Policy • SEZs have not performed well in Africa • Public sector management unresponsive • Poor infrastructure and institutions • Limited social infrastructure • Closed architecture

23. Geography and Public Policy:Special Economic Zones in Vietnam and Mozambique

24. Geography and Public PolicyAfrica’s SEZs Are Not Delivering Indicators of Physical and Institutional Infrastructure in SEZs

25. Geography and Public PolicySpatial Industrial Policy • Rescuing Africa’s Special Economic Zones • East Asia is the model • Management sensitive to need of the private investor • Combine world class infrastructure and institutions • The best have above average social infrastructure • Outward orientation is important (competition in local markets offsets productivity gains) • But an open architecture for domestic linkages • Traditional donors have lacked interest • China may be the answer