Case Studies of Decentralized Coordination in China
Case Studies of Decentralized Coordination in China
Abstract and Keywords
This chapter draws on both successful and failing cases of industrialization in China to analyse the role of local governments in fostering the growth of light manufacturing. The broad spectrum of support types and the intimate knowledge of enterprise conditions by these local governments make their support effective, particularly for the business expansion and cluster development. Local government policies towards enterprises are dynamic and tailored to the needs that arise at the various stages of the life cycles of firms, from start-up to growth and maturity. Government assistance has not always involved spending money. The successful outcome is a result of a ‘backing the winner’ approach.
This chapter draws on both successful and failing cases of industrialization in China to analyse the nature of cooperation between business and government at the subnational level and to draw policy implications for African countries. The case studies were conducted during a number of field visits to China in 2010 and 2012 and cover the five most common light manufacturing sectors: agribusiness, wood products, leather products, apparel (including apparel accessories), and metal products.1
China’s spectacular economic performance began in 1978 when Deng Xiaoping put forward the concept of ‘letting some people get rich first’. The gradual relaxation of the government’s institutional hostility towards the private sector followed quickly. In 1978, the government began issuing permits to allow individual businesses (ge-ti-hu) to hire up to seven employees. Subsequent reforms encouraged the growth of larger ‘private’ firms (with eight or more workers), which started to grow rapidly. Then, private enterprises—including sole proprietorships, partnerships, and limited liability companies—were permitted to set up joint ventures with foreign corporations, thus providing additional opportunities for ambitious entrepreneurs. At the same time, China adopted an export-oriented strategy that encouraged private and overseas investment in labour-intensive manufacturing. The private sector grew at an unprecedented rate beginning in the early 1990s as the government enacted a series of policy changes and legal steps that gradually enhanced the legitimacy of private business. By 2010, China had more than (p.146) 8.4 million registered private enterprises that employed more than 180 million people (Dinh et al. 2013).
A number of favourable circumstances have contributed to this success. At the global level, steeply rising costs had eroded the cost advantage of earlier global export leaders, creating an opening for Chinese exporters. China possessed an abundance of well-educated workers eager to trade diligent effort for low wages. When this workforce was combined with capital, commercial expertise, and knowledge of technologies and markets from ethnic Chinese entrepreneurs overseas, the result was ripe conditions for light manufactures. Domestic economic conditions also played a role. China’s plan system viewed consumer products as costs rather than benefits and therefore channelled resources away from light manufacturing. As a consequence, there was pent-up demand for clothing, shoes, and a wide array of other household and personal items, particularly among households in more prosperous urban areas. The immediate success of China’s agrarian reforms enhanced the prospects of light manufacturing by boosting rural incomes and, thus, the demand for consumer products, as well as by expanding the supply of raw materials and non-farm labour. Finally, the main competition for private sector entrants in this growing market for consumer goods was represented by lumbering state-owned firms with little experience in market dealings.
Section 8.2 reviews briefly the major constraints that have held back the growth of light manufacturing in Africa and how China has been able to overcome similar constraints over the last thirty years. Section 8.3 provides an in-depth analysis of the role of the central government and subnational governments in China in cooperating with enterprises and the private sector, particularly in the development of clusters. This is followed by a detailed account of various types of enterprise support supplied by local governments in China, including the concept of backing winners. The chapter concludes with a general discussion on the lessons of the Chinese experience for Africa.
8.2 How China Overcame the Binding Constraints on Light Manufacturing
In a previous book, Light Manufacturing in Africa: Targeted Policies to Enhance Private Investment and Create Jobs, we show that, to grow the light manufacturing sector, policy makers in Africa need first to identify, prioritize, and remove the most binding constraints in each sector (Dinh et al. 2012). These constraints vary by country, sector, and firm size. The decentralized coordination approach used in China can actually go a long way in identifying and (p.147) relaxing these constraints. Six binding constraints on African competitiveness in light manufacturing are identified, as follows:
• availability, cost, and quality of inputs;
• access to industrial land;
• access to finance;
• trade logistics;
• entrepreneurial capabilities, both technical and managerial;
• worker skills.
8.2.1 Availability, Cost, and Quality of Inputs
In the African countries we have studied, large and small firms alike identify input supply—including availability, quality, and cost—as a leading obstacle to the development of competitive light manufacturing (Dinh et al. 2012).
On average across the five subsectors, inputs were more than 25 per cent more expensive in Africa than in China, representing a 20 per cent production cost penalty because inputs account for more than 70 per cent of total production costs. In most cases, higher input costs wipe out Africa’s cheaper labour cost advantage. The main input policy issues are import tariffs, price controls and export bans on agricultural products, barriers to the import and distribution of high-yield seeds, and disease control in the livestock sector.
China faced similar difficulties at the start of its accelerated entry into global markets for labour-intensive manufactured goods. It responded by pursuing a two-track strategy to facilitate access to inputs. First, it developed good trade logistics early on to support imports of the inputs that could not be competitively sourced domestically. Second, it reformed and provided support to key input industries so that these could become competitive. It also transferred large numbers of government-owned enterprises to partial or full private ownership, instituted reforms aimed at commercializing the remaining state enterprises, dismantled many official controls over prices and resource allocation, encouraged foreign direct investment (FDI) for key inputs (such as in machine manufacturers), and developed sustainably managed wood plantations and competitive agricultural sectors. National and, especially, local governments supported the creation of input and output markets through the provision of land and financing (such as in the Yiwu market in Zhejiang Province, which was developed with the initiative and support of local officials) and supplied coordination along value chains. China exempted exporters from taxes and duties on imported materials. It also offered information and technical assistance on inputs, technology, and suppliers to small and medium-sized enterprises (SMEs).
It is ironic that land is a constraint on most manufacturing firms in land-abundant sub-Saharan Africa (SSA). Because all manufacturing firms need industrial land equipped with utilities and transport links to markets, SSA’s huge deficit in industrial land puts land policy at the core of its industrial development agenda. Problems with land acquisition often prevent firms in SSA with four or five employees from growing into businesses with more than ten to fifteen employees. To do so, they would need a larger workspace connected to affordable and reliable utilities and reliable transport links to the markets for inputs and outputs. Most small firms are located in the homes of the owners or in small workshops. Connecting to utilities requires large fixed investments that are typically beyond the means of small informal operators. The savings and retained earnings of small business owners are usually insufficient to purchase industrial land to expand the business. If the government attempts to provide factory shells outside cities, the transport costs for hauling raw materials and products are an additional constraint.
China’s successful industrial parks provide enterprises with security, good basic infrastructure (roads, energy, water, sewers), streamlined government regulations (through government service centres), and above all, affordable industrial land. They also supply technical training, low-cost standardized factory shells that allow entrepreneurs to plug and play, and free and decent housing for workers next to the plants. By helping small Chinese enterprises grow into medium and large enterprises, the country has also avoided the shortage of medium firms—the missing middle—faced by most countries of SSA.
In recent years, Chinese industrial parks have been offering one-stop shops that allow firms located under their jurisdiction to simplify and speed up official registration and regulatory transactions. Western buyers have an appetite for large orders, and China’s industrial parks allow the country’s firms to scale up rapidly to meet the needs of buyers. Such arrangements reduce search and transactions costs and promote the ready availability of information for buyers and sellers.
8.2.3 Access to Finance
Access to credit has been identified as the most binding constraint on small companies in developing countries (Dinh, Mavridis, and Nguyen 2012). But our study of African and Chinese firms has found that the initial start-up investment among entrepreneurs has been sourced mainly from personal savings or financing supplied by informal networks of family, business colleagues, and friends. The savings are typically accumulated through migrant (p.149) or other factory work, trading, or family workshops. In Jiangxi Province, local entrepreneurs built up savings through migrant work in nearby Guangdong and other coastal provinces during the 1990s, then returned home to set up garment, leather, and shoe-making enterprises. We found few instances of bank credit or of FDI in the start-up phase.
Financial institutions, however, are central in the growth from small to medium firms. In China, once the enterprise has achieved considerable success, start-ups may obtain bank loans to expand production facilities, build new factories, buy machinery or land, or acquire the working capital needed to execute large orders. The most common reason firms fail to gain access to bank loans at an earlier stage of their growth is the lack of collateral. If firms are able to take out loans, factory premises or land can be used as collateral, sometimes combined with a loan guarantee from a friend or from special companies established for this explicit purpose.
The clear implication of China’s light manufacturing experience for other developing countries is that help from a financial intermediary is not a necessary precondition for starting an enterprise. However, entry into formal credit markets can make a big difference for businesses that have achieved initial success and aim to enlarge the scale of operations, upgrade equipment and production processes, or both.
8.2.4 Trade Logistics
Poor trade logistics penalize firms that rely on imported inputs and doubly affect exporters, mostly large and medium firms in Africa. On average, they add roughly a 10 per cent production cost penalty across the five subsectors in the three African countries we have studied. Poor trade logistics also cause long and uncertain delays, unacceptable to most global buyers, especially in the time-sensitive apparel industry. As a result, production in most African countries is typically confined to small market niches. The small orders mean higher input costs, lower capacity use, and higher overheads.2
Similar to the enterprises in Africa, reliable transport services and streamlined customs clearance are critical for manufacturing firms in Ganzhou, Jiangxi Province. Although located in a landlocked area, Ganzhou has developed an administrative system for dealing with overseas trade, including (p.150) customs and inspection, foreign exchange, trade facilitation, and port clearance. Goods can be exported directly to foreign markets through integrated railway–sea and truck–sea transport services. The Longnan customs office in Ganzhou collaborates with peers in Guangdong Province to expedite the commodity transfer and customs clearance services between Guangdong, Hong Kong, Jiangxi, and Macao. An agreement with Guangdong customs officials allows enterprises in Ganzhou, located across the provincial border in Jiangxi, to submit customs declarations at the local office, while containers are inspected at coastal customs checkpoints. This means an exporter needs to go through only one declaration and inspection process instead of two (in the place of origin and at the departure port), thereby reducing customs clearance for a cargo vehicle from Ganzhou from ten to four hours (Dinh et al. 2013). Customs clearance costs also plunged from ¥300 (US$44.00) per vehicle to about ¥2 (US$0.30).
8.2.5 Entrepreneurial Skills
There is considerable heterogeneity in firm performance in Africa, partly reflecting the entrepreneurial and management skills and partly the lack of competitive pressure in many countries. Inefficient firms are not driven from the market, and entrepreneurs find entry difficult. Large productivity variations within narrowly defined industries arise from multiple factors: the limited dispersion of entrepreneurial and technical skills, market segmentation arising from policy interventions (for example, tariffs or entry restrictions) or geography (for example, poor roads), and limited competitive pressure.
The first generation of Chinese entrepreneurs in the post-reform era generally established new businesses without the benefit of formal training in business management. They acquired entrepreneurial skills through imitation and by learning from failures. Entrepreneurs in the light manufacturing sector in Jiangxi and Zhejiang provinces do not choose their industries and products randomly. They acquire knowledge and skills from three sources: (1) prior work experience in the production of specific production items, as well as interactions with friends and relatives involved in this production; (2) trading the products that they eventually manufacture; and (3) networks and contacts established through former jobs in state-owned enterprises in the same manufacturing sector.
Many Chinese firms have been able to gain the managerial skills required for expansion by forming partnerships with companies in Hong Kong or Taiwan or with overseas Chinese in other Southeast Asian countries. These investors provide capital and access to new technologies and managerial and technical skills. It is the central government that creates the environment conducive to these investors, while local governments provide the incentives that attract them.
While worker skills are often mentioned as a constraint on manufacturing growth in Africa, our study indicates that, with the exception of the manufacture of wood products, the efficiency of African workers overlaps the range observed in China in simple labour-intensive products. The numbers suggest that low-level skills are sufficient for jobs in, for instance, computer management technology operations in the apparel industry. Africa’s potential can also be inferred by the significant positive impact that targeted technical assistance programmes have had on both efficiency and quality (as in Ethiopia’s footwear industry discussed in Section 8.5). So, SSA can be competitive in light industries that do not require semiskilled workers because there is a plentiful supply of trainable unskilled workers.
To graduate to more complex production such as the manufacture of dress shirts or trousers in the apparel industry, manual or artisanal skills are important. If SSA wants to upgrade its industries to more complex products, there is no shortcut to a more vocationally trained labour force. Our qualitative interviews and factory visits in China show that assembly line operations involving weaving machines for the production of sweaters, sports shoes, and toys or even for labelling and packaging require more technical skills and literate workers. Comparative advantage is dynamic: mastering the production of the simplest light manufactures such as T-shirts can open the door to a comparative advantage in more sophisticated light manufactures, but not without a corresponding upgrade in industry skills. Because skills upgrading is a public good, there is a clear role for government policy.
Local governments in China pay attention to the labour needs of enterprises, particularly in the light of rising labour costs. Thus, in the case of the Dieshiqiao Home Textiles Market in Jiangsu Province, the local government helped Dieshiqiao firms obtain unskilled and skilled workers by establishing a labour market through which enterprises could recruit workers. The local labour authority has partnered with Anhui and Henan—provinces that provide about 70 per cent of the incoming domestic migrants—to recruit more workers. Similarly, in the case of Yongkang’s hardware cluster, the local government has set up thirty-six recruitment centres in ten cities and provinces to reach migrant workers in other regions. To meet the need for skilled workers, the municipal government has built twenty-eight training centres for local villagers. In cooperation with local vocational schools, these centres have processed nearly 90,000 trainees, of whom 36,000 passed the training exams and obtained employment in local hardware firms.
At any point in time, the constraints to enterprise growth vary by country, by sector, and by firm size. Even for the same firm, the constraints to growth vary over time. Thus, for a start-up firm, searching for clients may be the most important issue while for a growing firm, finance maybe the most binding constraint as the firm needs money to buy equipment for expansion. Intimate knowledge of the enterprises and the obstacles they are facing therefore are critical to the success of policy intervention. So is the ability to formulate and carry out effective policy implementation. Identifying and relaxing enterprise binding constraints therefore remain a challenge for most policy makers in the world, but particularly so for African countries with limited resources.
Local governments, by their nature and location, have more intimate and up-to-date knowledge of the enterprise constraints than the central government. As discussed in this section, the Chinese system maximizes this local knowledge to the benefit of enterprises. There are areas where local knowledge is simply critical such as land, finance, and labour training. On the other hand, there are policy areas such as tariffs and quotas (which affect the cost and availability of inputs), infrastructure (which affects inputs and logistics), or migration, which are not under local government control. The central government role in relaxing these constraints is crucial also. This decentralized coordination works not only at the policy level, but also at the knowledge exchange level. Whether by design or by accident, the system of decentralized coordination in China as described in this section has helped identify and solve the problems faced by manufacturing firms across the sector over the past decades.
8.3.1 The Nature of Government–Private Partnership in China
In China, the public sector has overcome its initial hostility at the beginning of the reform process, and, despite remaining obstacles associated with property rights, access to finance, rule of law, and so on, it has demonstrated a growing capacity to support and cooperate with private business, especially at the local level and in sectors such as light industry that do not occupy a prominent position in official development plans.
In Africa, by contrast, there is often an adversarial relationship between the public and private sectors. Public entities view private firms as a source of rents or as vicious, corrupt profit-seekers bent on exploiting the nation’s resources. Private firms see the public sector as a source of rent-seeking or trouble-making. Bridging this gap will take time.
(p.153) Government support in China includes policies across all levels of government, and these policies may vary from region to region and from locality to locality. In the early years of industrial development, the Chinese government built a reasonable track record in providing macroeconomic stability and gradually dismantled elements of the former planned economy that had prevented the establishment of openly private enterprises and hampered the expansion of SMEs in the public sector as well.
The remainder of this section traces out the respective roles of the central government and of subnational governments and their coordination in the development of economic activities in clusters. A cluster strategy can help overcome the constraints on the access to inputs, industrial land, finance, trade logistics, entrepreneurial skills, and worker skills that affect business and industrial development in low-income economies. Once a few firms in a specific industry have formed a cluster in a local community, the entry costs for followers are lower because of positive external economies (Marshall 1920; Fujita, Krugman, and Mori 1999). The agglomeration of similar firms creates a critical level of demand for specialized inputs and services. Clusters mature with the formation of upstream suppliers and downstream service providers in the local community. The deep division of labour among firms in the local community enables cluster firms to respond flexibly to market changes at low cost. Because local suppliers are available, cluster firms can subcontract urgent orders to other local firms without previous additional investment for expansion. One potential drawback is that the enormous convenience of doing business in clusters makes some firms reluctant to relocate, despite increasing labour and land costs.
Consistent with the fiscal literature on China, we discuss China’s government at five levels: (1) the central government; (2) provinces; (3) prefectures; (4) counties; and (5) townships. In practice, there is also another level, villages, which are under townships. Because the size of provinces is large, we will make a distinction between the central government, provincial governments, and the remaining government levels, which we designate simply as local governments.
8.3.2 The Central Government’s Role
The strong commitment of the central government to a market economy was critical to the formation of the first generation of private firms in China, while the fiscal reforms beginning in 1994 created strong incentives for local governments to foster clusters.
To incentivize local governments to promote clusters and stem growing fiscal deficits, the central government negotiated a tax-sharing system that (p.154) split the tax revenue from enterprise income: 60 per cent now went to the central government, and 40 per cent to local governments. Local governments could thus benefit directly from the development of nearby industrial clusters. Before 1994, all taxes had been channelled to the central government, and local government expenditures had been the responsibility of the central government. By establishing a tax-sharing system, the 1994 reform introduced a hard budget constraint on local governments in that they were now financially responsible to provide most public services within their jurisdictions. However, the reform also provided a legitimate means for local governments to raise revenue by promoting local industries, which had to pay land and income taxes, and local governments thus began aggressively championing local businesses. The fiscal reform, by encouraging such growth, also led to a substantial increase in central government revenue.
To encourage local governments to promote cluster development, the central government gradually implemented a new performance evaluation system for local government officials that was consistent with the country’s transition to a market economy. Besides political loyalty, local gross domestic product (GDP) is a decisive component of the system. Promotions among local government officials are greatly dependent on whether regional economic growth can catch up with or outpace the economic development of other areas in China.3 The central government established this performance evaluation system to enhance its political legitimacy through economic growth.
8.3.3 Provincial Governments
Compared with the central government, provincial governments play a more active and specific role in regional cluster development. They affect the formation and upgrading of clusters in two main ways: land allocation and cluster development planning.
Because China has little cultivable land relative to the large size of the population, the central government strictly controls the conversion of land from agricultural to industrial use. Each province is notified of an annual quota of industrially convertible land that it may allocate among various industries. In the highly industrialized coastal areas, such as Guangdong and Zhejiang provinces, land is the scarcest production factor because there is almost no idle land for industrial use. In recent years, there has been fierce competition for land among industries. Low-technology industries and industries that generate fewer jobs are at a disadvantage in this competition, and the land allocation (p.155) decisions of provincial governments have become tools of an industrial policy that tends to favour high-end clusters over less competitive ones.
Provincial governments use their market information and networks to identify exemplary clusters and design and implement cluster upgrading and development plans to support them. In Guangdong and Zhejiang, the provincial governments have established departments dedicated to such upgrading. Both governments have initiated projects to identify innovative clusters and provide financial support. They have also designed cluster development plans to promote collaboration and mutual learning among clusters, to facilitate the construction of joint research centres by universities and cluster firms, and to encourage cluster firms to explore international markets. In 2010, the Guangdong provincial government initiated a large planning project called ‘one specialized town cluster, one upgrading strategy’ to encourage each cluster, whatever its stage of development, to plan for structural transformation after the recent global economic crisis (Dinh et al. 2013).
8.3.4 Local Governments
China’s fiscal reform of 1994 and the performance evaluation system based on growth in GDP gave local governments a strong incentive to promote local industries. These incentives encouraged local governments to become more involved in the development of clusters. Thus, while all levels of government now benefit from the growth of clusters, no single level of government totally controls cluster development. The Chinese style of federalism has created a political basis for the success of cluster-based economic development (Montinola, Qian, and Weingast 1995).
China’s experience also illustrates the potential of local governments to support and contribute actively to industrial development. In some countries, the central government plans and develops strategic industries by mobilizing and allocating resources. These efforts to pick winners often fail. Local governments have fewer options. They cannot change the macroeconomic environment or build national monopolies, and they lack many of the resources available to the central administration for building industries. As a result, local governments have generally supported profitable firms that are already in business in local communities.
China’s experience in the development of clusters substantiates the argument that the government’s role is to nurture and support existing cluster firms rather than trying to create clusters from scratch. Local governments (prefectures, counties, townships, and villages) are directly connected to clusters, which generally account for most of the economic activity in a village or town. By focusing on individual clusters and communicating frequently with local (p.156) entrepreneurs, local governments can devise policies clearly targeting specific industries. They can take several measures to foster cluster development.
184.108.40.206 Nurturing Clusters from an Existing Industrial Base
Successful clusters are rarely built from scratch (Braunerhjelm and Feldman 2006). In China, entrepreneurs build clusters; governments nurture them, supporting the most profitable local industries. This industrial base can consist of private firms or state enterprises, such as the Chengdu footwear industry (Section 8.4.5). Potential entrepreneurs learn from these enterprises and form spin-offs. Local government officials in Haining explained how and why they picked the warp knitting industry to support as a strategic industry:
At the beginning, we here had several small warp knitting firms. After some analysis, we felt these products had a good market potential. … We had four or five firms. From this, we discussed with these entrepreneurs and decided to develop [the industry]. … Among the four or five firms, there is one called Zhejiang Jinda Materials Co., Ltd., which trained a lot of professionals in the local warp knitting industry, from front-line workers to technicians to middle-level managers. After acquiring some skills, these professionals started their own businesses. (2012 interview)
With the support of local government, the Haining industry developed into the world’s largest warp knitting centre, with 360 firms and 2009 sales revenue of ¥15 billion (US$2.2 billion).
Some local governments have encouraged trading or sales agents to move into manufacturing to develop clusters. For example, the Nanhai metal cluster evolved from a group of scrap metal recycling and trading businesspeople in Guangzhou, Guangdong Province.
220.127.116.11 Building Industrial Parks
Since most clusters develop organically, cluster firms are usually scattered across many villages or small towns. Rural areas are a good place for start-ups because the cost of land is low, but they are not such a good place to grow because there is no industrial infrastructure. In China, if local governments target a specific industry, they build industrial parks with good infrastructure and concentrate firms within the parks. Firms in these parks benefit from favourable policies on land acquisition, taxes, and duty drawbacks. Local governments may not be selective in the early stages of industrial parks, but, as more firms relocate into the industrial parks, local governments become more selective, and many parks are gradually dominated by firms in specific industries, thus becoming clusters.
As firms develop from family workshops to modern factories, they need not only hard infrastructure, but also soft infrastructure such as new systems of organizational management, technological research and development (R&D), and market exploration. Local governments often set up special platforms for specific industries. There are many examples of creative collaboration between the public and private sectors in this endeavour. In the Haining warp knitting cluster, the local government created professional platforms in science and technology, social services, cultural promotion, international communications, training, trading, finance, and business consulting. Thus, the park cooperates with Shanghai Jiao Tong University to provide high-level management courses for local professional executives, and has also built an experimental factory to offer training programmes for front-line workers and technicians. Some platform services are provided by professional companies set up by local governments. In Haining, the administrative committee of the Warp Knitting Industrial Park established a firm specializing in financial guarantees (danbao) to help firms obtain bank loans.
8.4 Tailoring Government Support to the Business Life Cycle and Backing Winners
Local government policies towards enterprises are dynamic and tailored to the needs that arise at the various stages of the life cycles of firms, from start-up to growth and maturity. A successful cluster policy focuses less on bringing firms together and more on helping firms overcome barriers to growth. In the beginning, local governments tend to provide start-up funding and technology for local enterprises. As enterprises grow, cluster policies focus on developing supply chains in the local communities, and the governments offer loan guarantee services to help firms obtain loans for expansion. As enterprises enter a steady state of growth, local governments supply over-the-counter services. Finally, when firms reach a mature stage, local governments encourage cluster firms to go public, build their own brands, and transfer labour-intensive manufacturing activities elsewhere. In this mature stage, it may be possible to create new clusters in other developing areas or in other developing countries. While government support has been wide-ranging, including fiscal incentives, infrastructure development, and advisory support on upgrading, assistance has not always involved heavy spending.
In light manufacturing, government support for domestic start-ups is typically small and may amount to little more than providing infrastructure in the same way other countries have done. Among joint enterprises receiving FDI, official support takes the form of across-the-board policy measures established by the central government such as rebates on customs duties, undervalued exchange rates, income tax exemptions, and so on. In this respect, government support in China hardly differs from that of many other developing countries. What seems unusual is the way in which China’s policy structures provide both central government officials and local officials with strong pro-growth incentives that make them eager to see businesses succeed because private sector success may elevate their own financial prospects and career trajectories. In many other developing countries, government officials consider the private sector an opportunity to share the wealth of the community, while the private sector looks at government officials as robbers.
8.4.2 Growth Phase
In the growth phase and the maturity phase (Section 8.4.2), government support in China is substantial and provides clear evidence that the government’s industrial strategy is designed not so much to pick winners as to back winners. This is a crucial difference with the strategy typically adopted in other countries. The range of enterprise support is wide and is best illustrated by the footwear example in Chengdu (Section 8.4.5).
Other areas of intervention during the growth phase include the following: (1) creating knowledge spillovers through the establishment of enterprise associations and chambers of commerce to strengthen local communication among enterprises and identify shortcomings in zone administration, (2) improving managerial and worker skills, (3) reducing the bureaucratic burden, (4) expediting payments, (5) reinforcing market signals, and (6) providing services such as quality control.
8.4.3 Maturity Phase
Government support during the maturity phase tends to be geared towards R&D, networking, marketing, assistance through trading companies, and completing the value chain through investment in upstream and downstream activities. Chinese officials, acting as matchmakers, connect firms with research agencies and consultants, thereby reducing the costs of access to information.
(p.159) In matching producers with research facilities, the government creates cooperative relationships that strengthen both sides. Bringing actors together reduces transaction costs, resolves key constraints, and saves firms time and money. Researchers thus gain inside access to information on how firms operate. In another kind of match-making, industrial park authorities in the Dieshiqiao home textile cluster in Jiangsu Province links firms with banks to improve the access of firms to finance.
Along with instances of successful official intervention, we find episodes of failure. The automobile project in the Yinchuan economic development zone in Ningxia Province failed mainly because local governments tried to develop a sophisticated industry for which they do not have any comparative advantage. The result demonstrates that a viable cluster cannot be built from above, but must rest on private initiatives that can stand up to market discipline. This reinforces our recommendation that government industrial policy should not aim at picking winners, but rather at backing winners, a lesson that also emerges from the failure of many state-owned enterprises in Africa (Dinh et al. 2013). Policies that provide preferential treatment for certain investors without taking account of comparative advantage may encourage moral hazard and damage the local economy. This illustrates the downside of policies linking the advancement of local administrators to growth in local GDP and inflows of investment: if there is no regard for the market or for local comparative advantage, such a policy may not represent an incentive to succeed, but a temptation to take risks.
8.4.5 An Illustration of Government Support in China
Up to this point, our discussion on the decentralization of government support in China has been carried out on an analytical basis, breaking down this support—first, at the level of constraints to firms and, then, at different levels of government in the development of clusters. While this approach is useful in understanding the distinct effects of government support, it does not reveal the full richness of local government support in each locality. We thus discuss a complete menu of government support for footwear in Wuhou District, downtown Chengdu, Sichuan Province. While the enterprise support supplied by local governments in China is varied, it can be classified into three broad categories: (1) facilitating production factors, including land subsidies, credit, and training programmes to develop worker skills; (2) creating externalities through industrial parks or cluster development; and (3) helping to establish upstream and downstream activities to complete the value chain of enterprises.
(p.160) Home to one of China’s largest footwear clusters, the Wuhou District invested ¥400 million (US$53 million) in 2007 to establish the Chengdu Wuhou Industrial Park Investment and Development Company Ltd, which functions as a large corporatized financing platform. Through fiscal funding and bank loans, the company raised ¥2.3 billion (US$302 million) in its first year, securing the funds for future development. The park’s management committee promotes investment, supervises investment projects, and collects taxes. It also raises funds, manages land, and builds infrastructure. To speed up government approval, the park administration has established a one-stop shop that brings together all the individual departments to decide on an investment application on the spot. The park administration offers preferential taxing, financing, and screening for enterprises moving into the zone. Large investments have been made in infrastructure, thereby helping many family workshops modernize.
In 2005, to cultivate local brands, Wuhou District launched the construction of the Brand Enterprises Base of the Western Shoe Center of China Industrial Park to establish an industrial platform for footwear materials selection, shoe buying and trade, R&D, and international logistics for women’s shoes. The Brand Enterprises Base attracts top brands and cultivates local brand-name enterprises. At 4,200 square metres, the international trade centre is one of the largest in China for footwear products. The centre provides the services of purchasing agents and commission agents and offers assistance in international logistics, as well as training programmes for professional and management personnel. All these functions enable face-to-face contact between merchants and manufacturers, lowering costs and maximizing profits.
The government has helped develop Chengdu into an industrial park through establishment of a complete supply chain that spans backward and forward links, from upstream shoe-making machinery and spare parts, leather and fabric, heels, soles, accessories, and other auxiliary materials to the downstream manufacturing and distribution of footwear, as well as design and R&D, logistics, and other services. Chengdu also has a raw materials market, as well as 160 logistics corporations, 10 shoe-making apprentice training schools, around 300 registered shoe trademarks, and nearly 100,000 employees. Chengdu’s footwear firms have a staggering production capacity: 100 million pairs of shoes a year, which are sold in 120 countries and account for 10 per cent of China’s footwear industry and 7 per cent of the world industry.
8.5 Applying the Chinese Decentralization Model to Africa
Compared to China, countries in Africa are of much smaller size, local government administrative capacity weaker, and the political system much (p.161) different. The success of Chinese industrialization has also come in part at the expense of farmers. The system whereby all land belongs to the state and can be taken to generate resources for the local governments only exists in a few countries. So, how far can the Chinese decentralized coordination model apply to African countries?
It should be noted that decentralization has already proceeded in Africa regardless what model was adopted. Since the mid-1980s, most African countries have started the transfer of power, resources and responsibilities to their subnational governments. Progress to date, however, has been uneven, with some countries already on a highly decentralized path (South Africa, Nigeria, Ethiopia) while there is hardly any progress in many others, particularly in the francophone countries. Obviously, the final decentralization model in each country will ultimately result from historical, cultural, and institutional factors and no one model can fit the specific circumstances of a country.
However, some key aspects of the Chinese decentralized coordination model discussed in this chapter are useful to Africa. First, there is a need for both the central and local governments in Africa to realize that private sector growth is beneficial to poverty alleviation and all governments have a common purpose of assisting enterprises to grow. Second, since local governments are more familiar with the specific conditions of enterprises, they should have an important role in the promotion and facilitation of business growth. The division of power and responsibilities among different government levels would have to depend on each country’s specific situation and would need to be clearly delineated. Third, the incentive framework for local governments should be realigned so that resource availability is linked directly to the enterprise performance. In the absence of land sale, local resources could be provided through grants and transfers that tie business growth to the size of the transfers. The criteria for allocation of these transfers should, however, be transparent and equitable. Fourth, communication channels between different levels of government have to be kept open and constantly reviewed. Finally, to make the local government system work, there must be efforts to build up the necessary managerial, organizational, and technical capabilities over time.
It is often said that one of the most serious constraints on Africa’s industrialization is the lack of entrepreneurship. Could it be that at the time of its take-off, China was endowed with abundant entrepreneurial skills which are lacking in Africa today? In our study, we find that if entrepreneurial skills are meant to denote the ability to sense profit and take advantage of it, a definition that Elkan (1988), used three decades ago, then Africa does have plenty of these talents, as seen in the large informal sector.
But entrepreneurial skills encompass more than the ability to sense profit and take advantage of it. Indeed, there are other critical aspects of the (p.162) entrepreneurial skills that are lacking in Africa when compared to China, and it is those areas where public policy can have an important role to play. Thus, obtaining advice and finance at start-up may be a channel for good entrepreneurship to come to fruition. Fafchamps and Quinn (2012) found that firms in SSA are less able to take advantage of links to globally competitive suppliers, customers, and competitors than their Chinese counterparts. Given the same individual skill set of an entrepreneur in China and one in Zambia, the one in China has the advantage of proximity to a competitive local manufacturing sector. One entrepreneur does not have to know everything, but in Africa’s manufacturing there is far less opportunity than in China for entrepreneurs to offset shortcomings arising from missing skills by accessing the established networks and institutions of a well-developed manufacturing sector.
As the Chinese decentralized coordination model shows, effective government assistance for industrialization does not necessarily involve spending money. There are many different ways a government can help entrepreneurs to grow in Africa, for instance, through technical assistance. An example is the Ramsay Shoe Factory in Ethiopia (Dinh et al. 2012). In 2009–10, the Ethiopian Ministry of Industry helped the Ethiopian Leather and Leather Products Technology Institute select the Indian Footwear Design and Development Institute to provide technical assistance for seven footwear factories in design, technical upgrading, quality assurance, productivity enhancement, and testing. As a result of this technical assistance, cutting at Ramsay Shoe Factory rose from 2,000 pairs a day to 2,400, and defect rates dropped from 3 per cent to 1 per cent. In July 2010 Ramsay signed a deal with Geox, an Italian shoe and apparel manufacturer, to produce 60,000 pairs a month to be sold in Geox’s outlets in Italy, carrying the label ‘Made in Ethiopia by Ramsay’. Clearly, the right technical assistance to owner-managers can make a big impact on factory performance.
Another area that entrepreneurs can benefit from good government policy, again without heavy government spending, is the acquisition of standard business practices such as book and inventory record keeping, because these are generally not implemented by the small, micro enterprises. African governments, both central and local governments, should seek opportunities to invest in programmes that can improve managerial and technical skills, especially among small-scale operators already working in high-potential subsectors. Governments should also support domestic firms to adopt and adapt existing technologies by providing targeted technical support and advice to owners and entrepreneurs. This support should encompass not only informal firms, but formal, large enterprises as well. Accordingly, policy interventions targeted at addressing this information asymmetry and providing public resources for awareness and skill-development may be appropriate in supporting manufacturing competitiveness in SSA.
(p.163) FDI offers another way to expand the domestic stock of entrepreneurial skill. Chinese firms benefited first from the knowledge provided by overseas Chinese entrepreneurs and foreign managers at multinational branch plants. Firms then benefited from the transfer of know-how associated with FDI, which contributed to a new generation of domestic entrepreneurs. Both the central and local governments play an important role in attracting FDI to specific industries and localities.
The discovery that African manufacturing entrepreneurs often lack access to sources of information that are widely available elsewhere, particularly in China, and may fail to appreciate the benefits linked to information that is available, provides a rationale for governments to go beyond the universally beneficial policy of expanding access to basic education. While fostering full and fair competition, central and local governments should create, fund, and promote programmes that are specifically designed to improve the managerial and technical skills of actual and potential entrepreneurs, starting with the high-potential subsectors, including the informal sector.
There are two reasons why market forces alone will not allocate optimal resources to create and introduce knowledge that entrepreneurs need in the informal sector. First, information spillovers and imitation are widespread, with the proximity of products of rival enterprises and the poaching of inputs and technical information from neighbours. Second, entrepreneurs may not know the value of training. As a result, the social return to creating and introducing new knowledge, both technical and managerial, exceeds the private return, resulting in socially suboptimal investment in new innovative knowledge.
Finally, the government can facilitate the entry of first movers to foster competition and establish new industry. First movers in late-mover countries typically face higher costs and risks—especially in Africa, which has limited infrastructure and high regulatory and governance risks. But strategic first movers can catalyse the growth of competitive new industries, as Ethiopia’s first rose farm clearly shows. First movers can provide many benefits, including demonstration effects for other potential entrepreneurs and their financiers, specialized infrastructure that can be shared, skill development, policy reforms, supplier industries, and improvements in the country’s reputation. The first producer of corrugated tin roof in Zambia attracted a dozen followers, largely replacing imports.
In the past, Africa’s experience with government intervention had been disastrous and had resulted in a complete reversal of development policy from pervasive state intervention to laissez faire. An important lesson from the decentralized coordination approach in China is how local governments should minimize its risks through backing the winners rather than picking the winners. This backing-the-winners approach combines market forces with (p.164) policy interventions to minimize the risk to public resources, all the while maximizing the potential for private success.
The concept of backing winners is not new in Africa. In the successful cases of industrialization in Africa, we found a wide presence of this approach (Dinh et al. 2013). However, in most cases, the approach was taken in an ad hoc manner and on a piecemeal basis, and was never put together as a strategy for industrialization. With the help of the government, Ethiopia’s first rose farm, Golden Roses, was created in 2000 by an immigrant named Ryaz. In 2002, based on the farm’s success, the prime minister agreed to support the industry by facilitating access to land and providing tax incentives, duty-free imports, and long-term financing for up to 70 per cent of initial investment. With this support and the demonstration effect of Ryaz’s farm, investors poured in, enabling the government to meet its goal of developing 800 hectares of rose farms by 2007. Since the government announced its support, more than seventy-five firms have entered the rose industry. By 2010, this sector accounted for 45 per cent of all manufacturing exports and more than 6 per cent of total exports. It employs more than 50,000 workers and earns more than US$200 million a year in foreign exchange.
The Ethiopian government has helped the cut flower industry emerge in several ways. It has provided land and eliminated many bureaucratic impediments to starting a flower business. It created a welcoming environment for FDI. A foreign investor can invest alone or jointly with domestic investors. The investment law guarantees capital repatriation and the remittance of dividends. The government has provided institutional support by establishing trade associations, such as the Ethiopian Horticulture Development Agency, which oversees the sector and provides facilitation services to individual firms, including skill development and marketing support. The government has offered a generous incentives package to investors, including access to low-cost land and to credit (up to 70 per cent of the total capital needs) at below market rates of 7 per cent, with a three-year grace period and ten years for repayment. A three-year loss carry-forward privilege is also offered, though it might not be necessary because most cut flower start-ups turn a profit from the beginning. Inputs, including packaging materials, are imported duty-free. The government also facilitates customs clearance and transport services.
In Kenya, too, cut flowers have become increasingly important, rising from 2.1 per cent of manufacturing exports and 0.6 per cent of total exports in 1980 to 16 and almost 8 per cent, respectively, in 2010. The Kenyan government has sought to facilitate the cut flower industry rather than directly intervene. A supportive trade and fiscal regime has alleviated some of the financing constraints of firms and has eased licensing and other regulatory constraints with the aim of allowing the private sector to flourish. Firms in the export processing zone receive a ten-year tax holiday on domestic taxes and on (p.165) withholding taxes on repatriated dividends, plus exemption from the value-added tax. The government also allows cut flower exporters to import plant machinery, equipment, and raw materials free of tax. Investors are able to obtain allowances on capital investments, including wear-and-tear allowances on items such as vans, tractors, other motor vehicles, aircraft, computer hardware, copiers, and plant machinery; industrial building allowances cover all industrial buildings; and farm work allowances cover all structures necessary for a farm to function properly. Kenyan exporters have gained from a favourable exchange rate.
The excellent performance of Mauritius’s textile and apparel sector can be attributed to the launch by the government of an export processing zone in 1970. Starting with almost nothing in the 1970s, the industry has risen to international prominence. By the 1980s, textiles and apparel had become the leading industrial sector in the country, accounting for more than 60 per cent of gross export earnings and a third of employment. The export processing zone ensured smooth access to inputs and land in a favourable location between producers of raw cotton and end-users. Incentives such as the suspension of import duties on raw materials and equipment and a well-managed exchange rate kept input costs low, a boon to export companies in early development. Moreover, underemployed women were trained, thereby providing a steady source of labour for production. Openness to foreign investment was a key to success, and the investments helped alleviate domestic financing constraints.
These examples show that policy interventions of the right kind did work well in Africa. What is needed now is a conscious effort to systematize this backing-the-winner approach into a strategy, tailoring the approach to fit specific circumstances of individual countries. The next step is for both the central and local governments in Africa to focus their scarce resources on identifying the binding constraints, taking policy actions to remove these constraints, and proactively developing competitive value chains and clusters in those industries where they have a comparative advantage in resource-based, labour-intensive light manufacturing.
The chapter is based on results of a World Bank project, Light Manufacturing in Africa, led by the author. I would like to thank many World Bank staff, especially Vandana Chandra, Vincent Palmade, and Ali Zafar; Deborah Bräutigam of Johns Hopkins University; John Page of the Brookings Institution, Thomas Rawski of the University of Pittsburgh, Finn Tarp of UNU-WIDER, and participants of the UNU-WIDER conference Institutional Reforms for Transformation, Inclusion, and Sustainability in Hanoi, Viet Nam, in June 2014 for valuable comments and support. All errors are mine. (p.166)
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(2) Ethiopia exports small volumes of low-value products. The free-on-board (f.o.b.) price of an Ethiopian polo shirt is around US$3.20, much lower than the US$5.50 price of an equivalent shirt produced in China. The higher Chinese f.o.b. price results from higher-quality shirts and the premium global buyers put on China’s capacity to offer greater choice, bigger volumes, and quicker and more certain deliveries. Tanzania exports polo shirts at an f.o.b. price similar to China’s, but these are small-volume specialty products garnering orders of as low as 1,000 pieces per style, not the fairly standard orders of 15,000–60,000 pieces.
(3) This system has also been criticized for promoting environmental degradation and income inequality.